From the Archive: Small-C January 2009 Letter

There’s not much to say about January’s performance, but we’ll ramble on for a bit anyways. The portfolio returned 2.2%, which is barely distinguishable from noise. TIPS did well, as 5yr inflation breakevens moved from -0.5% to +0.1%. Gold moved up slightly. China outperformed the S&P, but it was really our net short in S&P that helped there. Put options we sold on the S&P expired worthless. We bought sterling corporate bonds, which didn’t do much of anything during the month. While most of the general themes seemed to be working, many individual positions were down, leaving us with the feeling we could have chosen more wisely.

As January was the worst S&P return on record, we are increasing our short in February. VIX levels have made selling volatility marginally attractive, so we are using the options market for that view. We’re hoping to take in 2-5% of AUM in option premium this year.

Our colleagues, and really anyone we talk to, remain unconcerned about inflation. They have a point - there are no indications that prices will start to move up. But politicians are ascendant and mob rule is the order of the day. The mob of unworthy borrowers, imprudent chancers, and inefficient industries wants a bailout and will get one at the expense of those who worked hard and saved prudently. One of the first things they are doing is pilfering your savings, by keeping rates low and printing money. Inflation will come; the thing we are concerned about is whether they will game CPI so it doesn’t appear in official measures. It’s clear you can not be holding cash or anything like it. We also are increasingly nervous about intermediate/long yields and whether they will move before inflation does. So far, the Fed is talking a good game to keep them down and people are happy to buy bonds thinking there is security. But when they realize what’s going on, when the deficits balloon, when foreign investors stop cooperating, the crack could be dramatic. Many people who chased "safety" are headed for a crash lesson about "duration" - it’s a multiplier, folks.

We’re trying to think of other ways the mob will come after your prudently stored-up wealth. Inflation takes time, and they want your money now. Tax hikes are the obvious step, but politicians will have to be careful to appear to be taxing the "rich". The problem is there just aren’t enough truly rich to make a difference through income taxes. A capital gains tax will probably come - but who has any capital gains these days? We took all of our capital gains a year ago, when it looked like Hillary would be in the White House. Hope you did too. Quite possibly, an asset tax, of the type already existent in France and Brazil, will be imposed (coupled with handouts to retirees, who are already the group most disadvantaged by the financial crisis).

The BoE announced a plan to start buying corporate sterling debt this month, which left us scratching our heads since there are far worse problems in this country than BT bonds trading at +400bps. At margin, it should be positive for our sterling corporate debt position.