August 2001 Newsletter
Issue Eight, Volume Two

HEDGE FUND-ITIS

By Mike Gasior

The last few months when I have sat down to write the current edition of this newsletter I ponder all the news which has struck me in the preceding 30 days. Be clear that I know I can sound like an awful drone of bad news, and that reading some of my words can prove to be a “bummer” at times. For the many who know me personally I would hope you would vouch for the fact that I am truly one of the most positive people who believes that literally ANYTHING is possible and I even hold myself out as the living embodiment of this. No matter how many “You Suck” e-mail results from any given monthly newsletter, I cannot however stand not to call a spade a spade.

On average I read between 3 and 5 newspapers a day and a minimum of 15 to 20 magazines per month. I also pore over research reports from many of the world’s leading banks and investment houses. Of course, much of this is the result of my spending WAY too much time in airports and on airplanes. It is the result of all this reading, however, that sets the tone for this months newsletter, as well as the July edition. I would not be surprised if many of you might discount anything I may have to say given the fact that one of my January predictions has a 100% chance of being wrong. Although Tiger Wood’s victory this past weekend at the NEC Invitational was a cliffhanger, he is not going to win 2 major championships this year, and thus my suddenly tarnished reputation. After he won the Masters, which was the year’s first major tournament, I began counting my chickens and gave myself a sore shoulder from patting myself on the back. I will try to be more restrained going forward from here, only sharing things that I know are “a lock”. Here goes….

THE ECONOMY

The economy is bad. Very bad actually. And it is going to continue to worsen.

The Federal Reserve just dropped rates for the seventh time this year for a total of three percentage points. It used to be the conventional wisdom that when the Fed began to cut rates the markets would begin to move higher within six or so months. The facts though are showing us that the S&P 500 is 10% lower this year and the NASDAQ is 22% lower. My feelings are that both will be even lower by January. Perhaps another 10% each.

What investors seem to be successfully ignoring is that Alan Greenspan must be scared out of his shorts right now. The U.S. economy is stumbling to a halt. Europe is slowing worse than we are and Asia (led by Japan) is a disaster. When I read a headline in USA Today last week comparing the U.S. markets to Japan’s I nearly puked right then and there. I was speaking to a group that morning and I could not help but lament that the mainstream media constantly seems to be about two years behind on stories that I have been humping constantly? And are you freaking kidding me?? Comparing what has happened in our stock markets is like Pee Wee’s Big Adventure compared to Japan’s markets. The article detailed how the NASDAQ had reached levels that it hadn’t seen since 1998. Well a couple of days after that article the Nikkei 225 Index hit the lowest levels it has seen in 17 years. I sincerely feel that America has become a country of economic hypochondriacs and crybabies. Take the NASDAQ down to 1250 and leave it there for a decade and THEN Americans might understand what real pain feels like. So far the markets have given them little more than a nosebleed. The real beating has yet to occur.

My reasons for being such a wet rag about this subject? Just ask yourself the last time you can actually remember reading one item of honestly good economic news. I am actually impressed that the markets have held up this well in light of the recent headlines in the financial pages, which has grown to sound more and more like the obituaries.

There are only two legs holding up the U.S. economy at this point and neither has any business looking good. They are consumer spending and the housing sector. When I was in the Caymans a few weeks back a gentleman made a comment to me that hit me like a lightning bolt. The man was a Brit, and he commented that “the thing Americans seem most confident about right now is how confident they are.” How profound is that? The cover of Forbes has the picture of a couple that lost $1,000,000 on their house in the last year. More interesting to me was that the cover of Barrons this past weekend made no mention of the securities markets but instead was featuring the falling cost of wine.

Here are the facts:

--Layoffs are picking up at breakneck speed.

--The personal savings rate of Americans reached NEGATIVE 1.3% earlier this year.

--Strong U.S. Dollar situations around the world will make it difficult for U.S. exporters.

--An all-time record number of bankruptcies in the 2nd quarter to 400,000+.

--The highest tax burden in U.S. history, 32.6% of GDP. The previous high was 30.8% in the midst of financing World War II during the 1940’s.

--U.S. corporations have never been so in debt before, reaching 64.4% of GDP.

--Consumers are no better off with mortgage and their consumer debt eating of 14.3% of their disposable income.

--Durable goods orders (cars, washing machines and such…) plunged in the most recent report.

--The rest of the world is in no condition to help pull the U.S. out of this one, much like the U.S. helped the rest of the world back in 1998.

--Global “output” dropped .3% last month – the first decline in this statistic in 20+ years.

We are approaching a point of critical mass where we may be heading for an “L” shaped recession as opposed to the preferred “V” or “U” shapes. An “L” shaped recession is what Japan is currently in and shows no sign of escaping. Sadly, Japan’s situation only seems to look worse by the day. Think to yourself about how the markets have previously reacted to Alan Greenspan and movements by the Fed. Typically, just knowing that they were taking action would almost immediately help the economy and the markets. Now, after these unprecedented moves by the Central Bank, these moves don’t seem to have had ANY effect whatsoever on the economy. The Fed even made it clear that further easing of monetary policy might be necessary. Sooner or later this has to become real to consumers and then, “it’s all over”.

So I will summarize all of this for you. With regard to the worsening economy, the mainstream media is just beginning to climb on my bandwagon now. All you need to know is that this slide in the economy is going to be much worse than anything you’re hearing. But, if nothing else, please remember where you DID hear it.

HEDGE FUND-ITIS

About a year ago I wrote that hedge funds might be the place to be to ride out what I predicted would be some challenging markets. Their track records as a group always seemed to be that they outperformed mutual funds and other vehicles during difficult periods because they are free to pursue many other strategies that more regulated investors cannot follow. These include speculating in derivatives, selling short and using leverage. While ALL of those things can also backfire on managers, they do offer a certain degree of flexibility as well.

Recent research I have read now leads me to believe that the odds of hedge funds as a group outperforming other managed money is unlikely. Sure, there will be those funds that are the shining stars as there always are. Just like you will find individual mutual funds outperforming the markets. George Soros and his Quantum Fund hold an almost mythic reputation and truthfully deserve to be held in such esteem. Sadly your average hedge fund manager is no George Soros and never will be. Here are the facts that lead me to my contrition:

--There is now somewhere in excess of $500 billion invested in hedge funds.

--There are now something in excess of 6,000 hedge fund managers worldwide.

--The typical hedge fund charges investors between 1% and 2% in management fees.

--The typical hedge fund also gets 20% of any profits the fund enjoys for the year.

--The typical hedge fund does NOT share in any of the losses the fund suffers for the year.

--If you don’t know which hedge fund to invest in there are many consultants and brokers who would love to help you…for yet another fee.

--Literally anyone can start and run a hedge fund. Even goofy newsletter writers. Even convicted criminals since they are unregulated.

It has come to my attention in the last few years that it seems to have grown into a bit of an ego boost for many wealthy individuals and institutions to be able to brag about their investments in hedge funds. I have been a participant in numerous conversations where it seemed to me that the only reason that someone had invested in a hedge fund was because it was, to a certain degree, a “status symbol”. These conversations lead to the beginning of my worry.

Let me sum this all up in some facts that are difficult to dispute. For example, let’s assume that the markets are up 10% for the year. With your hedge fund manager taking between 1% and 2% to manage your money, taxes that you’ll owe on any profits and finally the 20% the manager will take as their cut, they will need to have a gross return of 17%. That is a 70% better return that the market offered. If you can genuinely imagine that 6,000 different managers and over $500 billion has any chance of beating the market by 70% on any regular basis, than PLEASE call me because I will just have to start a hedge fund of my own IMMEDIATELY.

Another problem is getting any accurate information on how hedge funds are performing. One outfit that tracks hedge fund performance is called MarHedge, which maintains statistics on 14 major categories of fund strategies. Since 1990 only one of those fourteen categories has beaten the S&P 500 during that time period. What is even worse is that the hedge fund managers are under no obligation to report their performance to outfits like MarHedge and whenever they have a crappy quarter, they don’t. In the first quarter of 2000 MarHedge had 573 funds offering up information to them. By the fourth quarter of 2000, after the markets had declined significantly, 167 of those funds decided not to report their statistics anymore. To make matters worse, since MarHedge depends on the good graces of the hedge funds to even exist, they tend to be VERY forgiving of the funds. When hedge fund manager Victor Niederhoffer blew his investors completely out of the water to the tune of $125 million, a 100% loss of value, MarHedge didn’t count the loss toward their industry statistics, but instead just dropped Niederhoffer from their lists. Hmmmm.

So I’m not saying that hedge funds are bad, or evil, or crooks. I’m just saying that today only a handful of funds truly stand any chance of beating the market during any given year. The buyer must beware and make an intelligent investment decision. Or they could always buy a good index fund instead and save themselves a world of grief. There might be another George Soros, Warren Buffet, Peter Lynch or Bill Gross someday, but picking who they are always seems easier after the facts are in. Don’t be a sucker in the meantime.

A NATIONAL SALES TAX?

A while back the U.S Congress passed a moratorium on any municipality from taxing commerce on the Internet. Well that moratorium expires in October of this year and you can count on the 7,500 U.S. municipalities who currently collect some sort of sales tax to be sticking their hand into your pockets pretty much immediately. With tax revenues in steep decline at every level of government there will be a stampede for new tax dollars.

Currently, Internet retailers are treated like any mail order outfit who isn’t located in the local area and are exempt from local sales taxes. This doesn’t seem like an unfair situation since why should local merchants have to be burdened by this tax when these outsiders are not. But truthfully, these out-of-town merchants don’t burden the local streets, sidewalks, schools, police departments and fire departments. Never mind the impact on American taxpayers who are already suffering under the heaviest tax burden ever experiences in the U.S. as a percentage of GDP. Don’t say I didn’t warn you.

Another tax you can prepare for in 2003 will be one on the stock that some 4,000+ U.S. companies offer their stock to employees at discounted prices. The basic position of the IRS is that if the company offers you stock at a 15% discount from “market value”, they think that the employee and employer should be liable for payroll taxes on the discounted amount. That amounts to 7.65% for each of them, or 15.3% overall. That funny sensation you are feeling in your pocket is once again the government sticking their hand in there.

You have got to wonder what sort of schizophrenia the government suffers from when they lament at one moment about how terrible Americans are as savers of money. The next moment all you read is how they hope we all go out and blow all of our tax refunds on a bunch of crap to help stimulate the economy. I just wish they’d pick a lane and drive in it.

GARY CONDIT

I’m sorry for being unable to avoid mentioning this creep, but I can’t. I watched that hideous interview with Connie Chung and the guy literally made my skin crawl. If I had no idea who this guy was I would have guessed he was a serial killer long before I guessed a Congressman. This guy is a world-class scumbag and it has nothing to do with any extra-marital affairs either. If anybody actually wants to defend him because he “has done so much for his district”, please don’t write to tell me. Just unsubscribe yourself from this newsletter since any defense of this dirtball makes you a dirtball too and I don’t like notes from your type. Okay….now I feel better. Thanks for bearing with me.

BERMUDA

I am extremely excited about the five, brand new seminars I will be offering in Bermuda from November 26th through the 30th. There is still room in most of the sessions and you can view course content or register by visiting:

http://www.afs-seminars.com/bermuda.html

You can also call my offices at (860)347-6568 for more information or to register. I would love to see all of you there.

http://www.afs-seminars.com

Copyright 2001, Michael Gasior. All Rights Reserved.

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