Hedging Risk: The Altissimo Letters is a compilation of 56 monthly partnership letters sent to partners in the Altissimo Fund LP between July 2004 and February 2009. The book is over 330 pages and weighs in at 125,000 plus words.

“If you want a unique and intimate look inside the mind of a fund manager, this book is in your wheelhouse” @SellPuts

During the period in question, the stock market returned a negative 5% per year on average while the Altissimo fund returned a positive 11% compounded per year.

This book gives you a view into the thoughts and actions of a small start up hedge fund shop during the period leading up to the crash in the markets of 2008.

It’s hard to believe it has been 5 years since the shotgun wedding era of Bear Sterns to JP Morgan. The market was imploding already with NASDAQ down 14% in the first two months of the year of 2008 with the S&P down 9%.

We were a roller coaster with a huge loss in January of around 13% but then we returned with an up 20% in February. We had been up in January until the Gerbil in Paris was caught with a massive position and ShockGen as we called them, unwound the position dropping European markets by 10% while the US markets were closed for a Holiday.

The Fed cut rates by 75 bps hours before we opened, and I watched a green month go red in hours. We scrambled to unwind our pain, and then boom February hit as I unwound the fund.

We are enjoying the market swings now that we have deleveraged our fund so that it‘s able to take advantage of dislocations as they appear. We believe an equity dislocation in the US markets is a given at this point. We are prepared for it, and waiting for the opportunity to buy some excellent companies at fire sale prices.

While it‘s very rare for the S&P 500 to be down for 4 straight months as it has recently (the record being 9 straight months in the 1974 bear market) we do not expect anything more than a very brief trend reversal in the near-term. The markets might put in a short-term bottom in the coming weeks. However, the overall leverage in the US financial system took many years to build up and will take more time to unwind.

The financial write downs necessary to remove the bad mortgage exposure at the major credit banks has not yet run its course. The estimates for the total amounts necessary to be written down has risen to over 400 billion, with only about 160 billion of it declared, as of yet.

It is our expectation that the Federal Reserve will experience its biggest stress test since it was founded. The majority of leverage that has been built up in the market has yet to be written down and absorbed back into the economy.

The process of editing my old partner letters into Hedging Risk: The Altissimo Letters, has been a walk down memory lane. Bear Stearns was about to be sold to JPM in a rushed shotgun wedding. The great blow up of banks was proceeding, and liquidity was drying faster than paint. Preferred shares in CEF invested in auction rates were toast. Fun times.

It has been interesting, remembering the era now that history has had a chance to bury it. In the coming days, I will be sharing additional comments from my upcoming book.

Best Wishes,

Jack

I have been on twitter and writing a personal blog for a couple of years now. It started as an outlet for my boredom while we lived at the beach. I threw myself into the idea of finding and making connections with people of like tastes on social media.

The reality is that Social Media exposes you to both the good and bad sides of humanity. I have been both lucky to make amazing new friends like Shiv Kapoor and unfortunately I have had my own mini catfish event from someone I thought was a friend but was more likely an intellectual vampire.

It doesn’t change the reality that life is about changing, and accepting that it changes. While I no longer live at the Oregon beach, and have in fact returned to warmer climates in California, I still look back and remember that period of time at the beach with fondness.

At the time, I was writing a weekly column for www.moneymorning.com called Buy Sell Hold. I really enjoyed that period of time, as they allowed me to give a personal rating on any stock, without regard to how their other guru’s were opining at the time. I had some good calls like selling HPQ up around $40ish and some real turkeys like buying SD after their panned GOM purchase.

This was a year ago, as I ended my tour there, and started to launch JHB Capital from  Molalla Oregon, the epicenter of Big Foot Sightings, in Oregon. I should have known this wasn’t a good sign at the time. My wife and I were lucky to escape that city.

While JHB Cap has not paid off in short term monetary gains one always hopes happens with a new project, it has opened doors unseen a year ago. Sometimes changes are for the better, but we just don’t realize it yet.

In the course the last year, I have met and made friends with a mix of people from social media. I have some bumps along the way, which ironically, is how life prepares us for our future.

Today, I have a neuronet like quant engine with 15 sub whole market models inside of it now called AOM (Alpha Omega Mathematica) which is still slowly developing into an interesting product.

The most obvious outtake of the model is that it makes a great point in time valuation score, which would naturally fit with independent brokers/advisers/CPA types who need an honest unbiased opinion in a stock for clients. AOM is perfect for alerting advisers with a morning update of each clients specific stock rankings, and if they have hit a predetermined score price.

I have been working on a new blog location to share financial thoughts, where a group of us now post at with a url of www.dydd.org

DYDD (Doing Your Due Diligence) is a transparent thought bomb location. Please consider joining us there for a quick read on the daily events from around the world

I asked my writers & editors to share their quick ideas there. If they decide they want to write up a long in-depth post, that is great, but what I want is short original thoughts for the blog. Later, we will launch an e Magazine with the editors longer thoughts in a monthly PDF format.

Its surprising how quickly the idea and project has come together. We now get about 500 daily visitor and 1,500 daily page views after two weeks of being public.

I will be changing more than just my personal by line from Macro Contrarian to Hedging Risk with this post. While I loved this era of Macro Contrarianism, I believe it’s time for Rodin’s thinker to stand up and do something else. In the coming days, look for a new Avatar to grace my twitter handle.

The first part of that, is releasing my partnership letters from my hedge fund days. When Jay & I had a falling out with the original primary founder of our shop, we launched DYDD Capital LLC out of the ashes that were Fresco Capital’s stillborn launch.

The Altissimo Fund LP was launched on July 2004, by DYDD Capital LLC a start up HF operation with zero experience running a fund. We had a passion for the markets, and a focus only youth can provide.

The eBook covers the 56 months between my first and last letters to my investors at DYDD Capital between July 04 and March 09. When i left for a sabbatical that turned into a retirement at the beach.

One could say this book is the education of a Portfolio Manager. In the beginning, each monthly letter was short and focused on our holdings. In time, the monthly letters grow in size and depth, but lose the resolution of our current holdings. They started to focus on the big picture of the global economy and the implications of what we saw was coming.

Hedging Risk: The Altissimo Letters is the title of my eBook that will be released  via DYDD Publishing, Amazon Kindle and Barnes & Noble Nook early next week. It’s over 125,000 words & covers 300+ pages (as of last edit).

I hope you enjoy reading it nearly as much as I enjoyed producing it for you. While changes happen regularly, its always good to stop every now and then, look around, and realize how blessed we are.

In the coming days and weeks, I look forward to introducing you to additional eBooks & an eMagazine from the Editors of www.DYDD.org

Best Wishes,

Jack

The great Q.E. III has formally been launched. Its open ended, and the mid 2013 goal posts for easing has been pushed out to 2015.  The comments made at Jackson Hole 2012 were foreshadowing to the catalyst for the announcement made on Sep 9/13/2012.

Mr. Bernanke was extremely clear in his speech on deflation back in 2002, what his actions would be in a worst case scenario. He has followed up on those statements with actions taken by the Federal Reserve under his leadership.

… The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand–a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers.¹ Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending–namely, recession, rising unemployment, and financial stress.

When this speech was written, the US was just starting to come out of the great tech crash of 2000. The US was starting to turn the corner economically speaking, as low interest rate fueled our housing bubble.

…Deflation great enough to bring the nominal interest rate close to zero poses special problems for the economy and for policy. First, when the nominal interest rate has been reduced to zero, the real interest rate paid by borrowers equals the expected rate of deflation, however large that may be.³

Outside of residential or commercial real estate, most liquid assets are being bid up around the world. Just look at the prices being paid for ranch land or the crops generated by them; grains or livestock.

The irony is that Bernanke talks of a parable about gold and its value dissipating overnight do to alchemy. At the time, gold was going for about $300 per oz.

…What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

As I write this, the US Equity Markets are up significantly this year. Bonds were at near historic lows, and the US Dollar had enjoyed a sharp bounce over the last year, as the European Union showed signs of unraveling.

This started to really change around the time of Jackson Hole this year. As word leaked out that the Federal Reserve was going to initiate its third round of Qualitative Easing.

Over the last year, the giant cash flush stocks, which have instant liquidity, and pay out a yield over 3% have become the retail and professional savings account of the past. This is the 21 Century version of the old Widow’s & Orphan equivalent investments of the 1930’s-1940’s.

Big safe cash yielding companies, with balance sheets strong enough weather what the economy is going to do in the near future, have already been bid up significantly in this period of a very old Bull Market.

High Yield is currently at historic low levels, as everyone chases yield. These moments never end well, but for now, even high risk companies have demand for their paper.

So where does that leave the average investor, Retail or Professional? In my humble opinion, the metal complex which has been cooling off for over 1 year, is now fully back in play. The Global Central Bank printing press wars are going to generate inflation, if it’s the last thing they do.

In my opinion its time to ponder the $AUY, $GG, $ABX, & $SLW and other larger producers that have the capacity to book higher precious metal prices. They tend to be debt free, have built in massive organic growth (AUY & SLW come to mind) over the next few years and pay a dividend competitive with sovereign debt yields for the US or Germany with out the same levels of risk.

• Bernanke Speech

During this summer, I referred to it as Mod C, or Model C. As the technology developed with the amazing help & now partnership of Shiv Kapoor, the project has changed, morphed and developed into a product I am proud to have my name associated with.

First there was Fundamental Analysis, then there was Technical Analysis, we have combined them and now use Quantitative Analysis to evaluate each equity trading in the US Markets. US & ADR’s.

Please swing by www.dydd.org, to check out what the technology now offers. In a nutshell, we have built a neuronet model that uses 15 sub whole market models, to build a concession.

We are taking 38 of the factors discussed earlier, and generating an opinion based on 5 strategies. Those 5 strategies are then evaluated at the Industry level, the Sector level or the Whole Market level.

In simple terms, we have 15 models x 38 daily factors x 6000+ stocks to evaluate each time we run our calcs. If you have a spare moment, please drop by www.dydd.org and plug in some symbols at the home page on the quick quote, or check out our tools online at the NeuroNet link, or if you want to play with the technology, log into the site and download our software available for beta testing.

Best,

Jack

The DVN vs CHK trade is starting to reverse with Carl Icahn involved and the momentum has come out of the scoring. So its time to go to the watch list and find a pair we like.

Please vote on which pair you like.

Please take the following poll. I am interested in your thoughts on these pairs. I have included the score generated by the model for each pair. This poll is setup to allow multi choice. You can pick up to 3 pairs. It is also setup to allow comments.

Please leave your own suggestions, and I will generate the score for it, for any posts in comments.

Thanks,

Jack H Barnes Jr.

The model scoring results are available here for the watch list.

I then took the same pairs, and built a quick and dirty backtest of the results since Jan. 1, 2012. The following is how they have performed YTD. This is just a comparison of the pairs based on the closing price Dec. 31, 2011.

This is for comparison purposes only, and is in no way a suggestion to buy or sell any of these pairs specifically.

This post is about the Sub-Sector Scoring Engine (SSSE) and how it will be incorporated into the model. This is the key module toward generating future trading pairs in the model that are not currently deployed.

The SSSE is reviewing over 6,000 stocks, divided into 217 sub-sectors, and updates its data daily about one hour after market close from www.finviz.com, allowing us to track changes over time.

The engine was designed and coded by my friend, Samir, at investexcel.net to generate each of the sub-sectors in U.S.-based equity markets. He was kind enough to add new features to his original Stock Screener model available here.

The SSSE gives a mean score for each of the 40+ factors we use in the model to track changes between two stocks. It generates an easy-to-use strategy for reviewing large numbers of nearly identical companies.

We can then take the comparisons and rank each of the underlying stocks, so we have a best- and worst-case score for each of them.

We then can compare and contrast the performance of these pairs, to see which have been trending away from each other at the highest rate of speed.

The screen capture above is the REIT Residential group, which has 26 equity selections in it. The model will compare and rank each of these stocks based on their average score in the sub-sector.

The obvious premise is we want to have the SSSE highlight the most divergent pairs to combine. It’s one thing for a model to have unique pairs that generate results; it’s completely another thing to have the model actively seeking to find the next best pairs to be used.

The SSSE gives us the ability to dive into the equity markets and find the most logical Long/Short stock pairs based on their ongoing results. The data is updated daily, as fundamentals & technical factors change through time.

Again, our long-term goal is moving these proof-of-concept Excel files to an industrial database that allows us to track each stock’s score against the others in its sub-sector.

We’ll be able to track historical performance and results between stocks to find the best performing pairs. If you have any suggestions on how to improve this model, please do so in comments.

Jack H Barnes Jr.

CEO & Founder
jack@jhbcapital.com
http://www.jhbcapital.com

1 (800) 658-7572 Phone
1 (888) 370-7610 Fax

Let’s dive right in and take a look at what stocks we have in the model, why they are in there, and what is driving the thoughts behind the process of selecting them.

I have set up this test model with a number of intentional failures, to see how it would treat these events on its own. Let’s review those trades, and see how the model is coping with them.

The model is reporting three false readings on its stable trade checkpoint. These would trigger the removal of the trade from the basket, and a new replacement trade being plugged in to redeploy the capital.

I am using .75 as the hard cut-off for a trade that is flirting with an equal ratio. In each of the test cases, the model would reject the trades, while two of the three are profitable trades.

As is obvious, the model caught the Coke versus Pepsi trade and would have put it on in the reverse direction. This was a planned test, and I was glad to see it. Coke has overperformed Pepsi YTD, and while the model is exposed to it from a test point of view, it would never have been put on or kept in.

The test model has a false positive trade embedded with its love of Ford over GM, while the equity markets have sold Ford and bought GM in comparison to each other YTD. This trade is listed as a true trade, but is in fact underwater as will be seen below. The trade would be allowed to stay in, due to its positive reading. It would get rejected if its losses reach 1.5% of the portfolio AUM.

The following model snapshot was taken end of yesterday during the writing of this article.

The only real failure in the model selection process is JPM versus Wells Fargo in the battle of the TBTF.

JPM is up YTD more than WFC is, and even with the model saying to reverse this trade I would instead pull it and watch. The model is trying to put on a losing trade YTD here.

While it may turn out to be correct, the vagaries of bank balance sheet reporting are such that I would suggest the model is only as good as the data being put into it. I believe, in all cases, a model should still have a human reviewing the individual trades.

The third false trade reading in the test model is based around XOM versus Chevron. These two companies are almost identical, and while the market prefers XOM over CVX, the model would reject this trade and book the profits. The Ratio strength level has hit a point that would generate a sell.

In Review

At this time, the model should have the PEP versus KO trade kicked out due to false ratio before .75, along with the XOM versus CVX trade and the JPM versus WFC. This would leave in the F versus GM trade due to it only being underwater, but is expected to turn around due to its current model score.

In reviewing the rest of the Model Portfolio, the additional trades, specifically CLR versus PBR, SRE versus EQT, AAPL versus GOOG, DVN versus CHK, and MSFT versus ORCL are positive trades, with a positive score in the selection process.

I will return to discuss the successful trades and the sub-sector scoring engine in future articles in this series.

Jack H Barnes Jr.

CEO & Founder
jack@jhbcapital.com
http://www.jhbcapital.com

1(800)658-7572 Phone
1(888)370-7610 Fax