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2007: A Look Ahead


There are alotta elements competing for our attention and discipline in thought, approach and action will separate the winners from the sinners.

So you run and you run to catch up with the sun but it's sinking.
Racing around to come up behind you again.

(Pink Floyd)

And just like that, the 2006 sunset is upon us. As we edge through the holiday season and turn the page on yet another financial chapter, it's time to take stock of what was, what is and what will be.

The beauty of our business is that at the end of the day, week, month or year, performance is measured in absolute terms. We spend countless hours debating the "whats, whys and ifs" but bottom lines are rarely ambiguous. We won, we lost, we learned.

And now we go on.

I've been trading for sixteen years. In that time, I've witnessed bubbles, contagions, opportunities and losses. I've also learned humility, a necessary trait for anyone who hopes to morph mistakes into the types of lessons that make us better at what we do.

It's not always easy. Nothing worth having ever is. But when it comes to our financial futures, we have two choices. Trust in others or empower ourselves.

Hopefully, we can do both.

It is in that vein that I offer the following vibes on the year ahead. Some you've heard, some are new and all are consistent with weaving together a construct that we can maximize our risk/reward. I'm of the mindset that capital preservation is the first step towards wealth accumulation. That means opportunities are sometimes lost but managing risk will sustain you longer than chasing reward.

I believe that certain dynamics will remain in play. Asset classes, as a whole, will trade inverse to the dollar. The reserve currency is bearing the weight of an anxious, debt-riddled world denominated in dollars. It's a double-edged sword--the dollar could rally as debt is paid down--and that would lead to a collective pfffft across the asset class board. Watch it as a key tell.

The bull case is that foreigners continue to consume US goods and real-estate as a function of the exchange rate. The bovine are betting that the US will be carried along in a global expansion driven by the Far East and India. And it's viable in the spectrum of potential outcomes. It's a delicate operation but it can be done. There's a lot of money already betting that it will be.

The caveat is that US fiscal and monetary policy is being migrated abroad. Foreigners hold more than 50% of the US' debt which makes them majority owners. It's a cultural shift as well, as corporations outsource the former US middle class to places we can't pronounce. Expect to see more press on the dichotomy between the "haves" and the "have nots" in the year to come. And expect to feel it with thy neighbor.

The elasticity of debt is a dynamic to watch. With upwards of $2 trillion in adjustable rate mortgages resetting, the consumer doesn't just gotta want it, they'll have to figure out a way to pay for it. I believe real estate prices have peaked and further expect the housing sector to resume its downtrend. Sub-prime lenders and REITS are both areas to watch for short-side opportunities.

I expect energy and metals to outperform tech and financials, not just in 2007 but for years to come. The relative performance will be dictated by the toggle between inflation and deflation (watch for stagflation to creep into the conventional wisdom). The inverted yield curve supports that thought and the fact that it's been dismissed only adds to its allure. Hard assets vs. subjective valuation seems right to me.

I believe volatility will uptick, which is pertinent due to the $370 trillion in outstanding exposure. In a finance based, interwoven global machination, we must respect the magnitude of these numbers. With volatility levels at decade lows, you can protect your portfolio for peanuts and hope to lose money on your hedge. I think that's smart and I sense it'll pay off.

With regards to the hedge fund community, I wanna be "long the quality and short the quantity." That spread should narrow in 2007, leaving alotta befuddled fund managers wondering what happened. I would also draw attention to the high level of correlation in strategies. If a particular log rolls over, know how that goes. Avoid log jams.

There are alotta elements competing for our attention and discipline in thought, approach and action will separate the winners from the sinners. Heading into the new year, I think it's safe to say that I expect the downside and respect the upside. If I had to venture a guess, I would offer that the beginning of the year will show some upside mo' (led by the large caps) with a jolting gut check thereafter.

Finally, I will say this. As someone who forgets this too often, balance will serve us all in good stead in the year ahead. If we "work to live" rather than "live to work," odds are that our forthcoming success won't simply be measured in dollars and cents. The purpose of the journey is the journey itself and by the time you reach your destination, the trip will have already ended.

May peace be with you.
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