There has been some interesting work coming out of Goldman Sachs as of late and we wanted to take a moment to highlight the latest piece we've stumbled across. If you missed it, make sure you check out their hedge fund trend monitor where they identify portfolio holdings across the hedge fund universe as well. Turning now to another recent report, we examine their piece entitled 'State of the Markets.' Members of Goldman Sachs' sales/trading desk have compiled possible current long & short strategies they are seeing in the markets. They touch on tradable themes and various other market opportunities. In particular, they focus on the topics of commercial real estate, balance sheets of public companies, Japan, the consumer and retail, as well as commodity and event-driven opportunities. Keep in mind that these thoughts do not reflect an official view of Goldman Sachs and are solely those of the sales/trading authors.
Drilling down those talking points, the main trading and hedging opportunities they see are derived from a notion that the combination of the housing bubble and equity market decline have essentially destroyed wealth (we touched on this theme way back in December). This leads to consumer debt repayment and a higher savings rate. Due to the economic malaise, elevated and prolonged unemployment becomes a real source of problems. In turn, you then see lower consumer spending. They've also identified a second theme to take advantage of: risk shifting to public balance sheets. Based on all of these notions, various members of Goldman Sachs' sales/trading desks have highlighted the following strategies as opportunistic within the context of the current market landscape:
- Short REIT Equities
- Buy AAA CMBS
- Buy FX Options on commodity linked currencies
- Buy Equities of non-US commodity producers
- Sell Caps on the US Tax Index
- Short JPY
- Buy Yen CMS Caps
- Short US consumer and retail companies (via equities or CDS)
- Sell Aluminum Caps
- Long crude oil vs short heating oil (short the crack spread)
- Engage in market neutral strategies (event-driven, etc)
As you can see, some of these strategies are obviously not executable by your average retail investor and that is why the piece is deemed possible hedge fund strategies. As such, we insert the necessary note of caution here: Don't trade anything you aren't familiar with. Nothing herein is a recommendation and we won't be responsible for your acts of stupidity when you decide to go leverage-happy trading FX options when you've barely even traded equities. Use your head with this stuff. More so than anything, we found their report to be intriguing and figured it was good food for thought. Acting like a lemming and just following whatever you read on the internet is not a smart investment strategy (in fact, it's not one at all). Just keep all this in mind when reading and do note our disclaimer at the bottom of the site.
Overall, this is definitely an interesting mix of possible hedge fund strategies being pursued in the current markets. (These strategies were compiled in August 2009). Since we typically focus on equity holdings of various hedge funds, we'll leave all the macro trades for another day and will instead focus on the equity strategies presented.
Firstly, we'll turn our attention to the proposed strategy of shorting REIT equities. This has already been widely discussed before as the collapse in commercial real estate intensifies by the day. Yet through equity dilutions-a-plenty, REIT equities have managed to stay afloat. The fundamental problems and macro picture duly noted, members of Goldman's team have identified an opportunity to capitalize on the divergence in commercial real estate price estimates between REIT equity and CMBS markets. They identify possible trade ideas as follows: short REIT equity, long CMBS through buying AAA CMBS or selling protection on AAA CMBX.
According to S&P's rating stress for CMBS, CRE values have apparently dropped 26% from their peak and could potentially drop another 20-30%. A few recent transactions have sold around 60-65% below the peak in 2007 prices. Not to mention, you have the awesome problem of store closings that could shut down numerous regional malls over an extended timeframe. It is all a domino effect as the consumer has been wounded from the economy. As the consumer goes, so does the retail sector. As retail slowly ceases to bask in their former profitable glory, commercial real estate property owners start to suffer from lost tenants, amongst other problems.
While US REITs have raised almost $13 billion in capital year to date (mainly courtesy of the equity dilutions we referenced earlier), they still might need $40-60 billion more to stay afloat and meet impending debt maturities. Despite property values falling and equity dilution, REIT share prices have continued to ramp up. REIT indices are up well over 50% since the lows in March, yet the problems in commercial real estate seem to be accelerating to the downside.
If there is indeed a 25% mis-pricing in loss expectations for CRE, there could be further trouble ahead.
An example of putting on the short portion of the trade would be to buy puts or put spreads on a REIT equity index or a basket of various REITs (they highlight retail and office REITs). You can either buy the put outright or sell a further out of the money put to create a put spread (and cheapen your cost). With put options, you define the amount you are willing to lose as opposed to shorting common where a stock can rally > 100%, compounding your losses. While this could potentially be an effective short strategy, you also have to keep in mind that they have also presented a long strategy that retail investors can't pursue. But, for those of you interested, the idea as referenced earlier is a long of AAA CMBS. Obviously the risk there is that if the loans cease to pay their mortgage payments, the value of the bond price could be impaired. In the past, we've covered how various hedge funds have been short REITs as this theme definitely looks to be in play. That about sums up the CRE play for now, and you can bet we aren't done hearing about the problems in this industry.
Secondly, we'll shift the focus to public balance sheet conditions. Goldman's team has identified strength in emerging market balance sheets as developed countries increase their public debt. As such, they have proposed shorting developed countries overloaded with debt and going long select emerging market economies. They also highlight the possibility to buy equities of non-US commodity producers or inflation proxy commodity indices.
And another idea:
While we don't typically cover currencies here, you could implement a makeshift version of this trade using currency baskets created with ETFs such as the Australian Dollar (FXA) and the Canadian Dollar (FXC). We've seen this theme (longing commodity producers) mentioned numerous times and we would venture a guess that hedge funds like John Burbank's Passport Capital have executed some form of this trade (we've also covered their curve steepener play in the past too). Commodities definitely have piqued the interest of many this year (especially Jim Rogers) so we'll continue to keep track of that trend.
Lastly, we want to cover the theme of lower consumer spending as it pertains to the retail sector. This theme is relatively straightforward as a weaker economic outlook will impact the consumer. This obviously hurts participants in the retail sector and Goldman's team highlights a possibility of buying 6 month or 1 year put spreads on the S&P Retail Select Index (you could also sell a Call to cheapen the option). Buying protection on an individual retailer or basket of names would make sense should consumer spending drop off due to continued weakness in the economy.
They postulate that we could be seeing a structural ( rather than cyclical) change as it relates to consumer spending. While many will argue that the American consumer is the engine that somehow miraculously keeps on chugging, it's tough to argue with the fact that the US household has lost 23% in net wealth over the past 18 months (totaling over $14 trillion).
Yet, similar to REIT equities, retail equities are up massively from their lows.
Unemployment continues to rise and the economy is by no means 'in the clear' yet. Many macro hedge funds (Clarium Capital, Tudor Investment Corp) will be quick to highlight unemployment as a main contributor to continued pain. Can consumer spending go back to normal at the drop of a hat? We'll have to wait and see if the giant American consumption machine will be fettered by the continued effects of the recession.
Overall, very relevant propositions as it pertains to possible hedge fund strategies in the current markets. Keep in mind that these are not recommendations and do not represent the views of Goldman Sachs (or Market Folly either for that matter). If you missed the previous hedge fund report out of Goldman, it is definitely worth reading. Their hedge fund trend monitor surveys the hedge fund portfolio landscape much as we do here at Market Folly. For more on hedge fund holdings, make sure to check out our hedge fund portfolio tracking series as well.