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Year End Review: Catamount Capital Preserved Clients’ Wealth in 2008

Jan 16, 2009

By proceeding, I acknowledge that I have read and understood the Disclosure and Copywrite Statements.

The numbers are in. The S&P 500 Index returned -38.5% in 2008 and -41.9% since the bear market began in October 2007. Most of the world’s stock markets behaved worse. Virtually every asset class including real estate, commodities, & bonds suffered severe losses.

Of the 10,720 domestic and 3,333 international equity funds, only 1 professional fund manager posted a positive return. Most of those managers lost 35-50%. On the other hand, Catamount Capital’s managed portfolios just barely slipped into negative territory after being up through the end of November. Catamount’s clients fared well compared to 99.992% of professional fund managers and the vast majority of the investment industry for one primary reason. We pared and hedged our exposure to the capital markets before the bear market began.

A number of investment professionals have criticized my tactics saying “Isn’t that market timing? Market timing is a losing proposition.” Here’s my response.

First of all, I really don’t consider myself a market timer – just a conscientious student of history, economics, finance, and the capital markets. From a macroeconomic perspective, anyone in my field who was paying attention could see that an enormous credit bubble was forming and that asset prices had become divorced from real fundamentals. I saw burgeoning credit, widespread real estate speculation, soaring home prices, and unbridled consumer spending. The evidence was everywhere. For instance, the savings rate for Americans was negative for several years while real wages and income from “productive” work weren’t rising. People were financing their lifestyles with debt and asset price appreciation. Credit was available for anyone and everyone regardless of their ability to repay, ordinary people had second homes (investment property), low income earners were driving expensive automobiles, and everyone was spending their home equity on vacations, boats, and flat screen TVs. It was the biggest credit bubble in history by a long shot – a perfect prelude to a meltdown.

Nobody can predict exogenous shocks (wars, natural disasters), but, it was not an exogenous event that caused the credit crisis, the bear market, or the recession. The Federal Reserve simply began withdrawing the gushing liquidity from the credit markets and the artificial boom came to an end. Like any bubble that bursts, the fallout has been messy but not completely unexpected given its magnitude. I’ve heard investment professionals refer to the Lehman failure as the exogenous event that caused the market meltdown, but let’s be honest. Lehman wasn’t the root cause of the stock market meltdown. There were a host of financial institutions that failed (i.e. Countrywide, INDYMAC), were severely impaired (i.e. Fannie & Freddie), or were bailed out (Bear Stearns) before Lehman closed its doors. If analyst couldn’t see in advance that the housing/credit bubble would end badly, certainly they should have been on alert well in advance of Lehman’s demise.

So there’s my global macroeconomic view. For grins, let’s consider the situation from another analytical perspective to see if we would have reached different conclusions about the prospects for the market in 2008. Let’s look at stock valuations.

From a pure bottom-up perspective, stock valuations across the board were toward the high end of the historic range before the stock market tanked, particularly when you consider that corporate earnings were at record levels and being propelled by record “debt driven” consumer spending. In other words, corporate earnings were artificially inflated by debt driven consumer spending and were bound to suffer “reversion to the mean.” Mean reversion of corporate earnings would portend that stock prices were very high relative to normalized corporate earnings. I would think bottom-up investment analysts would factor this into their models but evidently they did not. In my calculation, the vast majority of stocks as an asset class were priced for absolute perfection before the bear market began. Historically, stocks have not been a good long-term buy and hold investments unless they are bought well below their average P/E ratios. Stocks should be sold when they are trading above their intrinsic value.

To me, there was no top-down (macro) or bottom-up rationale for investing in equities in 2007. Therefore, participating in the stock market (on the long side) represented pure speculation or momentum investing. If you are momentum investor, you had better have a method to follow trends, track momentum, and assess market sentiment (some form of technical analysis) to let you know when momentum is no longer working in your favor. In the absence of sound macro economics and compelling valuations, I leaned on technical analysis and intuition to navigate through the bear market. The technical indicators for the broad markets began to deteriorate in August of 2007 and have not signaled a definitive change in market direction since. In conclusion, fundamental, macroeconomic, and technical analysis all pointed to difficult markets.

As you know, I have expressed grave concerns about the condition of the capital markets and economy for 3 years. My comments may sound like Monday morning quarterbacking. But, take a look the chart of the S&P 500 attached to your email. On the chart, I have superimposed a series of comments I published and archived on my blog site. Catamount portfolios have trounced the S&P 500 Index by more than 12% annualized since inception. Catamount Capital opened for business in January 2006, 3 years ago.

From my lense, the economy and capital markets will present historic challenges for investors in 2009. Tremendous opportunities will follow for investors equipped to navigate these waters. Catamount remains at the helm and alert for what lies ahead.

Here’s to a better year in 2009.

All the Best,
Greg

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