Condition Bear Market Rally
S&P Target 1020
Hedge XLF -19.93%


Position Date Return Days Call
SE 6/27/2011 10.24% 124 Hold
CLH 7/6/2011 8.29% 115 Hold
GCI 7/14/2011 -10.58% 107 Hold
GTAT 9/8/2011 -24.08% 51 Hold
CSGS 10/3/2011 15.99% 26 Hold
NLY 10/25/2011 3.60% 4 Buy
DD 10/27/2011 2.03% 2 Hold
AMGN 10/27/2011 -1.21% 2 Hold
KBR 10/27/2011 -2.35% 2 Hold
VG 10/27/2011 0.26% 2 Hold

Mousetrap Return 5.20%
S&P Return -4.47%
Hedged Return -4.16%

Mousetrap Annualized 12.57%
S&P Annualized -10.81%
Hedged Annualized -10.06%

Long Advantage 23.38%
Hedged Advantage 0.75%

The percentages being reported include all open and closed positions from 5/31/2011, when the test began.

So far the long-only version is continuing to outperform, but at less than the 30% target. The hedged position is being crushed by a 20% surge in Financials on hopes for Europe.

There are a few problems with Europe:

1) The Greek bailout still won’t save Greece.
2) Italy is next.
3) No one knows the extent of derivative contagion.

That third point is the most important, because derivatives wrap existing debt in so many layers of leverage that it is impossible to determine the true “debt” crisis a default would create. This week bondholders in Greek debt were requested to voluntarily forgive half of the debt to Greece. That’s not enough to save Greece in the long run, but in the short run the euphoria over Greece doesn’t account for the fact that the default burden was merely transferred from Greece to the bond holders. If that were the end of the story, then folks would be out a finite amount of money.

But that isn’t the end of the story. Those same bondholders had repackaged their bonds into other investment “vehicles” that other people took out… on leverage.

No one knows how many times this was done, or what the true debt burden is. It is possible that all of the losses and derivative losses will be within everyone’s tolerance limits. But it at any point margin calls occur, the extent of the damage will never be known until it’s over.

In simplest terms, then, the default burden was delayed in Greece by being transferred to “volunteers” who might be driven into default themselves. Worse, the derivatives mean that a lot of “volunteers” won’t even know they’ve been volunteered until their derivative of a derivative of a derivative investment mysteriously blows up in their face.

Rumor also has it that Europe and the US will coordinate some more quantitative easing. We could have another fake bull market, which, while meaningless for the economy, would punish short positions.

Things might get rather annoying in the short run for my XLF hedge.

Tim