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The View from a Bear's Chair: One Fund Manager's Dismal Outlook


Doug Noland, head of BEARX, sees downside ahead.

Doug Noland is 46, but these days, he says he's feeling a lot older.

Who can blame him? It isn't easy being the manager of a bear market fund when the market has risen as fast and furiously as it has in recent months. Noland runs the Federated Prudent Bear Fund (BEARX), an actively managed bear fund engineered to help investors benefit from a declining stock market.

Employing a "bottom-up meets top-down" strategy, BEARX uses a combination of short sales of stocks, market indices, and futures as well as put options and long positions in stocks of gold, precious metals, and miners.

Like any bear market fund, BEARX struggles when the market is rising (it's down 7% for the past three months), but during tough times it shines: last year, as the market tanked, BEARX generated a total return of 26.9%. Through August 10, the fund's 10-year annualized return of 9% beats the S&P 500 by 10.19 percentage points, clinching the top spot in its Morningstar bear market category.

The fund carries a front-end load of 5.5% and requires a minimum investment of $1,500.

Minyanville recently spoke to Noland to get his take on the market, the economy, and what sectors he's betting the hardest against right now.

: The stock market has skyrocketed from its March 9 low. Where do you see it going from here?

Noland: It's a tricky question. The market has benefited from a huge short squeeze. Coming into the year, bearish sentiment was very high. There was a huge amount of shorting that had been done. We have seen the unwinding of a lot of this in response to policymaking decisions out of Washington. When you are in a crisis environment, where you have a huge amount of shorting and huge amount of derivatives and huge amount of just systemic risk hedging, if policymakers are able to stabilize that situation, then you are in an environment when you can get a big unwind of these bearish bets and hedges. That is where we are. I'm not arguing that things aren't better. But a lot of this has just been a big short squeeze.

: What kind of economic recovery do you expect to see in the US?

Noland: It will be unimpressive. This type of reflation is unhealthy. It doesn't help resolve the problems in the underlying economy. It sets the stage for an artificial boom in the stock market, global markets, and it will not be sustainable down the road. I don't believe the private credit system will able to rejuvenate itself and create enough credit to stabilize the economy. So the government will have to continue to pump credit into the system. I don't have a lot of confidence that government credit really helps mend the underlying economy. To me, it's a band aid and it's dangerous: it jeopardizes the credit worthiness of the entire economy.

Minyanville: Grade Ben Bernanke for us. How has the Fed head performed during this crisis, in your opinion?

Noland: I don't have huge faults with how they responded to the crisis. The system was imploding and they're expected to do what they can to stop them. But Bernanke thinks that we wouldn't have had the Great Depression if the Fed had created enough money to recapitalize the banking system in the early 1930s. I argue differently. The issue wasn't recapitalizing banks back in the 1930s. It's the same issue as it is today: it's the amount of new credit the economy required to stem the financial implosion. We have to restructure the economy so it doesn't require $2 trillion of credit and the government running massive deficits and the Fed to keep interest rates at zero.

Noland: Let's talk about BEARX. Explain your strategy for us.

Minyanville: Our fund is unique. We are very focused on risk/reward. We think this is necessary as a bear fund. This is my 20th year on the short side. I have learned lots of hard lessons. Here, when the market environment is favorable for shorting, we do more of it. When it's unfavorable, we have less short exposure. Basically, all the other bear products are essentially 100% short or 200% short. They are always fully short and I think that is a flawed strategy. To be successful on the short side, you have to be able to rein risk in when the environment is unfavorable, as it has been in the last few months.

Minyanville: What factors do you use when determining whether to short a stock?

Noland: A lot depends on the environment. Today, we want to avoid the stocks with big short positions. So, even with the companies we would like to be short, we avoid them today because of our risk discipline. This year, for instance, we have had more interest in the consumer staples area because we saw them as lower risk shorts as opposed to retailers and cyclicals.

[Noland declined to discuss his shorts but, as of June 30, filings from the fund show that he was betting against Burger King (BKC), Clorox (CLX), Comcast (CMCSA), Darden Restaurants (DRI), Home Depot (HD), ITT Educational Services (ESI), Mastercard (MA), and Verizon (VZ), among others.]
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