Griechenland Bezahl' Deine eigenen Rechnungen

This commentary is going out later than usual to coincide with the 3-year anniversary of one of the reasons I am living and working in the BVI — the Lehman Brothers bankruptcy … my beloved, albeit now infamous, former employer.  After the bankruptcy, I was fortunate enough to go on to Barclays Capital as part of their acquisition of Lehman; however, during the several weeks I had off while the two banks’ trading systems were being integrated, my friend, Steve, and I began to hatch a plan to sail the Caribbean. While we had no sailing experience, at the time, we thought getting out of the toxic atmosphere that was Manhattan was probably the healthier option (see Streak Freak below) Fast forward 3 years, and I am still in the Caribbean, Steve is married to a woman he met on Virgin Gorda and living back home in San Francisco, and the markets are once again in a similarly precarious position as to when I left.

Solvency issues that should have been contained to Greece and other periphery European countries are spreading and possibly metastasizing in some of Europe’s largest banks and insurance companies (see table below). As such we have shifted our base case scenario from the European crisis being successfully contained and minimal disruption to the European financial system to a base case where Greece defaults and possible one or multiple large European institutions need to be bailed out. 

Source: Financial Times

As a result, we have decided to ride out the current market uncertainty with a relatively conservative stance across all of our portfolios. This means we have been slightly more active over the past several months in terms of re-positioning our portfolios than we would generally like to be and have reduced high beta equities and commodities exposure, while maintaining or increasing our fixed income positions.  


Additionally we rolled our put hedges to the SPY Oct 2011 115/105 put spread and/or maintained our VXX position. (After initial success these put spreads have not produced much in terms of current returns however they have significantly reduced portfolio volatility and allowed us to sleep better knowing we are protected should the market make another big downside move.)  We expect to maintain this defensive stance until there is more clarity on how European banks will be supported in the event of a Greek default. 

We will be looking to buy again near this year’s lows (around 1100 in the S&P 500), as long as any combination of the following catalysts (with the last one being most important) are met: further stimulus from the US Fed (expected next week), the passing of Obama’s jobs bill (unlikely given the mess in Washington, but if a majority of the plan is passed then the market should rally), and Europe finally resolving their issues and insulating European banks from Greece and the other PIIGS (no longer our expected outcome).  If we get any combination of these, then we should see a huge buying opportunity possibly similar to March 2009.  Until then, we are willing to sit on the sidelines holding relatively conservative bonds and safe-haven commodities with little to no exposure to equities.  The obvious risk with this strategy is that if things are less worse than expected then the market could quickly rally higher and we will miss out on the upside.  For now, we are willing to accept this risk.

For the rest of this commentary I am going to defer to an excellent blog post from another investment manager that articulates the European dilemma much better than I can:

This week, the German Constitutional Court ruled that Germany’s role in supporting the EU’s periphery was not unlawful. The market’s knee-jerk reaction was to blast higher on the news, as the alternative would have been a total disaster. Upon closer inspection, it appears that smooth sailing into the future is far from certain. The court stressed that the decision was not a “blanket” approval for future bail-outs and demanded that the German Government “ask permission” of the Budget Committee before handing out any more cash to their southern neighbors. At the end of the day, this means that future bail-outs will be even more difficult to execute as the process is slowed further by administrative tape around afternoon siestas.

This is important. Time is quickly running out for the EU. The lack of a comprehensive solution after two years of “can kicking” means that the periphery’s disease has infected the core and the odds of a disorderly default have increased substantially. Rather than proactively addressing the challenges in the region – restructuring debt, recapitalizing banks, promoting growth, etc. – policymakers have waited for market’s to force their hand and only then, did they plug another hole in the periphery with their finger. With one year Greek debt within spitting distance of 100% yields, they are now running out of fingers. With Italian and Spanish yields back on the rise, the holes are getting too large to plug. Something’s gotta give.

To read more please go to http://www.viewfromtheblueridge.com/2011/09/09/you-lick-mine-first/

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On a final note: to read more about Lehman Brothers (and maybe a little more on why I considered the high seas as possibly safer than an investment bank trading desk) read Streak Freak, written by the former head of my ETF Trading desk, Jared Dillian.  

Just the Facts: S&P's $2 Trillion Mistake

Just the Facts: S&P's $2 Trillion Mistake: "In a document provided to Treasury on Friday afternoon, Standard and Poor’s (S&P) presented a judgment about the credit rating of the U.S. that was based on a $2 trillion mistake. After Treasury pointed out this error – a basic math error of significant consequence – S&P still chose to proceed with their flawed judgment by simply changing their principal rationale for their credit rating decision from an economic one to a political one.

S&P has said their decision to downgrade the U.S. was based in part on the fact that the Budget Control Act, which will reduce projected deficits by more than $2 trillion over the next 10 years, fell short of their $4 trillion expectation for deficit reduction. Clearly, in that context, S&P considers a $2 trillion change to projected deficits to be very significant. Yet, although S&P's math error understated the deficit reduction in the Budget Control Act by $2 trillion, they found this same sum insignificant in this instance."

“Just when I thought I was out … they pull me back in.”

For some reason that quote by Michael Corleone from The Godfather: Part III keeps popping into my head. For the past several months, each time we get a glimpse of a reprieve from volatile markets, new (or old) issues surface. Just when I think we have blue sky ahead, new clouds appear …

Yesterday’s market action was extremely ugly. FX intervention by the Japanese Central Bank and the Swiss National Bank enacted to weaken the Yen and Franc forced investors out of their safe-haven holdings (Yen and Francs) and simultaneously to reduce their riskier holdings—equities, commodities, etc. Furthermore, this intervention combined with weak global economic data, particularly in the US, and signs that the European Debt Crisis is spreading to larger, systemically more important countries such-as Italy to produce near panic selling.

Fortunately, last week (Thursday, July 28), we hedged some of the equities exposure for our clients invested in our 5 Model Portfolios because of the politics that were taking place in Washington. These hedges act like an insurance contract, going up in value when the markets go down—therefore protecting our clients’ portfolios if/when the markets decline. For the hedges we used one of the following strategies:

• VXX: We used the VXX ETN, which was created by my trading desk while at Barclays Capital. (In fact, I was one of the first traders to ever trade the product in 2009.) VXX tends to go up when market volatility goes up and the markets go down. 
• Vertical Put Spread: For other portfolios, we used an option strategy known as a Vertical Put Spread. For this hedge we bought the SPY Aug 20, 2011 132 / 124 Put Spread (SPY was trading around 131 at the time), which provides downside protection below 132 in the SPY, an ETF that tracks the S&P 500. 

These hedges were our response to a unique short-term opportunity where we thought we could avoid unnecessary market turbulence associated with the debt ceiling debate—effectively canceling out some of the downside market movements. Initially, we intended to only hold these hedges through the resolution of the US debt deal, however given weak global economic data and the resurgence of Europe’s debt issues we decided to maintain the hedge, which has proved a wise decision.

Please do not hesitate to contact us to learn if your portfolio is properly diversified for the current economic environment or to learn more about the hedges described above.

Bottom Line: The likelihood of some sort of QE3-like action by the US Fed has significantly increased over the last several days. Furthermore, Jean-Claude Trichet, of the European Central Bank, will likely announce additional stimulus soon as well. If/when this occurs it should provide a lift to the markets and continue downward pressure on the US dollar. In the meantime, all markets (including commodity currencies which have performed extremely well despite the world’s economic woes) will continue to be volatile; meanwhile safe-haven assets such-as Treasures, gold and possibly even the US Dollar could outperform.

Finally, at the risk of sounding like a broken record, in times of market stress like we are experiencing now it is always important to remember that these market moves are relatively minor in the context of a long-term investment strategy. As always we will diligently take the steps that we feel are appropriate to protect your portfolio—currently this is via an equity hedge and through safe-haven assets such-as US Treasuries and Gold.

PRESS RELEASE: Offshore Investment Advisor and Josh Ungerman write a White Paper on ‘Accidental Americans’ and the Offshore Voluntary Disclosure Initiative

TORTOLA, BVI – July 19, 2010 – Offshore Investment Advisor, a Registered Investment Advisor in the Caribbean, in association with LGS & Associates, announced today that it has teamed with Josh Ungerman of Meadows, Collier, Reed, Cousins, Crouch & Ungerman, L.L.P., to raise awareness within the Caribbean community on some of the tax implications associated with being a dual citizen with a US passport or US birth certificate.

“We are pleased to have teamed with Josh Ungerman, as part of our new financial education campaign called ‘Raise Your Financial IQ’, to write this White Paper and educate individuals on the IRS’ new Offshore Voluntary Disclosure Initiative,” said James Bridgewater, principal of Offshore Investment Advisor. “At Offshore Investment Advisor we believe that wealth management is more than simply helping clients create and manage portfolios tailored to their unique financial needs.  It is as much about minimizing unnecessary losses due to penalties associated with improper tax reporting or relying on very conservative securities, such-as short-term CDs, that currently offer a negative real rate of return.” 

“It is not uncommon for residents of the Caribbean to travel to the United States, USVI or Puerto Rico and have a baby.  As a result, a relatively high percentage of Caribbean residents were born in a US territory and therefore are dual citizens of their home country and the US,” said Josh Ungerman, a former US IRS Chief Counsel Senior Attorney & US Department of Justice Tax Division Special Assistant US Attorney is one of the foremost experts assisting clients with US tax obligations.  “While there are many benefits of US citizenship, once an individual is subject to the US tax regime, the individual is taxed on his/her worldwide income.” 

Though this is shocking to some at first, it is not as onerous as it sounds because there are certain provisions in the new OVDI that allows for significantly reduced penalties provided that individuals take action before August 31, 2011.

This new White Paper educates individuals who have a US passport or birth certificate on the steps they need to take in order to meet their obligations to the US IRS.  In particular, it highlights the key requirements for an individual to be considered an ‘Accidental American’ and therefore qualify for significantly reduced penalties from 25% to 5% (or even 0%). 

“Ongoing financial education across the Caribbean is important to our ability to remain a vibrant, growing community and to evolve with the rapidly changing and increasingly complex offshore financial landscape,” said Lorna Smith, founder of LGS & Associates, a BVI-based consultant on international business and finance related matters.  “This White Paper will help individuals understand the new realities of this changing environment.”

Please visit http://www.offshoreinvestmentadvisor.com/Investor-Resources/white-papers to download the White Paper.

Media Contact:

James Bridgewater

Offshore Investment Advisor

james@offshoreinvestmentadvisor.com

284-495-4179

About Offshore Investment Advisor

Founded in 2005, Offshore Investment Advisor has established itself as a leading investment manager in the Caribbean by leveraging the strengths of TD Ameritrade Institutional, a globally recognized leader in brokerage and custodial services, as well as by working closely with our clients to understand their entire financial picture and then delivering on their specific financial needs and goals.  Headquartered on Tortola, BVI, we are a boutique provider of wealth and asset management to individuals, families, trusts and BVI employers.  Our services center on your unique requirements and include the following comprehensive solutions: Private Wealth Management & Retirement Plan Services. 

For more information please visit: http://www.offshoreinvestmentadvisor.com/

About Josh O. Ungerman, Partner

Mr. Ungerman specializes in the resolution of tax matters.  He specializes in IRS voluntary disclosure and has extensive experience in the IRS 2009 VDI Program as well as the current IRS 2011 OVDI Program.  The tax matters in which Mr. Ungerman is involved are typically very complex from both a factual and legal perspective. These matters often require legal and accounting skills.  Mr. Ungerman is also a Certified Public Accountant.

Prior to joining private practice in 1994, he was a civil prosecutor for the Internal Revenue Service, Dallas District Counsel office. He was also a Special Assistant United States Attorney for the Department of Justice Tax Division in Dallas during his time as a civil prosecutor.  Prior to becoming an IRS attorney of a special assistant US attorney, he served as a law clerk to the Honorable Carolyn M. Parr at the United States Tax Court in Washington, D.C.

Mr. Ungerman is a past President of the Dallas Bar Association and a past Chair of the State Bar of Texas Tax Section Controversy Committee.  He is currently a Fellow of the American College of Tax Counsel and is currently a Vice Chair of the American Bar Association Tax Section Civil & Criminal Penalties Sub Committee.

Mr. Ungerman was admitted to practice in Texas in 1990.

For more information please visit: http://meadowscollier.com/attorneys/ungerman-josh-o/

Gold hits a new high but pound for pound this puppy is worth more!

Gold is hitting new all-time highs on possible QE3 and safe-haven protection as the European debt crisis and US debt ceiling talks heat up.



But at 50 pounds, this puppy is worth more than his weight in gold (and may offer more protection):

"A red Tibetan mastiff has become the priciest dog in the world after being sold for 10 million Chinese yuan, or £945,000...  Big Splash, or Hong Dong in Chinese, was bought by a coal baron from the north of China."  To read more please see Red Tibetan Mastiff: 'Most expensive' dog sold for nearly £1m | Mail Online

Prepare for a Sell-Off When the Debt Deal Is Struck - Seeking Alpha

Prediction markets, like Intrade, are by no means the be-all and end-all when anticipating the likely outcomes of future events. Many times they can be thinly traded or poorly designed, among other issues. However, prediction markets can be a very useful tool for gaining information on an unknown future event and provide an additional data point to fill in missing or unclear information. So with that said: What does Intrade predict for the timing of a U.S. debt ceiling increase?

To read more please read: Prepare for a Sell-Off When the Debt Deal Is Struck - Seeking Alpha

No Rest For The Weary

Well that was an interesting month. An interesting six months really!  I can’t remember a time when there were so many breathtaking, heartbreaking, earth-shattering headlines: Middle-East uprisings, Japanese catastrophes, bin Laden dead, European sovereign debt crises, US debt ceiling debates, floods, etc.  And to top it all off the sensational and controversial conclusion of the “OJ Simpson-like” murder trial of Casey Anthony.

While the 1^st half of the year has been disappointing, we expect the 2^nd half to provide a better environment for gains as there is resolution on Greece/Europe and the US debt ceiling, among other things.  Very similar to last year, May and June were tough months; however July 2010 through December 2010 produced a 20%+ rally in the S&P500.  2011 could be similar as negative headlines wane—case in point: markets having already staged a tremendous rally over the last week of June and into July.

In June, our focus was on Europe where it appears that Greece has been given a new (temporary) lease on life.  Despite agreement on the Greek bailout, there are still questions on how a debt roll-over will be treated by the ratings agencies, whether or not the Greeks will deliver on their austerity promises, not to mention the health of other periphery European countries (in particular Portugal whose debt rating was lowered to junk by Moody at the time of this writing).  Despite these hurdles it appears that many of the near-term major issues have or will be been resolved.

Now in July, our focus has shifted to US politics where political empowerment seems to be taking priority over common sense and the need for financial stability.  In our opinion, Republicans need to compromise and agree to some tax hikes and Democrats to significant budget cuts.  However, so far, Republicans have been unwilling to compromise and this has manifested itself in predictions for if/when the US debt ceiling will be raised.  According to predication markets leader, www.intrade.com, there is only 33% chance that debt ceiling will be raised above $15.1 trillion by July 31, 2011.  See figure 1 below.

Figure 1: The chart above shows the likelihood that Congress will approve an increase in the US debt ceiling to $15.1T or more before midnight ET 31 Jul 2011.  Source: www.intrade.com

If the debt ceiling is not raised before the August 2nd deadline, then the current rally that resumed at the end of June will be hindered.  Despite the importance being given to raising the debt ceiling, it is important to note that the US congress (Republican and Democrat controlled alike) has raised the debt ceiling 22 times since 1981—from $1 trillion to the current level of $14.3 trillion (source: Wikipedia).  So this is nothing new.  What is different this time is the extraordinary polarization of American politics, partially attributable to the Tea Party’s rise to power in the past election.  We are confident that a deal will made, however the timing is questionable.

On a final note, I apologize for so much gloom over the past several commentaries … I am usually a much more cheery person!  Sometime (hopefully soon) the tone of these commentaries will turn rosy again and we will be talking about how many gazillions of dollars people are making from social media stocks or some other extraordinarily positive news.

Bottom Line: No rest for the weary.  Although we are getting close to resolution on most outstanding issues, it is not time to head to the Soggy Dollar to sip Pain Killers during the summer slowdown quite yet.  The US debt stalemate is a huge issue, but, as history suggests, it is a resolvable one.  As such, we still consider corrections as buying opportunities in select markets.  As we have stated over the past several commentaries, with resolution we should see a substantial lift to the markets.  We saw it with Greece; now hopefully we will see it with the US debt ceiling.  Should the situation in Europe significantly deteriorate again or the US Congress prove unable to reach an agreement, then we will reassess our position.