Stan Druckenmiller: "I Basically Have a Large Bet on Economic Growth"

Duquesne Family Office founder Stan Druckenmiller appeared on CNBC today to give his thoughts on the markets and election. 

He noted that after the election a lot of regulation will be taken out of the system which should help get things going.  Other changes like tax reform, especially reducing the corporate tax rate encouraged him as he was "quite optimistic" on the economy.

Druckenmiller said that, "I have a large bet on economic growth ... I'm short bonds globally ... I'm short bunds, I'm short Italian bonds, I'm short US bonds.  I like sectors of the equity market that respond to growth, value, and materials, not things like staples and traditional growth stocks." 

He also added he likes the US dollar, with an emphasis against the euro.  And he has dumped his gold long (he actually sold during the night of the election).  He noted the reasons he previously owned it for 'might be ending.'

Druckenmiller also added, "If it wasn't for the messy conflict of rates rising with the stronger economic growth through fiscal policy, I would think there's so much low hanging fruit in terms of deregulation and tax reform, we could get a jolt of 4 percent growth for about 18 months."

That said, he's also cautious that interest rates rising could push that down to high 2, low 3 percent growth.  "I think the market is going to force this.  The market is going to push them to raise interest rates if my hopeful scenario turns out to be right."

He added that monetary policy essentially helped get Donald Trump elected as it caused a 'massive reallocation' of wealth from the middle class to the rich.

"Dr. Copper: have you seem him lately?  It's been rising.  Interest rates have been at stupid levels, they've been held down... they're like beach balls under water."

Embedded below are some of the videos from Druckenmiller's interview on CNBC

Video 1




Video 2

Paul Singer's Sohn Conference Presentation: Macro Overview & History of Markets

We're posting up notes from the Ira Sohn Conference 2013 in New York.  Next up is a summary of the presentation from Paul Singer of Elliott Management, a ~$20 billion hedge fund.  He presented a financial overview and talked about quantitative easing and the need for economic growth.


Financial Overview & History of Markets

Singer gave a “history of financial markets since WWII.” There was less debt back then. Sound financial institutions. "Long term entitlement programs are the effective equivalent to debt." Countries are unwilling to even do non-threatening changes to these entitlement programs.

In Japan, it is 800% of GDP. In US, 500% of GDP. "Obligations that cannot possibly be met, no matter what the tax rate, or the growth rate." Financial institutions are now doing not just loans, but they are doing a lot of principal trading. Typical bank now: 200B equity, 2- 3T of assets, and 50-80T of notional value of derivatives. He claims it is hard or impossible to know what those derivatives actually are. Still completely opaque, and their risks are not understandable. VAR totally misstates risks. Also highly levered.

"Central Banks have reveled in their role, flooding the market with money, they think printing money is 'free' and they don't see the cost- since there is no inflation." We have modest growth, and build-up of risk. "The world needs growth; from innovation." Quantitative easing has caused a distorted recovery. People owning bonds, stocks, is doing fine. Ordinary citizens are not feeling the effective equivalent of Dow 15,000. Causing class warfare.

His idea: Those who own long-term bonds of US Governments or others, own things that are not priced correctly. There is no safe haven in these markets. There is no such thing.


Check out the rest of the hedge fund presentations from the event: notes from Ira Sohn Conference 2013.

Jeff Gundlach's Sohn Conference Presentation: Short French Bonds, Short Chipotle, Long Gold

We're posting up notes from the Ira Sohn Conference 2013 in New York.  Next up is a summary of the presentation from Jeffrey Gundlach of DoubleLine.  He talked a lot about quantitative easing and various other topics.


Gundlach's Talk on Quantitative Easing

He thinks quantitative easing will stay for a long while for many months if not years into the future.  It's a way to keep interest expense low and can also generate lower insurance premiums so he would avoid insurance companies.

Just because rates are low now doesn't mean they have to rise quickly.  Timing is everything in investing.  The Fed mentions the downside of QE just "so they can say they talked about it."  He said this isn't the beginning of a new bull market.  If you want to play QE via stocks, do it in Japan.

Gundlach said that Cyprus' taking deposits worries him as a precedent has been set so he said to avoid sticking money in the bank.  If you want to play QE in Europe, just short French bonds. 

He points to Treasuries not being a crowded trade.  Asking the audience to raise their hands if they own them, very few hands were raised.  He says QE is a put on Treasuries. 

Gundlach's picks:  Short Chipotle (CMG) ~ "gourmet burrito" is an oxymoron, short French bonds, gold.  Avoid bank deposits.

For more on this manager, we've also highlighted some of Gundlach's previous thoughts on holding cash here.


Check out the rest of the hedge fund presentations from the event: notes from Ira Sohn Conference 2013.

Ray Dalio: Cash Will Move Into 'Stuff' in 2013

Ray Dalio, founder of Bridgewater Associates, spoke with CNBC at Davos about a myriad of topics.  Dalio started Bridgewater with $5 million and now manages $130 billion.  His Pure Alpha hedge fund ended 2012 up 0.8% though his long-term returns are much more impressive.


Cash Will Move Into 'Stuff'

The Bridgewater founder thinks 2013 will be a year of transition as cash moves into 'stuff' like goods, services, financial assets (equities, gold, etc).

He points out that there's so much cash in the system due to central bank action.  Since cash has a negative real return, he argues that it has to go somewhere as risks are being reduced.  The desire to hold cash is being reduced. 

Dalio laid out his framework as essentially a scenario where US investors pile into stocks driving markets higher which will then give the Fed confidence to start to tighten, which will then cause a pullback across risk assets.


Bearish on Europe

However, he's quite bearish on Europe it seems noting that there's a terrible economy with a gradual restructuring.  He says there will be a depression there or a 'lost decade'.


Wisdom From Dalio

Dalio also had a some fantastic quotes about approaching investing, saying that,

"The way to look at any market... is to look at the buyers and sellers and to understand who's buying and who's selling and what the motivations are behind that."

He went on to note that,

"Too many investors are reactive decision makers... if something has gone up, they say 'ah, that's a good investment,' they don't say 'that's more expensive.'  It's the most common mistake in investing.  You have to look ahead and say what is the transaction? What will determine the buyer or seller?"

Dalio also points out:

"So much of the driver of any asset class returns is based on how events actually transpire relative to expectations. So there's a certain discounted growth rate in equities."

Lastly, Dalio made an excellent analogy comparing investing to poker:

"The bets are zero sum.  In order for you to beat me in the game, it's like poker, it's a zero sum game.  We have 1,500 people that work at Bridgewater, we spend hundreds of millions of dollars on research, and so on.  We've been doing this for 37 years and we don't know that we're going to win.  We have to have diversified bets.  So it's very important for most people to know when not to make a bet.  Because if you're going to come to the poker table, you're going to have to beat me, and you're going to have to beat those who take money.  So the nature of investing is that a very small percentage of the people take money essentially in that poker game away from other people who don't know when prices go up whether that means it's a good investment or if it's a more expensive investment."

This analogy is not a new concept and there are actually many similarities between poker and investing/trading.  Numerous hedge fund managers play poker (like David Einhorn) and we've highlighted the link between hedge fund managers and poker.

Embedded below are the videos of Dalio's interview from Davos:

Video 1



Video 2



For more on this legendary investor, Dalio is profiled in the book The Alpha Masters.  You can also check out Dalio's other in-depth interview on QE3, gold and other topics.

Howard Marks: Fixed Income Returns Not Worth The Risk (Latest Memo)

Longtime readers will know we're big fans of Howard Marks' commentary mainly because he often tackles investment process and other key concepts of investing.  The latest memo from the Oaktree Capital chairman is entitled "Ditto" outlines how history doesn't repeat itself but it does rhyme and he outlines some of these repeating themes in financial markets:

- Importance of risk and risk control
- Repetitiveness of behavior patterns and mistakes
- Role of cycles and pendulums
- Volatility of credit market conditions
- Brevity of financial memory
- Errors of the herd
- Importance of gauging investor psychology
- Desirability of contrarianism and counter-cyclicality (we've highlighted an excerpt from Marks' book on contrarianism in the past)
- futility of macro forecasting

As you'll notice, many of the above are related to behavior/emotion (see recommended reading on the topic here).  Because while fundamentals, technicals, or whatever metrics you follow matter, you also have to worry about the two factors that seemingly move markets the most: greed and fear.

He goes on to write, "The good news is that today's investors are painfully aware of the many uncertainties.  The bad news is that, regardless, they're being forced by the low interest rates to bear substantial risk at returns that have been bid down.  Their scramble for return has brought elements of pre-crisis behavior very much back to life."

The key here, is that he's referring mainly to fixed income securities.  After the financial crisis, everyone was looking for "safety."  And then during the low interest rate years, everyone began to stretch for yield.

Marks reiterates something he said in 2004 by saying that, "there are times for aggressiveness.  I think this is a time for caution.  Here as 2013 begins, I have only one word to add: ditto."


Marks' latest memo "Ditto" is embedded below:




You can download a .pdf copy here.

For more wisdom from this manager, be sure to check out Marks' previous letter.

Hugh Hendry On Gold, Treasuries, Japan, China & More: Buttonwood Gathering

It's been a long time since we last checked in on Hugh Hendry of Eclectica Asset Management so today we're highlighting his recent talk at The Economist's Buttonwood Gathering.  He touched on hot topics such as gold, treasuries, China, Japan, hyperinflation and a myriad of other things.

Key Takeaways

Hendry continues to like gold, but not the gold miners.  While he has been an advocate of the precious metal for many years, he continues to like it (albeit with slightly less conviction than previously).

We've highlighted one hedge fund's view that miners are better than gold and Hendry obviously disagrees with that.  And recently at the Great Investors' Best Ideas conference, David Einhorn made a quip that one should have gold miners in their portfolio.  Clearly, this is a divisive topic.

Hendry is also worried about creditor nations.


Notable Quotes From Hendry

Hendry said that, "My community of global macro managers always wants to short the JGBs and short the yen, and yet they've gone the opposite direction ... If you want to be short JGBs for the ultimate response, you don't survive the journey."

We've pointed out Kyle Bass' negative views on Japan and JGBs in the past.  Hendry points to real problems coming in Japan should some of their major companies near bankruptcy (he mentioned Sharp).

Hendry on Treasuries:  "Don't tell me China will sell their US treasuries.  If they sell their treasuries, the renminbi goes higher and higher and higher.  And their companies that export go bust."


Embedded below is the video of Hendry's entire talk at The Buttonwood Gathering:



We've previously highlighted some of what Hendry was buying earlier this year.  And for further hedge fund commentary from the Buttonwood Gathering, head to David Einhorn's talk.

Delivering Alpha Less Than Zero Panel: Lasry, Richards & Fleming

Continuing coverage of CNBC and Institutional Investor's Delivering Alpha Conference, next up is the Less Than Zero Panel featuring Avenue Capital's Marc Lasry, Marathon Asset Management's Bruce Richards, and Morgan Stanley's Gregory Fleming in a talk on the hunt for yield.

If you missed previous posts from the conference, check out a summary of the best ideas panel as well as the global opportunities panel.


Marc Lasry (Avenue Capital):  He argued that 10 year Treasuries will be around 2.5% to 3% in 5 years.  He talked about investing in European debt, saying that you're getting (over)paid for the risk premium.  We've highlighted Lasry on European opportunities recently.  He said that he's buying bank debt in private markets (in Europe), saying that you want to be in regions where "everyone's nervous."  Lasry also argued that 10% plus annual returns are doable if there's a 7-year lockup.


Bruce Richards (Marathon Asset Management):  He said that government bonds = highest risk, lowest return.  He likes structured credit as he thinks the hunt for yield will get insane through 2014 as he made a Hunger Games reference.  He also says that everyone knows inflation is the way out for the US government.  Additionally, he argued he could make 12-14% in high yield.


Gregory Fleming (Morgan Stanley):  He highlighted the retail investor's demand for yield while still having major risk aversion.  It's difficult to combine the two, obviously.  Citing Jim Grant, he also called Treasuries "return free risk."


Sources: Notes from readers, II's blog, @iimag, @ldelevingne, @footnoted, @aarontask


For more from the Delivering Alpha Conference, head to a summary of the best ideas panel (including Leon Cooperman, Jim Chanos and more) as well as the global opportunities panel (featuring Richard Perry).

Doug Kass on the End of the Bond Bull Market: Value Investing Congress Presentation

Continuing our coverage, today we're posting up more notes from the Value Investing Congress.  Below are notes and the slideshow presentation from Doug Kass of Seabreeze Partners.  His talk was entitled, "The end of the bond bull market from an equity investor's perspective."

The following notes are courtesy of Kyle Mowery from GrizzlyRock Capital.  Kass quoted Warren Buffett: "Chains of habit are too light to be felt until they are too heavy to be broken."

Doug Kass argues that shorting bonds has been a great hedge against profits.  He says that shorting bonds might be the trade of the decade - to go against the grain and short bonds.  This is currently the largest position Kass has ever taken in his partnership.  Will Rodgers says that "You have to go out on the limb because that's where the fruit is."


The End of the Bond Bull Market

Example of risk of extrapolation:  Siegel stocks for the long run - labeled stocks safe for the long-term right about the top.  Howard Marks: "extrapolators fail to understand that things mean regress. And crown wrong at extremes."

BusinessWeek - "Death of Equities" was right at the end of the lost decade of equities and then the market gains 18% per year after the article was published and then did 19% annually for the next 20 years with only 2 down years.

Key Factors to the Short

- Flight to safety premium erodes
- Muddle through economy gains steam
- Fed policy on hold - leads to natural price discovery
- Inflation on ascent
- Housing recovering (thinks housing could add 1% to US GDP next year)
- Stocks vs bonds approaching reallocation trade
- US fiscal imbalances are not being addressed

Simple observations on the 10 year:  stock market 2% return is 50x earnings. Pay 40% to Uncle Sam - after tax yield is 1.2% and with inflation at 3% it's a negative real yield.

Real GDP 2.5 and inflation of 2% = 4.5% with current yield of 1.9% - "tons of daylight in the middle."

He also discussed Ocwen Financial (OCN) - subprime mortgage servicing.  Banks are getting out of servicing and outsourced portfolio solution $12 at spin in 2009 to $60.  Trades at 15 and will earn $2 per share in 2013.


Embedded below is Doug Kass' slideshow presentation on the end of the bond bull market:




Be sure to click here for other presentations from the Value Investing Congress.

Kleinheinz Capital: Inflation is Biggest Threat to Emerging Markets

John Kleinheinz's hedge fund Kleinheinz Capital recently sent out its year-end market commentary and 2011 outlook. The focus? Emerging markets and why inflation is the biggest threat to the belief that those countries can rebalance global growth.


Emerging Markets / Developing Economies

In the hedge fund's third quarter commentary, Kleinheinz said Russia is the cheapest emerging market. Their commentary this time around focuses on developing nations in general. They feel that food inflation is a large threat as it causes social unrest. However, the most important reason inflation is a concern is because,

"if developing economies cannot grow at above trend levels in a non-inflationary way then the whole proposition that these economies can gently rebalance the world economy may be untrue. The above average rates of growth in markets like China may simply be the result of trade surpluses that arise from lower cost of labor and fast monetary growth spurred by large domestic and foreign investment in capacity. Without real productivity advances and a migration to higher value-added products and services, which would allow higher incomes, the citizens of those countries cannot be expected to upgrade to a Western lifestyle that favors consumption over savings."


End of Bull Market in Treasury Bonds?

Another interesting focus of Kleinheinz's year-end letter is the notion that the three decade long bull market in US Treasuries is over. In the past, Kleinheinz held some bonds as a hedge. However, they sold out of those positions in the third quarter of last year.

Since then, they've begun "tactically shorting bonds ... until we become more certain about the timing and magnitude of a secular decline in longer dated bonds."


Japanese Yen

On the other side of the spectrum, the hedge fund has also started short positions in the Japanese Yen and Japanese government bonds. The rationale behind the play?

"Simply put - because Japan cannot afford to let its interest rates go higher, its currency will likely go lower to adjust interest rate differentials, slowing trade surplus and dwindling savings."

Readers will recall that hedge fund colleague Kyle Bass is short Japanese government bonds as well.


At the end of 2010, here were Kleinheinz's Top Holdings:

1. Apple (AAPL)
2. Research in Motion (RIMM)
3. China Mobile (CHL)
4. Veeco Instruments (VECO)
5. Monsanto (MON)
6. Hong Kong Exchange & Clearing (HK:0388)
7. LUKoil Holdings
8. Google (GOOG)
9. Major Drilling Group (MDI)
10. Yahoo! (YHOO)

From the third quarter to the fourth quarter, the most notable change in the upper echelon of their portfolio was Baidu (BIDU) falling just outside of the top 10 and their position in VECO ramping up a few spots.

Since inception, the fund has seen a compound annual growth rate of 26.6%. Intriguingly, you can replicate Kleinheinz's portfolio via Alphaclone. Investing in Kleinheinz's top 10 US equity holdings returned 19.5% 2010 compared to the hedge fund's actual performance of 22.86% (get free access to Alphaclone here).

To conclude, we'll leave you with a quote from John Kleinheinz's letter that stuck out the most: "A broad correction in stock market multiples will only occur if ten year U.S. government bond rates exceed 5% and corporate earnings growth slows to low single digit levels."

Zeke Ashton, Guy Spier, & Michael Lewitt: Value Investing Congress Presentations

Given the large amount of speakers at the Value Investing Congress, we're trying to dissect the day's events into digestible nuggets of information. The following article details the presentations from Zeke Ashton (Centaur Capital Partners), Guy Spier (Aquamarine Fund), and Michael Lewitt (Harch Capital Management).

We posted up comprehensive notes from day 1 of the Value Investing Congress here encompassing presentations by John Burbank, Lee Ainslie, and more. We've also highlighted Bill Ackman's question and answer session in a separate post as well. Make sure to check out those resources. Without further ado, the rest of the presentations from day 1:

Zeke Ashton ~ Centaur Capital Partners

Ashton has seen an impressive 16% CAGR since inception with his hedge fund, Centaur Capital Partners. He had some ideas in the property & casualty insurance space, notably Fairfax Financial (FRFHF) as well as Aspen Insurance (AHL). Fairfax is run by Prem Watsa, a man many have dubbed the 'Warren Buffett of the north' as he's based in Canada.

Aspen Insurance is a name we've seen in David Einhorn's portfolio for a while as well and Ashton believes it could see $40, a book value of 1.15 (it currently trades around $30 per share) as the company continues to buy back stock at a discount. He also sees Liberty Mutual as potential value when they eventually come public.

Turning to his next play, Ashton brought Biglari Holdings (BH) to the table. While he believes retailers in general are cheap, he sees BH trading at 8x free-cashflow and Sardar Biglari (the man in charge) only gets paid if FCF grows 6% per year. Many investors (particularly in the value investing community) have taken issue with Biglari's compensation package. Ashton sees lots of real estate value in BH and likes that they are shifting to a franchise model with their Steak n' Shake stores.

Biglari is essentially trying to create a Berkshire Hathaway-esque holding company/model as his company has made buyout offers for insurer Fremont Michigan (FMMH). Many have pondered whether or not Steak 'n Shake (now Biglari Holdings) was the next Berkshire Hathaway. Biglari also recently revealed a position in Sonic (SONC).

Centaur Capital Partners currently has 20% overall exposure to the retail sector. Ashton believes diversifying between retailers, restaurant, and a high quality operator (like Target - TGT) is beneficial in the space.

Lastly, Ashton mentioned that equity asset managers are cheap due to the public's current distaste for equities. He feels buying a basket of these stocks is a solid approach. He cited (CLMS) as an undervalued asset manager, Janus Capital (JNS), and also MVC Capital (MVC). Interestingly enough, the Centaur Capital Partners manager also noted his use of the iShares 20+ year treasury (TLT) as a hedge against interest rate risk.


Guy Spier ~ Aquamarine Fund

From a theoretical/educational standpoint, Spier highlighted to pay heed to a sign in Warren Buffett's office reading 'invest like a champ today.' Spier profoundly professed that starting relationships with the right people can have a very strong impact on your life as an investor. In particular, choosing the right investors for your fund sets your fate. He highlighted Whitney Tilson and Glenn Tongue's partnership to form hedge fund T2 Partners as well as Markel Corp (MKL) as another good example. On this notion, Spier recommended Michael Eisner's book, Working Together: Why Great Partnerships Succeed.

Shifting to specific picks, Spier actually sees Japan as a compelling potential investment. Screening for stocks in this universe returns a lot of companies with negative enterprise value, many of which are paying dividends and partaking in share buybacks. In particular, the Aquamarine Fund manager singled out Otaki Gas (TYO:9541), a pipeline company that owns assets in Japan. His best idea is slightly morbid in Heian Ceremony Service (JSD:2344), a funeral service business that can benefit from Japan's aging population.

Lastly, Spier had an intriguing quote on the notion of liquidity. He says that liquidity today is not important. Instead, liquidity is important when you want to exit a position.


Michael Lewitt ~ Harch Capital Management

Lewitt, also the author of The HCM Market Letter, started out by saying that we need to rid ourselves of fiscal problems because the traditional tools aren't working. He would prefer a constructive approach instead of pumping out another trillion dollars via quantitative easing round two. Lewitt feels that central banks are destroying currencies (especially in Japan). Also, he feels that naked credit default swaps (CDS) shouldn't exist and highlighted the situation with BP (BP) as an example. You'll recall that in the past we highlighted that Bill Ackman bought BP CDS.

In terms of opportunities, Lewitt sees bank loans as an attractive asset class because they are secured, can be leveraged to enhance returns, and many have 7% floating rates. As a play on bank loans, he likes KKR Financial (KFN). He highlights the 5.5% yield which should increase. He also singled out Tetragon Financial Group (AMS:TFG) trading in Europe.

Turning to bonds, Lewitt says junk bonds have been on fire (obviously). While he likes them, he notes you obviously have to be very selective due to their very cyclical nature. In particular, he finds value in BB and BBB corporate bonds.

Lastly, The HCM Market Letter author recommended utilizing ProShares UltraShort 20+ Year Treasury (TBT) as a way to short bonds. Keep in mind that since this is a leveraged ETF, it suffers from tracking error over longer time periods. He also advocated a long position in gold, something many managers have done.


That wraps up the presentations from these speakers. If you are on Twitter, we are posting live updates from the Congress on our @marketfolly Twitter feed. Be sure to also check out our comprehensive notes from day 1 of the Value Investing Congress.

Best Investments During Deflation

Today we're laying a loose framework for the best investments during deflation. Why? Because deflationary signals have reared their ugly head as of late. Not to mention, many prominent investment managers have voiced their concern about the dreaded scenario. While inflation versus deflation has been the great debate over the past two years, the deflationistas have been boasting quite loudly as of late.

We've detailed how David Gerstenhaber's global macro hedge fund Argonaut Capital thinks deflation is the greater risk. Additionally, Broyhill's Affinity hedge fund has been betting on deflation as of late. PIMCO's bond king Bill Gross has been buying treasuries in order to combat these fears. And for more, The Reformed Broker has a quick summary of the New York Times' deflation round-up as well.

While investing during the dreaded 'D' word is not impossible, the options to preserve and grow capital are certainly limited. So, what is the best investment for deflation? Very broadly and in no particular order, here's some potential answers:


Cash/US Dollar: The phrase "cash is king" is often cliche. It's not cliche during deflation, it's rule number one. Assuredly, cash is one of the few 'safe' investments you can make in this scenario. Over the normal course of investing, most investors focus on their return on capital. This time around, the focus is simply on return *of* capital. While many wouldn't consider this an investment, having physical cash notes saved and on hand can be crucial during extreme situations including: bank failures, a collapse in credit, or the government defaulting on its debt. Not to mention, the US dollar has been a strong performer during deflationary times. Holding the physical currency is easy enough, but those wishing to further their wager can play the PowerShares US Dollar Bullish Index (UUP).


Pay Off Debt: Again while 'paying down debt' doesn't sound like an investment, it most definitely is during deflation. In a period where literally every single dollar matters, each dollar of debt can become crippling.


Buy Long-Term Bonds: Alternative to cash, fixed income is also seen as an option for those who seek protection. While fixed income yields decline due to Federal Reserve easing in an effort to combat deflation, the underlying bond should appreciate (or at the very least, depreciate much less than equities). US Treasuries are highly coveted here as they are the safest and most in-demand. If one were to go the corporate bond route, seeking high quality bonds is preferred. The thesis behind this play is laid out by Broyhill's Affinity hedge fund in their presentations: ten reasons to buy bonds as well as their bet on long-term treasuries. The most logical wager here would be the iShares Barclays 20+ year Treasury (TLT).


Short Equities: Traditional investments will start to suffer as underlying companies will see lower margins and losses. Not to mention, highly leveraged companies make ideal short selling targets and certain companies can face the risk of becoming insolvent. If your conviction is strong enough, you could simply short the S&P 500 index (SPY). There is, however, one potential safe haven in equities (keyword being 'potential'), which brings us to the next investment:


Buy High Quality Dividend Paying Stocks: Understand that during deflation, equities in general are one of the major investments to avoid. However, high quality stocks could be a potentially dim light in an otherwise dark scenario. While the majority of companies will lose pricing power and succumb to weak margins, large cap high quality companies that dominate their industries may be able to maintain pricing power. Not to mention, many of these stocks pay dividends which generate valuable cash during deflation. Seek companies with pristine balance sheets.

GMO's Jeremy Grantham recently voiced concern about deflation and one of his few investment recommendations was to buy high quality stocks. For ideas, hedge fund T2 Partners recently issued a presentation on 3 large cap stocks. Sectors to look toward include healthcare, technology, and telecom as those have outperformed in Japan during their deflationary lost decade. Microsoft (MSFT) is one name that has been repeatedly mentioned by strategists and managers. Keep in mind though that despite being high quality blue-chip companies, these are still equities. As such, there is obviously inherent risk in owning them during deflation.


Short Housing/Avoid Real Estate: In deflation, prices fall. As such, rent rather than own. Stand back and let the landlords watch the values of their properties plummet. You can short the iShares Dow Jones US Real Estate (IYR) for some exposure.


Short Leverage: Deleveraging should be a big theme playing out in the future, environment notwithstanding. As mentioned earlier, short the equity of companies that have poor balance sheets and are highly levered. In deflation, leverage begins to unwind and currency plays can be found. A massive leveraged carry trade in the Yen has taken place over the years and as such would be unwound in deflation, thus benefiting the Yen.


Long Technology: Regardless of environment, technology will advance and will be in demand. The technology sector was highlighted as one of the few areas to possible allocate capital in high quality equities. Companies that have strangleholds on their industry should have an advantage. A basket of technology stocks could be purchased via the technology exchange traded fund (XLK). However, that gives you exposure to a lot of companies and it's probably more preferable to single out high quality technology names with pristine balance sheets such as Microsoft (MSFT), Intel (INTC), and Cisco Systems (CSCO).


Gold: Conventional wisdom says to avoid precious metals during deflation. During the Great Depression from 1929-1932, commodities in general crashed. However, in very extreme circumstances (emphasis on extreme), some have argued that gold can make sense when acting as currency. The majority of proponents for owning gold during deflation would cite its store of value or hedge against uncertainty. While gold can be played via the SPDR Gold Fund (GLD), many hedge funds advocate physical gold. That said, those doing so are mainly seeking inflationary protection.


Buy TIPS: Treasury Inflation Protected Securities, or TIPS, serve as long-term protection from inflation. Buying TIPS during deflation? What's the point? This is an option if investors believe that deflation will eventually lead to inflation two or three years later. As policy makers attempt to combat deflation, the natural antidote is inflationary medicine. As such, investors looking further down the road can fend off these inflationary pressures with TIPS. And even if deflation persists for an extended period of time, TIPS still produce income via yield and investors can regain their bond's face value at maturity. This can be played via iShares Barclays TIPS Bond Fund (TIP) for those looking for an easy solution.


That sums up some of the best ways to position a portfolio when confronted with deflation. Recent concern is duly warranted considering that deflation typically rears its ugly head after periods of prolonged globalization and global growth. Such growth leads to increased investment, a massive increase in production, and thus excess capacity all around the world. This excess capacity then brings forth lower prices. In deflation, companies suffer while the consumer is the real winner. The above present theoretical options of how to invest during such a scenario. Make no mistake though, investing during deflation can be quite difficult and painful.

Back in August 2008 when the crisis was heating up, we penned a very broad outline of investment scenarios for inflation versus deflation. During the pinnacle of the crisis, it wasn't quite clear which situation would play out so it made sense to lay a framework for each context. (And arguably, it's still not entirely clear. Many have hypothesized that we'll see a compromise of views: deflation in the near-term and inflation in the long-term). A few months ago, inflation was all the rage. Now, deflation is the primary concern. Investors have been flip-flopping more frequently than politicians as of late.

Regardless of outcome, it makes sense to be prepared for either environment. Check back tomorrow as we'll turn the tables and outline the best investments during inflation in order to present both sides of the argument. In the mean time, be sure to see what hedge funds are investing in these days with our daily coverage.

Broyhill's Affinity Hedge Fund: Betting on Deflation (Q2 Letter)

Broyhill started as a family office to manage Paul H. Broyhill's assets and has since evolved into a multifaceted investment firm. Their Affinity hedge fund was up 4.6% for June and was up 6.6% for the year at that time. We've touched on how the majority of hedge funds had a very rough second quarter performance wise. That said, not every hedgie out there as been battered down and Broyhill is evidence of that. So, how did they sidestep the volatility, you ask? They called in an old fashioned contrarian prescription to combat the market's sickness.

Their hedge fund has put on a contrarian bet on long-term treasuries (outlined via their ten reasons to buy bonds). Yet with a lack of inflationary signals as of late, maybe their bet isn't so contrarian after all. While hedge funds in general have had below average net long exposure, it was still evident that many funds were taking on more risk than they realized when May and June came around. The fact that most asset classes seemed to move in lockstep didn't help things either as everything seemed correlated to the downside. Everything but treasuries, that is.

Believe it or not, Broyhill had actually been short treasuries up until about March of this year. They then went long essentially as a hedge against deflation. Broyhill isn't the only one worried about deflation either. We just detailed how David Gerstenhaber's global macro hedge fund Argonaut Capital thinks deflation is the greater risk.

In recent commentary, Broyhill has reminded us that legendary hedge fund manager Michael Steinhardt coined the term 'variant perception' in which he focused on contrarian analysis and wagers by taking positions opposite those of consensus opinion. East Coast Asset Management recently highlighted the consensus versus variant perceptions in today's market as well. Broyhill has done the same as their bet on treasuries represents their highest conviction variant perception.

Christopher Pavese, the fund's Chief Investment Officer writes,

"Quite simply, we believe investors are worrying about the wrong type of 'flation' here and now. In the near term, the ongoing contraction in private sector credit - estimated by the OECD to reach 7% of the developed world's GDP or $3 trillion - combined with the threat of fresh credit strains ahead, should more than offset the long-term inflationary impact of increased government spending. The major point here is that most strategists today remain adamant bond bears, and after missing the call at four percent, it is near impossible for them to recommend buying treasuries yielding three percent!! We welcome Wall Street's hatred of government bonds and expect to hold our position at least until the consensus capitulates .... which looks to be a ways off given today's sentiment."

Here are the Affinity hedge fund's top ten longs:

1. iShares Barclays 20+ Year Treasury (TLT): 11.1% of assets
2. Vodafone (VOD): 3.2%
3. Wal-Mart (WMT): 3.2%
4. Kraft Foods (KFT): 3.1%
5. Humana (HUM): 3.0%
6. Nintendo (NTDOY): 2.9%
7. Market Vector Gold Miners (GDX): 2.8%
8. iShares Silver Trust (SLV): 2.8%
9. PowerShares US Dollar Index (UUP): 2.7%
10. Republic Airways (RJET): 2.7%

Keep in mind that we've previously detailed Broyhill's write-up of the bullish case for St. Joe Company (JOE) as well. So in addition to their hefty treasury position, it's clear that Broyhill has two other portfolio themes in play: high quality large caps, as well as precious metals exposure. For the latter, they've chosen to play silver and a bundle of gold miners. For the former, they've picked Vodafone (VOD), one of David Einhorn and hedge fund Greenlight Capital's largest holdings. Additionally, we've seen many hedgies favor Kraft (KFT), including Bill Ackman's Pershing Square.

Although they do not disclose specific positions, Broyhill's Affinity hedge fund has revealed its top sector short positions, including:

Education (5.2%) of assets
Global Financials (2.9%)
Business Equipment (2.9%)
Euro (2.7%)
Automotive (2.5%)
Appliances (1.9%)
Employment Services (1.8%)
Credit Rating Agencies (1.7%)
Global Resources (1.7%)
Recreational Vehicles (1.2%)

We'll continue to keep an eye on this hedge fund's successful wager on treasuries and embedded below is Broyhill's second quarter letter:



You can download a .pdf copy here.

For more on this deflationary wager, head to Broyhill's ten reasons to buy bonds as well as the thesis behind their bet on long-term treasuries. Additionally, more research from the hedge fund can be found in their bullish case for St. Joe (JOE).

Ten Reasons To Buy Bonds

Earlier this morning we presented the first quarter investor letter from Broyhill Asset Management's Affinity hedge fund where we highlighted their contrarian bet on long-term treasuries. In a time when seemingly everyone is betting on inflation, Broyhill has taken a converse stance and thinks caution is warranted. They anticipate an acceleration away from risk assets and into fixed income. They recently posted up the rationale behind this position on their blog View from the Blue Ridge and we wanted to highlight the key takeaways from their deflationary wager. Thus, we continue our impromptu inflation versus deflation debate as we earlier cataloged how hedge fund manager Kyle Bass sees inflation & currency devaluation in store around the globe.

Believe it or not, Broyhill had previously been short treasuries and covered in March. They've since gone long and see the 10 year treasury as an effective hedge against deflation. They have been buying here and will continue to do so on any weakness. Investors wishing to jump on this seemingly contrarian bet can buy exchange traded fund IEF for 10 year treasuries, or TLT for 30 year treasuries if you wanted a longer duration. This investment of course is in stark contrast to the myriad of other hedge funds that have been shorting long-term treasuries. Hedge fund Broyhill's rationale for owning bonds is refreshingly presented with various research found via the financial blogosphere. You can of course keep up with Broyhill's latest thoughts on their blog, View from the Blue Ridge.

Before getting into the ten reasons, we'll first start with their chart of 10 year treasury yields that has been in a decisive downtrend for the better part of two decades. Various crisis events over the past twenty years have caused momentary spikes in treasury yields, only to later resume the trend of decreasing yields.

(click to enlarge)

And now, without further ado, here are Ten Reasons to Buy Bonds:

1. "Core inflation historically falls after the end of a recession. In the 11 recessions from 1950 through July 2009, the end of recession was followed by declining inflation, with CPI bottoming on average, about 29 months after the recession ended. Longer term inflation concerns are warranted, but there are more immediate threats in front of us."


2. "With core inflation declining and nominal economic growth rates weak in the aftermath of financial crisis, bond yields should trend lower in coming quarters. Investors looking to purchase long-term inflation hedges, should see more attractive entry points in the period ahead. Be patient."


3. "The average long term Treasury rate since 1870 is 4.3% and the average annual CPI is 2.1%. If inflation trends toward zero (before moving much higher later in the decade), then long term bond yields could naturally fall toward 2%."


4. "A near term deflationary environment bodes very well for long term bonds. Long term Treasury rates dropped from 3.6% in 1929 to 1.9% in 1941. Interest rates in Japan fell from 5.7% in 1989 to 1.1% in 2008 while the Nikkei dropped 77.2% over the entire period."


5. "The most common argument from Bond Bears is higher levels of debt must lead to higher yields. The reality is that the economic cycle still dominates intermediate swings in bond prices – a growing list of leading indicators are pointing to slowing economic growth ahead."


6. "The velocity of money is falling at the same time money growth has come to an abrupt stop. Monetary policy is effectively pushing on a string."


7. "Nearly 80% of money managers in Barron’s Big Money Poll say they are bearish on Treasuries. When everyone agrees that rates are headed higher, something else is bound to happen." As we here at Market Folly had posted up earlier, hedge funds had a record short position in 10 year treasuries, as illustrated below by Societe Generale:

(click to enlarge)

8. "Similarly, retail investors are once again, near their highest allocation to equities at the market’s highs. I believe some call this Predictably Irrational. The last time bullish sentiment was this high was back in December 2007 when the S&P 500 was trading at 1500!" Bespoke Investment Group had in the past put out a graphic showcasing extreme levels of bullish sentiment found below:

(click to enlarge)

Additionally, Pragmatic Capitalist charted out a survey of asset allocations that highlighted how everyone and their dog had moved out of cash and into stocks:

(click to enlarge)

9. "Greek default and contagion risks across the Eurozone periphery. Cascading disruptions throughout the European banking system. This risk will not go away anytime soon. News will get worse before it gets better. Think back to how subprime was “contained” or how the Bear Stearns rescue marked the “panic lows” for the markets. Greece is a pebble in the Euro Pond. The ripples it causes will ultimately be very messy."


10. "Read number nine again."


Specifically regarding the recent implications of Greek default, we want to highlight that just this morning we posted how Kyle Bass' hedge fund Hayman Advisors is very concerned about currency devaluation and inflation around the globe. There's an interesting dynamic here because while Broyhill thinks the events in Greece will cause investors to 'flock to safety' in bonds, Hayman Advisors believes these sovereign defaults will only lead to inflation. The difference between these two stances is that Broyhill's position is based on a near-term reactionary move by investors while Hayman's thesis is centered on a theoretical long-term consequence.

An intriguing and well thought out set of reasons for a wager on bonds from Chris Pavese at Broyhill. They've definitely made a contrarian wager here and until yields on the 10 year treasury break out of that multi-decade downtrend, you can't really argue with their position in the near-term. Only time will tell whether we ultimately have inflation or deflation. But that certainly hasn't stopped hedge funds and investors from placing bets in the mean time.

Overall though, we've seen the vast majority of hedgies anticipating inflation. Howard Marks of Oaktree Capital laid out ways to play inflation. East Coast Asset Management came to the same conclusion of an inflationary stance in their deflation-reflation continuum research. And again as we noted this morning, Kyle Bass is now anticipating currency devaluation around the globe.

However, we do make note of a few select firms that are notably bullish on bonds and reside in the deflationista camp, including Hugh Hendry of the Eclectica Fund. Indeed, this is what makes markets great: a never-ending difference of opinion. Perhaps a compromise of views would be deflation in the short-term followed by longer-term inflation. We'll have to wait and see. For a primer on how to position portfolios for either outcome, head to our previous post on investment scenarios for inflation versus deflation.

Hedge Funds: Very Short 10 Year Treasuries

Societe Generale is out with the latest edition of their hedge fund watch and in it we see that they've found hedge funds to have the "shortest position ever on bonds." That language is slightly misleading as they've only been tracking these exposure levels since 2005, but still. The fact that hedge funds have more than 270,000 short contracts on the 10 year treasury bond certainly speaks volumes. This comes a few weeks after SocGen initially published research that hedgies were net short 10yr Treasuries. It's very evident that hedge funds are concerned about inflation and the impending Federal Reserve rate hike (whenever it may eventually come). As we've covered numerous times in the past, many hedge funds have put on curve steepener trades in order to play this.

As you'll see from the chart below, hedgies certainly are short bonds:



In their research, SocGen also found that hedge funds still had large short positions in 30 year treasuries as well. They've been net short all year to the degree of around 100,000 contracts on average. So, they are certainly short the 10 year to a larger degree than the 30 year. Retail traders/investors who want to piggyback this play can short the exchange traded fund IEF for the 10 year and TLT for the 30 year. And as always, keep in mind that this should not be construed as a recommendation to buy/sell various securities.

Societe Generale's other main conclusion regarding hedge fund exposure levels was that hedgies are "strong net sellers of the yen (50,000 contracts net short)." Additionally, we see that hedge funds are buying US dollars in spades against all the other major currencies. This falls in line with what we've seen recently as hedge funds were aggressively short the yen. Interestingly enough, after re-shorting the euro recently, we now see that short positions on the euro have been reduced over the past few weeks. If you don't have access to forex markets, you can play the yen via exchange traded fund FXY. You can also play the US dollar via UUP and the euro via FXE.

Lastly, turning to equities, we see that their research comes to similar conclusions as the Bank of America research we typically cover. In that report, we saw that the smart money was selling equities. SocGen confirms this writing, "even though index price is rising, the percentage of non commercial positions on total open interest on the S&P 500 has decreased significantly." Their research shows that hedge funds are now net sellers of the S&P 500 while still slightly net long the Nasdaq.

Embedded below is Societe Generale's latest hedge fund watch document:



You can download a .pdf here.


So, the trend remains in tact. Hedge funds are pushing the limits on a steep yield curve as this is certainly a crowded trade. Hedgies are massively short the 10 year treasury but also have quite a trade against the 30 year treasury as well. While some agree that inflation is not a near-term problem and instead is a long-term concern, it's very apparent that hedge funds anticipate interest rates to rise in the future. For more on the latest hedge fund exposure levels, head to our post on how hedgies are selling equities.

Whitney Tilson's Hedge Fund T2 Partners: Annual Letter

Whitney Tilson and Glenn Tongue's hedge fund T2 Partners has put out their annual letter. In this latest letter to investors, they address the macro environment, talk about how their portfolio fared, and discuss their largest long and short positions.

Since hedge funds often do not reveal their short positions, we wanted to make special note of this glimpse we get into their short book. We had previously seen some of their shorts, but the list below is more expansive. Whitney Tilson and many other prominent hedge fund managers will be presenting investment ideas at the Value Investing Congress May 4th & 5th in Pasadena and we highly recommend attending. We've secured a discount to the event for our readers so make sure to use discount code: P10MF5.

T2 Partners' ten largest short positions heading into this year were (in alphabetical order):

1. Capital One (COF): In T2's letter, Tilson and Tongue mention that this is a hedge to their long of American Express (AXP).

2. Dow Chemical (DOW): This is a hedge to their long position in Huntsman (HUN).

3. Homebuilders (various plus an ETF): T2 Partners has been bearish on the housing market.

4. InterOil (IOC): Tilson has been bearish on this name for a while and argues that all their press releases (there's a lot of them) have artificially lifted the stock higher on no substantial news.

5. iShares Barclays 20+ Year Treasury Bond (TLT): We now see yet another hedge fund shorting long-term treasuries as a bet on rising interest rates, inflation, etc. This was one of Howard Marks' main recommendations in his recent plays for inflation. One of the original hedgies Michael Steinhardt himself has called treasuries foolish. Legendary investor and ex-Quantum fund manager Jim Rogers shares this sentiment and dislikes treasuries. Hedge fund legend Julian Robertson is betting on higher interest rates and is doing so via constant maturity swaps (CMS).

6. iShares Dow Jones Transportation Average (IYT): This appears to be another macro hedge.

7. Moody's (MCO): T2 Partners joins hedge fund colleague David Einhorn & Greenlight Capital who are also short MCO. In Einhorn's recent investor letter, he mentioned how this short position has been causing them pain, but they still feel Moody's faces headwinds.

8. Netflix (NFLX): Shares are up sharply on this name after they just reported earnings. This stock had been heavily shorted by hedge funds and looks to be causing everyone on the short side some pain.

9. Retail HOLDRs (RTH): This seems to be another macro hedge/short as they wager against consumer spending, and in particular discretionary spending. This gives them exposure to a basket of names.

10. Vistaprint (VPRT): This short position is intriguing because we've known many other hedge fund managers to be short. However, a few prominent hedgies also have long positions, so it's interesting to to note the difference in opinion. When we looked at the portfolio of Stephen Mandel's Lone Pine Capital, we noticed they had a large Vistaprint stake. Additionally, fellow hedgie Matt Iorio and his White Elm Capital had been long. We'll have to see which side of hedge fund land wins this battle.


Moving on, we also got to see their twelve largest long positions as of 12/31/09 and they are as follows:

1. General Growth Properties (GGWPQ): We recently covered their thoughts on GGWPQ.

2. Berkshire Hathaway (BRK.A/BRK.B): Tilson was recently out talking about how he thinks Berkshire is undervalued and how it could be added to the S&P 500. His latter point just recently came to fruition as BRK.B replaced Burlington Northern in the index. This creates a ton of buyers as index funds will need to buy $38 billion worth of BRK.B, around 23% of the total shares outstanding.

3. Iridium stock/warrants: They note that it is growing very rapidly and has taken market share from competitors.

4. Microsoft (MSFT): They think this name is cheap, safe, and rapidly growing.

5. American Express (AXP): While they have been trimming their long position as it has risen, they deem it currently at 'reasonable valuation' and continue to hold.

6. Huntsman (HUN): They believe the company is now well poised to ride out the economic crisis after their net debt declined by almost $3 billion and they have no more meaningful maturities until 2012.

7. Pfizer (PFE): We've started to see a lot of smart investors pile into this name. Fairholme Fund manager Bruce Berkowitz has a large Pfizer position. Also, we recently noted that Pfizer was the second most popular stock held by hedge funds. Berkowitz is certainly not alone in his fondness for this name. John Griffin's hedge fund Blue Ridge Capital had Pfizer as their third largest US equity holding when last we checked.

8. dELiA*s (DLIA): T2 Partners likes this name because it has a low probability of permanent loss of capital and a good chance of making multiples on their money.

9. Sears Canada (TSE: SCC): Tilson notes, "This stock trades at 4.2x trailing EV/EBITDA, around half the valuation of comparable retailers."

10. Yahoo! (YHOO): This is definitely a contrarian play in the tech space as most of the hedge funds we follow are long Google (GOOG). T2 believes that Yahoo's intrinsic value is nearly double its current price.

11. Fairfax Financial (FRFHF): They feel this is a "diverse collection of high-quality insurance businesses at a discount to intrinsic value."

12. Wendy's Arby's Group (WEN): They are confident Nelson Peltz and his team can turn Wendy's around just like they did with Arby's.


So, there you have their long and short positions. Embedded below is hedge fund T2 Partners' annual letter in its entirety (RSS & Email readers will need to come to the site to see it):





For more great investment ideas from hedge fund managers, make sure to check out the Value Investing Congress May 4th & 5th in Pasadena. We've secured a discount to the event for our readers so make sure to use discount code: P10MF5.

For more insight from Tilson & T2, head to our coverage of hedge fund T2 Partners.

Hedge Fund Exposure Levels: Still Very Long Equities

Bank of America Merrill Lynch is out with some recent data on hedge fund portfolio positioning as of the first week of December. Per their hedge fund monitor report, we see that hedge funds were still very much long equities as they have overweighted that asset class as well as energy and precious metals. We also learn that they were covering shorts in 10-Year Treasuries and the US dollar index. Those two short positions have been widespread in hedge fund land for some time now as hedgies bet on inflation via rising rates and a weak dollar. While in the past we've covered specifics like what ten stocks are most popular amongst hedge funds, we're taking a step back today to highlight the broader picture.

Overall Exposure Levels

Long/Short Equity Hedge Funds: While most L/S funds typically have had 30-40% net long exposure historically, December kicked off with hedge funds net long by around ~45%. This comes after long/short funds had hit a multi-year high level of 50% net long in mid November. Some recent action by these funds suggest that their inflationary expectations are declining and they have been shifting from value and high quality names into small cap names.

(click to enlarge)

Market Neutral Hedge Funds: They note that market neutral funds have stuck to their name and have gone back to 'neutral,' having spiked in weeks prior. Overall, they are largely neutral on equities and have negative inflationary expectations.

Global Macro Hedge Funds: Additionally, global macro hedge funds have been in a 'crowded long' of the S&P 500 and have also been in an even more crowded long of emerging markets. Bank of America Merrill Lynch's readings on net long emerging market positions are at the highest they have been since August 2008. They also apparently have been selling 10-Year Treasuries and have been modestly covering shorts on the US dollar (a crowded trade).


Commodities

We also now want to turn to commodity exposure levels as they have taken center stage again with Gold's parabolic rise.

Gold: Their research indicates that in the first week of December, large speculators were selling gold. However, this is still very much a crowded trade to the longside. They note that gold completed what they call a 'head and shoulders continuation pattern that projects up to $1300-1350.' So, interesting to see their price targets on the precious metal as those levels fall largely in line with technical analysis price targets on gold that we've seen. Also, we've recently covered the latest offering from hedge fund icon John Paulson. Those interested in gold should read his rationale in our in-depth post on his new gold fund.

Silver: They are noting that large speculators were buying silver somewhat at the beginning of December and that it is stuck in a trend channel. Their target upside is in the $20 area and they see support in the $14-15 range. The long-term upside target on silver is an old high of $50.

Copper: Well, Dr. Copper was holding steady as large speculators pretty much left their net long position unchanged. They note that copper has an upside potential to $350 while they are identifying support in two areas: $290 as well as $260.

Platinum: Large speculators mildly increased their bets on this metal in the first week of December. After falling off last year due to weak automotive demand, the metal has bounced back and has support at $1250 and resistance at $1500 according to Bank of America Merrill Lynch's research.

Crude Oil: In this commodity, large speculators held their steady net long positions as of the first week of December, having been selling at the end of November. They note that crude has been trading in a sideways range of around $65-75 since July and a breakout above this area would obviously prove to be bullish. They end their note saying that the "crowded long position remains a contrarian negative." We also recently highlighted a technical analysis video on crude oil that identified a potential pattern in this commodity as well.

Natural Gas: This commodity has been on a deathspiral for some time and it looks set to continue. As of the first week in December, large speculators were holding their deep net short position. Bank of America Merrill Lynch has commented on current action, saying it "appears to be in a broad base-building process."


Fixed Income

Moving lastly to fixed income, we thought it would be prudent to check in on hedge fund positioning as it relates to US Treasuries. As we've detailed on Market Folly before, there have been tons of prominent hedge fund managers involved on the short side of this trade. Many prominent hedge funds and market gurus have previously warned of inflation and have shorted long-term US treasuries. One of the original hedgies Michael Steinhardt himself has called treasuries foolish. Legendary investor and ex-Quantum fund manager Jim Rogers shares this sentiment and dislikes treasuries. Hedge fund legend Julian Robertson is betting on higher interest rates and is doing so via constant maturity swaps (CMS).

There are also managers playing the other side of the trade as bond vigilante Bill Gross of PIMCO is betting on deflation and has been buying treasuries. What's interesting here is that technically, both sides of the trade can win. One side of the trade could profit from short-term ebbs and flows, while the other side of the trade could win out in the long-run. It will arguably take years for the final verdict to play out, but that doesn't mean money can't be made in the mean time.

Here is the latest hedge fund positioning on 30-Year Treasuries, 10-Year Treasuries, as well as 2-Year Treasuries:

(click to enlarge)

That wraps up Bank of America Merrill Lynch's coverage of hedge fund exposure levels as of the first week of December. While it's good to see overall hedge fund exposure levels, those of you wanting more specific positions can head to our post on the top ten stocks owned by hedge funds. It's interesting to see how hedge funds are positioned heading into the close of the year and we're sure they'll be adjusting once the new year starts as well. To see how hedge funds might position themselves for next year, check out ten investment themes for 2010.

Treasuries At Resistance (TLT Chart): Will the Trend Hold?

Kevin has recently brought a great chart to our attention. He pulls up the TLT which is essentially the 20 year treasury in exchange traded fund form. While some could argue technical analysis on this vehicle is a moot point, we still think there are some interesting observations at it has held numerous trendlines in the past.

This time around, Kevin has targeted $95 as the line in the sand for TLT. And, we completely agree with that. If you look at past trends for treasuries/bonds, you'll see that they typically put in a seasonal low around May or June. We are obviously right in the midst of that. What makes this interesting is that TLT is currently bumping up against its downward trendline (the red line), possibly set to breakout to the upside. This scenario would yet again solidify the seasonal aspects bonds have exhibited in the past. This might seem like mumbo-jumbo to some people, but it's still interesting to at least highlight.

(click to enlarge)

Currently, TLT is facing double resistance: from the downward trendline and also from the previous low established back in early May (the green horizontal line). So, watch this current area as a pivot point for the next big move in treasuries/bonds. If resistance holds, you can get short. If it breaks resistance, then get long for a trade. Either way, this vehicle often represents the inverse of the equity markets. So, a breakout in treasuries (people flocking to 'safety') would obviously be bad news for equities.

We saw this phenomenon in a big way back in October/November of last year. While it is unlikely we'd see that violent of a decrease in equities (and subsequent rise in TLT share price) again, the fact that numerous people have been calling for more downside is a cause for concern. This suspicion could possibly be confirmed if treasuries breakout to the upside. At the very least, it's an interesting indicator to monitor.

For additional thoughts regarding treasuries, make sure to check out hedge fund legend Julian Robertson's steepener swap play. That bet has sparked a lot of conversation in the debate as to which direction treasury yield curves are headed. Julian argues that they are headed 'steeper', while many others argue 'flatter' in a reversion to the mean trade. And, this is obviously very relevant because if TLT breaks out to the upside as hypothesized above, that would indicate the yield on the 20 year Treasury falling. (Remember, bonds have an inverse relationship between price and yield). Those betting on inflation and yields rising (by shorting TLT) have certainly had their way since the start of 2009; yields have risen and TLT has plummeted. Now it's time to see if the trend holds or not.