FINANCIAL MARKETS "ON THE LAM"
Why Lehman, AIG and Merrill rocked your Monday, and what's coming next

 
 
Normally, we try to publish GreenThought$ about 3-4 times per month.  Given the chaotic events of this past weekend, and the drama of today's global stock market session, we thought we'd disrupt the normal format and add some thought$  today. 
 
WHAT HAPPENED?
 
With major financial institutions being thrown around like players in a Fantasy Football league, we asked ourselves why.  The key to us is that by being part of a bank, Merrill can now do one important thing that banks can do and brokers can't - tap the lending pool available through the Federal Reserve bank.  In our opinion, anyone who says its good news (and some will) when major Wall Street firms run to the government for help is either a dreamer or owns the stocks of the companies in question, and is trying to put lipstick on a well, you know the rest.
 
 
WHAT DO, WE, AS INVESTORS DO ABOUT IT?
 
As we have said in this space many times before in this space, managing a portfolio in bear markets (yes, we are in one for stocks, and possibly soon for bonds too) requires a different set of rules versus those used in the 1980s and 1990s.  Replace buy-and-hold and traditional asset allocation with a more FLEXIBLE and ADAPTIVE approach. 
 
 
HOW IS EMERALD POSITIONING FOR WHAT HAPPENS NEXT?
 
For the past few months, our strategies have been positioned for the kind of market shock we saw this weekend.  While we didn't know the exact cause a few months ago, there were so many possibilities for what would cause the next leg down in the stock bear market, the odds were in our favor that something bad would happen.  You don't clean up a 20-year mess in a few months. 
 
Here's a quick recap of what we are doing in our strategies in this environment:
 
HYBRID
 
During the past two months, we reduced our exposure to commodities and commodity stocks, which had been a major source of profits for Hybrid in the previous two years.  We did so in the midst of a large and sudden reversal in commodity prices that began in mid-July.  However, even holding a modest commodity weighting through a few of our managers was enough to produce a decline in the overall portfolio. 
 
We also eliminated positions in two mutual funds that short the bond market - one shorts U.S. 30-Year Treasury Bonds, the other High Yield Bonds.  While we still feel that inflation and the rapidly rising U.S. Government deficit will ultimately force Treasury yields higher, we are now in a time where U.S. Government Bonds are considered a "safe haven" for investors around the world (though perhaps not for long). 
 
Now the storm we anticipated is here, and if it continues, we will look to take advantage of further market declines.  We have and will do so by adding to our already significant short positions, adding to some of our favorite core holdings, and by seeking to add new positions in mutual funds whose styles don't rely heavily on higher stock prices to succeed.  Arbitrage strategies are one example.  Hybrid and our other strategy models held higher cash balances over the past two months than at any time in their history.  We have slowly started to put that cash to work.
 
CONCENTRATED EQUITY
 
A 10% hedge position and the 20% cash balance we are holding, give us a ton of alternatives going forward.  We can add to the short position, buy one of the equity funds we have been eyeing for some time, do both or neither. 
 
GLOBAL CYCLE
 
Global Cycle's 10-year investment time horizon allows us to be very patient.  Still, 2008 has produced such volatility that we have felt the need to make changes more quickly than usual.  We built up cash during the summer after selling our oil position up near its July peak.  We expect to put it to use over time in some contrarian themes, and there are many to choose from given the huge price declines in commodities, housing and financial stocks.  We also have a position in a mutual fund that actively shorts stocks, and will not hesitate to increase our short position in Global Cycle, as with the other strategies.
 
If you would like to receive the GIPS compliant performance history of our strategies, you can do so by email request to mmichaelides@emeraldeas.com   We'll continue to keep you in touch with what we are seeing and how we are reacting. 
 
The preceding article is not a complete analysis and should not be considered investment advice.  Emerald Asset Advisors, LLC is a registered investment advisor.  If you would like to receive more information about Emerald, please contact us for a copy of our disclosure document, Form ADV Part 2 and Schedule F.

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