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Where We Are and Where We're Going


Time for a mid-year checkup.

"Nobody said it was easy. No one ever said it would be this hard."

As last year drew to a close, we revisited our 2007 themes and weighed them in kind. Many of them came to fruition, others were early, but most hit the mark.

When we entered 2008, we offered a fresh set of forward-looking expectations. With a conscious nod that we must stay humble or the market will do it for us, it's time to reflect on those thoughts as we cast an eye towards the back nine.

Theme 1: Hedge Funds Buying Brokers

January thought: The critical issue facing financial institutions, after years of engineering and risk recreation, is the solvency of their balance sheets (particularly if they're forced to move Level III assets back onto their books). Look for large, well-capitalized hedge funds to take selective stakes in troubled brokers as the financial continuum comes full circle.

Update: During the recession of 1989-1991, 25% of the financial universe disappeared. Thus far, in the midst what is an entirely more problematic credit crisis, only 8% has evaporated.

Given the financial sector shed 50% of its value since last spring, the "easy" downside trade has passed. Some banks and brokers currently in existence are doomed to fail but the winners who traverse this prickly landscape will be in a position to prosper on the other side of the slide.

I continue to foresee mergers as a function of need rather than want as institutions strive to survive. Many hedge funds don't have the balance sheet baggage of the big banks and will look to capture inherent brand and infrastructure value.

Theme 2: Migration Toward a Middle-Class Mindset

January thought: As Kevin Depew wrote on Minyanville, "If the '90s were about wealth, accumulation and consumption, 2008 will continue the mean reversion toward something altogether more austere, if not more sensible. Debt reduction and the rejection of (and guilt projection toward) materialism will continue what began in 2006 and 2007 as meditations on not just doing more with less, but doing less... period."

Update: While the last few years highlighted the chasm between to have's and have not's, both sides have suffered this year. Case in point was the American Express (AXP) news last week that "credit indicators deteriorated beyond expectations. As they run the gamut from green to gold to platinum to black, this is somewhat telling.

There are two dynamics to watch-involuntary thrift and voluntary thrift. The former is when folks can't afford to fill up their tanks to take the family to Applebee's. The latter is when the well-heeled set tightens their belt with expectations that times will toughen. Both processes are currently in motion.

Social mood and risk appetite are the determinants of price action and can manifest in many ways. The flashy rides and outrageous spending habits that were badges of arrival during the era of consumption now serve as hollow reminders of misplaced priorities.

Theme 3: Return of the Dollar

January thought: While risk remains -- for instance, if OPEC decides to denominate crude in Euros -- it's important to remember that the dollar "crash" already occurred. The greenback is off 37% since 2002 and a stunning 97% since 1913. Factor in the widespread negativity of money managers, rappers and supermodels, and a counter-trend bounce doesn't seem so strange.

Update: The buck, as measured against a basket of currencies, has lost five percent in the first half of 2008. Through the lens of "dollar devaluation vs. asset class deflation," one would think equities would have benefited in kind. The fact that they haven't may be an ominous omen.

It remains my view that the greenback will rally, either as a cause (foreign holders pressuring for higher rates) or an effect (as our indebted world pays back dollar-denominated obligations). When that happens, look for asset classes-including commodities and equities-to ultimately migrate lower in kind.

Theme 4: Relative Performance of Pharmaceuticals and Consumer Non-Durables

January thought: I still foresee the energy sector reassuming the top weighting in the S&P (as first shared in 2003). As our financial destination isn't as important as the path that we take to get there, however, defensive sectors such as pharmaceuticals and consumer non-durables will likely outperform on a relative basis as global slowdown fears permeate.

Update: The Morgan Stanley Consumer Index (CMR) was off 12% and the AMEX Pharmaceutical Index (DRG) was 15% lower versus respective declines of 14%, 13% and 14% in the DJIA, S&P and NASDAQ.

I expected a better showing from these traditional safe havens as perception spread of slowing global growth. In the case of the consumer non-durables, margins have been squeezed by the incessant uptick of input prices.

Look for a pullback in commodities to reduce costs and, as they won't immediately pass those savings through, improve margins. Potential plays include Sara Lee (SLE), General Mills (GIS) and Campbell Soup (CPB).

Theme 5: The Other Side of Zero-Percent Financing

January thought: While subprime was the first domino to fall, more ominous issues loom. The other side of zero-percent financing will manifest through credit-card delinquencies, auto loans and other forms of consumer-credit deterioration.

Update: Consumers are attempting to pay their tab after years of bellying up to the "no money down, zero-percent financing" bar. Corporate America, the proverbial bartender in this analogy, carries the risk that patrons will pass out before settling up.

Adding fuel to the fire under the feet of the cash-strapped consumer, $440 billion in adjustable rate mortgages are due to reset this year with a like amount coming due between 2009-2011. As the consumer generates 70% of the GDP, the credit crunch will continue to ripple through the proverbial pond.

For years, we've spoken about "financials in drag" such as General Electric (GE), General Motors (GM) and Ford (F) that made money from their finance-based operations. That grim reality has come to pass, as evidenced by their respective stock prices, and phase two of the credit crunch is set to begin.

The most intuitive risk is within the retail sector although peripheral damage could spread to technology (enterprise spending is also at risk), real estate investment trusts, credit card franchises and commodities, including the energy complex.

Theme 6: Dislocation

January thought: Despite Herculean efforts by global central banks, I believe we will see a market dislocation this year as measured by a 10% move (or more) in a single week.

Update: We often talk about the difference between taking our medicine as a function of time and price and being injected with artificial drugs with hopes of staving off the disease. There have been several instances when supply seemed ready to overwhelm demand but the powers that be were at the ready.

The market has suffered three quarters of negative return for the first time since the 1970's and the June swoon was the worst showing since the Great Depression. Still, perhaps as a function of the liquidity injected into the system, the VXO-widely considered to be the angst proxy on Wall Street-is less than half the levels we've seen at previous historical fear fulcrums.

Real risk remains as a function of the disparity between credit and equity markets. While market dislocations are by definition a low probability affair, this could come to pass if certain stars begin to align.

Theme 7: Vertical Social Networking

January thought: Last year, we offered that life-stage marketing would emerge as a media catchphrase and vertical social networking is a direct extension of that. The ability to connect with others who share common interests and similar goals will not only build brand loyalty, but also create organic global distribution that will challenge traditional models of big media.

Update: Social networking, once considered to be the second coming of the "killer app," is quickly becoming the cost of entry in the online space. Most media outlets either have-or are building-applications that allow their networks to commingle.

While acceptance is spreading, the pace of innovation is deflating the value of these properties. TechCrunch recently reported that an insider offered Facebook equity at a $3 billion valuation, far below the $15 billion valuation that Microsoft (MSFT) paid in October 2007.

Valuation aside, the next phase of this media ancillary will be theme brands that cover vertical market segments such as sports, science, healthcare and finance. The trick-and opportunity-is to identify properties with branded properties across industry continuums.

Theme 8: High Anxiety

January thought: We've already entered recession, one that's been masked by the lower dollar and hidden behind economic numbers skewed by a slimming margin of society. This dynamic will inevitably manifest into the elections, both stateside and abroad, as political infighting and geopolitical tensions mount.

Update: In December 2006, I was asked what concerned me most about the stock market. My response was that while the Dow Jones was at all-time highs, nobody really felt like we were at all-time highs.

In a finance-based globalized economy, our way of life is a direct extension of asset prices around the world. With the BKX (banking index) and China both off 50% since last year, it's no wonder that social mood and risk appetites are in the midst of a seismic shift.

My sense is that tensions will continue to percolate, both domestically and abroad, and the potential of geopolitical strife in Iran remains a risk before the election.

Theme 9: Transfer of Wealth

January thought: We should continue to see a transfer of wealth as foreigners purchase depressed equities, real estate and possibly homebuilders. While this is an intuitive progression in the era of globalization, it will likely serve more as a buffer than a savior.

Update: After a string of stakes in financial institutions such as Merrill Lynch (MER) and Citigroup (C), foreign investors have been surprisingly quiet. Given how quickly they lost money on their initial investments, I suppose you can't blame them for taking a step back.

Distressed assets, coupled with continued weakness in the dollar, should begin to lure cash flush overseas funds and I expect high "franchise properties" to be absorbed before this process completes.

Theme 10: Run to the Light

January Thought: The financial dynamic will become increasingly difficult but individuals, instead of burying their heads, will demand greater involvement in their financial decision-making process. This evolution of empowerment, or the need thereof, will be a central tenet of our forward progress.

Capital preservation, debt reduction and financial intelligence will stand tall when 2009 comes knocking.

Update: The first half of 2008 was far from easy and anything but fun. Despite historic intervention by the Federal Reserve and Treasury Department, equity supply weighed on the tape as credit conditions deteriorated.

I will again offer that as the owner of a small business, I would benefit from an economic boom that lifts the veil of despair and climbs a wall of worry. That is my sincere hope although I've learned far too often that hope isn't a viable investment vehicle.

Once we cycle through the deleveraging process, the foundation for a legitimate economic expansion will be in place. Unfortunately-and please don't shoot the messenger-we could be in for five lean years before that happens.

The destination we arrive at isn't as important as the path that we take to get there. As such, I continue to operate with two buckets of capital-a short-term trading pool (that attempts to capture volatility) and my nest egg, which is 100% cash (backed by t-bills with no commercial paper).

I'm being careful not to press the short side and, in fact, I picked up some merchandise into the teeth of yesterday's supply for a pure trade given the current doom and gloom.

When the rally arrives, however, I'll be careful not to get caught up in the chorus of "all clear." The market is a marathon, not a sprint.

Discipline over conviction as we find our way.

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No positions in stocks mentioned.

Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at

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