December 21, 2010

Congratulations Ben!

My sincerest congratulations go out to Banana Ben Bernanke, who as of today, has managed to surpass his first trillion dollars in US Treasury holdings!  This makes the Fed easily the largest holder of US Treasuries in the world.  Combined with their holdings in mortgage backed securities and other assorted garbage, the Fed has over $2.5 trillion on the balance sheet.

At his current pace, by this time next year, Ben will have managed to surpass $4 trillion.  By then, gas should be well over $5/gallon and I'm sure the serial liar will still claim that there's no inflation and that he's not monetizing the national debt.  Merry Christmas, ya fucking bastard.

Posted by: Hermit Dave at 12:02 PM | No Comments | Add Comment
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December 09, 2010

The crimes of the Fed

If you want an excellent (if a bit hyperbolic) summary of what was revealed by the Fed's recent forced document dump, read this.  Strong proof that, until the government deals with the Fed, your votes mean absolutely nothing.

(via Black Listed News)

Posted by: Hermit Dave at 12:25 PM | No Comments | Add Comment
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December 08, 2010

Protecting against an asset crash

Bonds almost always lead stocks for the simple reason that it's a much, much bigger market and a hell of a lot harder to play games with.  Stock traders are complete pikers compared to the bond boys.  So, it's somewhat unsettling to see bond yields rise fairly dramatically since the start of QE2. 

For example, the 10-year rate (arguably the most important point on the yield curve, as it's the most closely tied to mortgage rates, among other reasons) has increased almost 0.75%, going from about 2.5% to about 3.25%.  The iShares Barclays 7-10 Year Treasury Fund (ticker IEF) is down almost exactly 5% since the start of QE2 (bond prices move inversely to yields).  This is extremely bad news for housing prices and will eventually put heavy pressure on stocks.

There are other factors at play that might give us pause when it comes to asset prices.  The Fed's current attempt to generate inflation might fail, or they might be forced to change their policies.  Other nations could get completely sick of our approach to our predicament and start dumping assets wholesale (the Chinese have started tightening their monetary policy).  Some EU nations could try to stop the insanity and start letting countries and banks go under (Germany is starting to make serious noises about being sick and tired of trying to bail everyone out).  Hell, the EU itself could break up quite easily.

All this brings us back to the question of whether we should be in cash or holding a wealth preservation portfolio.  This is a hell of a difficult choice to make, but could be crucial to our long-term fiscal health.  Or can we have our cake and eat it too?  To a certain extent we can, by hedging our wealth preservation portfolio by going short the US stock market.

The way to do this would be to either sell futures or buy puts on a major stock market index.  The S&P 500 is probably the best index to use as a hedge.  For futures, one would sell an amount that would insure the notional value of one's wealth preservation portfolio.  Now, instead of just holding an outright position in risk assets, one would be effectively holding the spread between a wealth preservation portfolio and an investment portfolio.  There's a lot less total risk in this position, but most likely less upside as well.  It's also an expensive strategy to implement as one has to divide his funds evenly between the long and short positions.

A much less expensive strategy (in terms of up-front cash) to implement is to buy puts.  A put is one of the two types of options (the other being the call), and gives one the right (but not the obligation) to sell an asset at a specific price at a future date.  For example, one could own the March 2011 1050 puts on the S&P 500.  This would allow one to sell the index at 1050 (about 15% below the current market level) at the option expiry date in March.  This gives us protection against a major asset crash, while committing less than 10% of our total funds to doing so.  Of course, this strategy comes with a different price:  time decay.  Even if the market goes nowhere, one would lose the premium paid to insure his portfolio.  In the worst case (a completely flat market), this would cost us about 5-8% a year.

So, there are no completely free lunches -- hardly surprising.    The only way in which one gets burned by this type of hedging strategy is if we have a low-inflation economic recovery.  In that case, an investment fund would outperform a wealth preservation fund, causing us to lose on both sides of our positions (obviously I think this is just a tad unlikely, to say the least).  On the other hand, we could have a high-inflation economic collapse, giving us a win on both sides.  Most likely, we'll capture some outperformance by hedging, while significantly reducing our risk. For those with significant assets to protect, insuring at least part of one's portfolio against an asset crash is, in my opinion, a very good idea.

Posted by: Hermit Dave at 05:21 PM | No Comments | Add Comment
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