Friday, January 1, 2010

Up Against It

Death by 1,000 cuts. That's what it's been like the past six months since I started the Ithaca Experiment. Almost every day the downward spiral of my holdings has been amplified by being leveraged to the short side and the steady drip, drip , drip of a Chinese water torture has slowly eroded my confidence. However, we are not talking about a postmortem scenario here, just down for the count on a temporary basis. I still find flaws in the logic that we are in a new bull market and that the lows last March was a generational buying opportunity. I'm of the belief that we will retest those lows and go further down to a P/E of around 8 in the S&P 500 once the government subsidies run out. Right now we are experiencing a resiliency in price action while downbeat consensus forecasts permeate the economic landscape. Sure, there are those that think we've still got another leg up, but by only 10% for all of 2010 if you listen to the bullish pundits. I try to stay focused and listen to both sides of the argument, but I'm just not buying what the bulls have to sell. Eventually a correction has to come and I'm willing to sit on my holdings until that time arrives.

On December 29th on Bloomberg there was an article about a hedge fund manager from Canada, Mr. Eric Sprott, whose fund has returned 496% the past nine years compared to the S&P 500 which has lost 32% over that same time period. Sprott is saying that the S&P 500 will retest the lows and then some so I am not alone in my stance. In fact, there is a dichotomy right now in the investing world so my projections aren't as far flung as you may be led to believe. I just got in too early, which certainly hurts my wallet, but let's not forget where we were last March - falling deeper and deeper into a black hole. This black hole is depicted in Andrew Ross Sorkin's Too Big To Fail which might be too big to read since it runs 550 pages. The book is not for everybody because quite frankly, it's just too long, but it did galvanize my convictions that we are still not out of the woods as far as the financial crisis is concerned. It may seem that way because the market has rallied significantly the past nine months, but we are still teetering on the edge of catastrophe.

Too Big To Fail is about the collapse of an investment banking system run by "fat cats", but they more accurately can be called vultures or sharks. They eat what they kill and Mr. Sorkin makes this very clear in his book. It's a take no prisoners world on Wall Street and these bankers can smell blood and take a carcass to the bone like a school of piranhas when one of their competitors is wounded. When the world-wide economic system was on the brink of collapse, these investment bankers zeroed in on the wounded and cherry-picked the assets they could salvage which during normal times would be the prudent thing to do, but not when they are getting bailed out with a trillion dollar TARP program. Is there any wonder why we are on the verge of class warfare in this country with the bonuses and golden parachutes that are being offered on the tax payer's dime?

The implosion of the investment banking system was a worst-case scenario with no regard for moral hazard as these pariahs used leverage and financial engineering to commandeer whatever profits were available. When the government implements its "exit strategy" somewhere down the road, heads will roll once more as the system just can't accommodate all of the toxic debt. Should the government have stepped in and bailed them out? Yes. It would have been a lot worse if things would have been left to decline on their own accord, but maybe we are avoiding the inevitable. In whatever case may ensue in the upcoming year it will be interesting and I'm looking forward to it. I've done my due diligence.