Prologue Capital on the US Housing & MBS Markets

Today we present some interesting commentary on the mortgage backed security (MBS) and US housing markets from hedge fund Prologue Capital.  Prologue is a $2.1 billion global macro fixed income manager that focuses on inflation-linked investments. 

Their latest commentary features thoughts from portfolio manager Noah Estrin and Chief Economist Tomas Jelf and they believe that the housing market will shift from a headwind to a tailwind.


Prologue writes that,

"A modest increase in home prices from current levels will translate into a large swath of credit impaired borrowers being able to refinance, significantly increasing mortgage supply. However, the doves at the Fed will be reluctant to step away from the assistance they are providing the economy until they are 100% certain that the recovery can stand on its own."

Prologue sees housing starts "increasing by around 60% to 1.5 million in the next 2-3 years, which brings it in line with natural rate of household formation."  They also highlight a shift in housing-related employment which is growing at an accelerated pace.

You can read the entirety of their thoughts below, but suffice it to say that they feel the "positives outweigh the negatives" in the US housing market and that Spring has sprung.

Embedded below is Prologue Capital's commentary on the MBS market and US housing market:

Hedge Fund Prologue Capital's Latest Macro Outlook

It's been a while since we checked in on global macro hedge fund Prologue Capital, so let's get their latest economic assessment. We track the fund as they've shown solid performance through very rough waters, up 18.86% in 2008 and up 12.41% in 2009. Prologue was up 3.69% for the year as of the end of June (net of fees). In the fund's second quarter letter, Chief Economist Tomas Jelf echoes chairman Bernanke's declaration that the US economic outlook remains "unusually uncertain."

The $1.014 billion hedge fund points to strength abroad, notably accelerating economic output in India and Singapore as well as a strong recovery in Germany and the United Kingdom (following the earlier fiscal stresses). This comes after their previous commentary where Prologue saw cause for concern.

Jelf notes that the US saw mostly strong corporate earnings in Q2 yet key economic indicators (confidence, employment, housing and consumer spending) suggest a sluggish recovery ahead. The one bright spot was the improvement in capital expenditures. Second quarter GDP estimates have been reduced to 2.5% in light of the harsher economic reality. Jelf foresees continual deleveraging in the corporate sectors and the perseverance of low rates as the Federal Reserve becomes more cautious.

He argues that the picture in Europe is not nearly as bleak, as the markets have reacted favorably to numerous indicators surprising to the upside. Investor confidence has also benefited from the increased transparency following the completion of the bank stress tests. Weak credit growth and fiscal difficulties still pose challenges in the future.

Given all of the above, how is Prologue positioned? They plan to generate returns via the following core strategies:

- Structurally long duration, particularly in the US via forward swaps and higher yielding countries where appropriate.

- Active participation in the underwriting process of government bonds.

- Exploiting dislocations between futures, cash, swaps and mortgages.

- Relative value strategies within core country yield curves.

- Short Europe vs. the US and the UK.

Definitely an interesting approach by the global macro firm given all the uncertainty out there. For more insightful commentary from hedge fund Prologue, they previously detailed why macro factors are positive for risk assets. In terms of other hedge fund manager commentary, Crispin Odey also recently said that equities remain attractively priced but unloved.

Global Macro Hedge Fund Prologue Capital Sees Cause For Concern

Global macro hedge fund Prologue Capital is out with their most recent letter to investors. They immediately address the most volatile month in the markets this year wondering, "Was it all just a storm in a teacup? And if so, will the economic recovery continue unabated? We don't think so. Rather, recent events are symptomatic of economic and financial vulnerabilities that will remain for some time." This is an interesting stance and we'll detail how they've positioned their portfolio below.

While May was a brutal month for hedge funds, Prologue did well to avoid carnage as they were up 0.85% through May 28th. This brings their year-to-date performance to 2.80%. Prologue now manages over $1 billion and were up 18.86% in the crisis-ridden 2008 and up 12.41% in 2009.

In assessing the global macro scene, Prologue's Chief Economist Tomas Jelf evaluates the US, Europe, and UK. Economically speaking, Jelf feels that there are still two main concerns. He writes, "The fiscal accounts of most developed countries create two immediate problems. First of all, the need for fiscal consolidation is a drag on economies at a time when recovery attempts to morph into an expansion. Furthermore, governments' indebtedness limits their ability to provide the type of backstop we have seen in recent years. Second, banks have yet to clean up their balance sheets to a degree that removes solvency concerns."

Overall, Jelf notes that repairing balance sheets and fiscal consolidation takes time. As such, Prologue expects some sort of turmoil to return in future quarters/years. It's obviously hard to peg the timing of such turmoil, but they are more concerned here than they have been in recent months certainly. They are concerned that this could "create more drawn out risk asset deflation and potentially halt the recovery." This isn't the first time we've seen such concern from a global macro hedge fund. Louis Bacon's Moore Capital Management pondered a return to a bear market in their past commentary. At the same time though, Prologue fully acknowledge that this turmoil could amount to nothing more than just 'hiccups' on the road to recovery.

Focusing specifically on the US, Prologue highlights the slowdown in discretionary spending. They are also concerned by an assumed rollover in housing now that the home buyers credit has expired. Overall, Prologue expects "declining year over year inflation figures throughout 2010. That, coupled with the worsening growth momentum, may lead to a decline in inflationary expectations. Suffice to say that the Federal Reserve will keep rates on hold for a long time."

In the UK, Prologue thinks there will be ample opportunities to take advantage of given that the monetary policy outlook is quite uncertain. While inflation expectations there have risen, the Bank of England's models have led them to a continued dovish stance. In Canada, Prologue favors flatteners but also thinks that bonds are cheap relative to US Treasuries. In Australia, they've reduced their exposure to the currency until the monetary path is more lucid.

Given their macro assessment, let's see how Prologue is positioned. In their last commentary, they detailed why macro factors are positive for risk assets. This time around, they are certainly more cautious as the month of May seems to have given them cause for concern. Here are their latest positions:

- Tactically long duration in the US and Eurozone

- Continued active participation in the underwriting process of government bonds

- Cross market Fixed Income - long US vs UK

- Exploiting dislocations in futures versus cash and swaps caused by flight to quality fears

- Volatility in FX options

Unfortunately, we can't post up the actual letter due to revealing watermarks. It's always interesting to see how global macro hedge funds are positioned given the fragile nature of many economies and the constantly morphing economic landscape. Those of you interested in this macro hedge fund's views can see their past commentary. For more global macro research, we have previously detailed investment commentary from John Brynjolfsson's Armored Wolf. And to learn from some of the most knowledgeable global macro fund managers around, we highly recommend Steven Drobny's new book The Invisible Hands: Hedge Funds Off the Record.

Hedge Fund Prologue Capital Outlines Why Macro Factors Are Positive For Risk Assets

Global macro hedge fund Prologue Capital is out with their latest market commentary and we get a look at what themes they're playing. In Prologue's previous investor letter, we learned that they were bullish on Canada, Switzerland, and Sweden. This time around, their Chief Economist Tomas Jelf outlines that there are four broad macro forces in play currently:

1. Strong Global Growth Momentum
2. Close to Zero Percent Policy Rates
3. Disinflation
4. Fiscal Stress

As Jelf notes, "The first three are positive for risk assets and have so far outweighed the negative impact from fiscal stresses. The last three are positives for core fixed income markets and have, to a greater extent than we thought, neutralized the negative impact from positive growth developments. Thus we have been in an environment which is positive for risk assets and neutral for fixed income."

This obviously is quite straight forward as investors yield chase in an environment where interest rates are at the lowest of the low. As such, market participants are willing to take on more risk in exchange for potential return. Not to mention, as a reactionary response to the crisis, bond funds saw massive inflows. And now, capital that was previously on the sidelines has made its way into the equity markets in search of returns. A lot of the year-long market rally has been driven by liquidity as money seeks out a home. Prologue's macro summary outlines just why the environment is positive for risk assets. And while the environment is currently 'neutral' for fixed income, it will eventually shift to 'negative' once interest rates start to (eventually) rise.

Then you compare the above synopsis with Prologue's latest portfolio strategy. They have assembled positions in curve flatteners in small developed countries, are short duration in AUD, and are short the euro and the yen versus the US dollar. Additionally, they've employed relative value strategies "that take advantage of the supply calendar in Europe" and Prologue continues to also underwrite government bonds. Lastly, they are also long the Renminbi and gold. Does this look familiar? It should. As we've detailed countless times, hedge funds are aggressively short the yen and have also been short the euro in size. Of course many prominent hedgies have been long gold for quite some time as well and we've detailed their extensive fundamental research.

Prologue Capital has fared like many fellow global macro funds over the past few years. They avoided losses in 2008 and in fact were up an impressive 18.86%. Then, they returned 12.41% in 2009 and are up 1.88% thus far in 2010. So, while they've underperformed the markets in general recently, they certainly protected from losses when it mattered most. They currently manage just under $1 billion.

Embedded below is global macro hedge fund Prologue Capital's April letter to investors:



You can download a .pdf here.

As always, an interesting macro take from Jelf and the Prologue Capital team. For more global macro research, we also just yesterday posted up investment commentary from John Brynjolfsson's Armored Wolf which also presented a current look at where we stand. To learn from some of the most knowledgeable global macro fund managers around, we highly recommend Steven Drobny's new book The Invisible Hands: Hedge Funds Off the Record.

Prologue Capital Likes Forward Curve Steepeners (Investor Letter)

Below you will find Prologue Capital's December 2009 investor letter. Prologue is a UK-based hedge fund managing $800 million. They returned 6.92% in 2006, 7.47% in 2007, 18.86% in 2008, and 12.5% in 2009. They certainly didn't have any problems with the tumultuous markets of 2008. Their letter is part of our wisdom Wednesday series of documents and resources.

Chief Economist Tomas Jelf authored the letter and laid out their strategies for 2010:

- Forward curve steepeners in the US & UK

- Continued exposure to higher UK break even inflation

- Short UK gilts outright and against Europe

- Asset swap narrowers in Germany

- Cross market Eurozone bond strategies that short fiscally challenged countries against core Eurozone countries with healthier fiscal outlooks

- Long gold via options

- Continued active participation in the underwriting process of government bonds


So, some very interesting macro plays there as we continue to see hedge funds wagering on higher interest rates via curve steepeners. Howard Marks of Oaktree Capital has also recently outlined his suggested plays for inflation. Additionally, we've detailed how hedge fund legend Julian Robertson had been betting on higher interest rates via constant maturity swaps (CMS).

It's also interesting to see them play gold via options rather than owning the metal as this leveraged bet offers them more opportunity for upside. We've started to see a few other global macro funds favor options over playing the metal itself, which could be a rising trend. The various long/short equity funds we track on the site have favored owning physical gold (David Einhorn of Greenlight Capital). And of course hedge fund Paulson & Co (John Paulson's firm) has started a gold fund.

Embedded below is Prologue Capital's December 2009 investor letter:




You can also download the .pdf here.

We're continuing our theme of 'wisdom Wednesday' (yes we know, lame name) where we've been posting up insightful letters, research and resources from various sources. We've already posted up:

- Bill Gates' 2010 annual letter
- PIMCO & Bill Gross' February investment outlook
- Bank of America Merrill Lynch's hedge fund trend monitor report
- Corsair Capital Management's investor letter

Definitely check those out for more investment insight.