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When Leverage Gets Unwound...

Fri, Oct 3 2008, 06:32 GMT
by AdviceTrade.com Team

AdviceTrade.com

Q&A with Jay Matulich, Septos Capital Management

What do you see happening with the markets?

What's going on with the markets is what I've been talking with you about for the last year -- that there's a great unwinding of leverage going on, and it's going to continue until at the earliest the middle of next year. What that has done is put a tremendous amount of pressure on selling all asset classes. This winding down of leverage has gone from subprime into other mortgage products and mutated into other areas of the debt market. This has caused all asset classes to be under pressure, since basically all the asset classes from March 2003 went up together, a correlation of 1.0, except for the dollar. As leverage gets unwound all positions get taken off, and it's been very vicious.

What have you done to protect yourself and your fund?

Since last year back in the summer of 2007 I've been saying that cash was a good position to be in, not knowing it was going to be a great position to be in, as I look at it now. I would be still be in cash preserving capital for the next market cycle. We've had a bifurcated bear market, quite frankly. I've never really seen one before like this where the major averages are down, but you've got underlying sectors that are just decimated. Financials have been decimated, so the value players that have been in the financials for the last 2 1/2 years have just done awful. And now the big momentum players that were the ones doing well up in the spring time are now as bad off or even worse than the value players. With the basic materials going down and with technology now going down in a big way, specifically in the basic materials area, commodity stocks have just taken a round trip, and gains over the last nine years have almost all evaporated.

You've been getting far better returns this year than merely the interest on cash. What have you been buying -- or shorting?

If you remember back in July I said that I thought commodities were a big sell and that's where I did very well. I think that now at least for the next six months any rally you see in the commodity sector, whether it be fertilizer stocks, the shipping stocks, even in the energy sector, wherever you see rallies now you can short those rallies, because these stocks have gone from momentum plays to value plays. And when they go to a value play it means they're going to be rocking along the bottom or making new lows for a while. I think we're in a global recession and we started this global recession when the fertilizer stocks peaked in the spring time.

Should one be shorting this market?

Right now I'm basically in cash. I was short some last week and was in good shape. I'm reticent to go short here because I think the government could go into the futures market and buy stock index futures at any time because there's such a confidence issue with the market that I just don't want to be short, because any type of short gains could evaporate in two minutes with this type of market. So I'm waiting for what I think will be a short-term rally. I think we're close to that. How long that rally lasts, I don't know. I think we have the makings in the next few days going into early next week of a rally going into the election where I think we could get a 10-15% rally in the S&P. It might be choppy but we still could get there. However, you've got to be nimble about it and you've got to be very flexible, because I just don't think these problems are over with. We've got a lot more to go as far as this unwinding of leverage and write-downs go.

How important is tomorrow's vote in the House in the long term?

I think in the long term it's not very important. In the short term I think it is because it kind of puts a finger in the dike. I think the $700 billion will get used up a in minute, there's so much bad paper out there. I think the $700 billion will be like a toxic incinerator, so to speak, it'll just be chewing up the worst paper around, and there's a ton of it out there. When it's all said and done instead of $700 billion you could be looking at $2 trillion-plus.

So we rally even if the House votes the bailout bill down?

I just think there's been enough selling in the marketplace that we could get a big washout, followed, as I said, by a rally into the election. It's also possible that they don't bring it to a vote tomorrow if they don't have the votes.

What would you be buying if we do rally?

The general indices, and financials. They have basically had a put with those shorting rules and the fact that they have been going down for the last 2 1/2 years. Again, I say this as a very short-term rally and trade. I'm still very cautious on this whole market. For people laden with equities that are still over-invested, if we do get a good rally I would use it to lighten up, to tell you the truth.

This bailout is not a savior like a lot of people think. A lot of people have been saying this is RTC2 -- the Resolution Trust Corporation 2. It's not. The original RTC set up for the S&L crisis was basically for bad banks with good assets. Here we have good banks with bad assets. It's just not the same and not even close, and these bad assets are what's taking a lot out of this economy.

So again, I think there's an imminent rally but it's just very short tem, and then we're back to where we were before. And the unwinding of this leverage that we're going through here is just starting to happen in Europe, and I think the biggest problems in the next months come from Europe.

Parting shots?

The markets that we've had over the last year, especially in the last four months, I think, show investors that they need to be active, they need to be on top of things, they need to be able to separate the wheat from the chaff, so to speak, and who they listen to on television. It seems like now everybody's got an agenda, the basic agenda being always to keep assets, whether it's a portfolio strategist, an analyst, some pundit who's being paid by brokerage firms for advertising. Their goal is to have you keep your assets with them. And you've got to get smarter and be able to manage these on your own. Because that's the only way I think, that the individual investor is going to be able to outperform the general market going forward.

Published on  Fri, Oct 3 2008, 06:34 GMT