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Conversations With Nick & Toni


Trading these days can't be taken lightly.


Editor's Note: The following conversation is shared for the benefit of ye Minyan faithful. For real-time market analysis, please tune into our premium Buzz & Banter each business day.

So, did I miss anything?

After taking a much-needed respite on the eastern end of Long Island , I've slipped back in the saddle to find the wheels wobbling on the wagon.

Minyans shouldn't be shocked to see this rough and tumble ride-we've been waiting for it since last summer-but reading it and living it are two entirely different dynamics.

Thursday night, while sipping an El Corazon and noshing on gnocchi at the wonderfully fantastic Nick & Toni's, I had the pleasure of dining with one of the world's most renowned short-sellers.

Having stayed at his East Hampton estate for the week while he tended to business in the big city, this was an opportunity to catch up and talk tape.

As a soft summer breeze blew gently across the patio and the Divine Ms. T sat nearby with a perfect posture, we delved deeper into our wild world.

Tony: How bout them Yankees? And quiet week in the market, eh?

Minyan Nick: It comes down to containment vs. contagion. Government officials have assured us of the former last spring but we've watched the latter matter in a big, bad way ever since.

From sub-prime to Level III to dilutive offerings by the financials to fed-up sovereign wealth funds, the bloom is clearly off the credit rose. Now, after a full year of pain, we've finally arrived at the center of the mess, Aunt Fannie (FNM) and Uncle Freddie (FRE).

This is, in many ways, ground zero-the whole magilla-their ability to maintain credit-worthiness will dictate the next leg of this market.

Tony: Pithy words for a Slacker, like yourself, who spent the week contemplating his navel on Georgica Beach!

You summed it up well, but, as always, the key to the market's riddle is not what happened but rather what is about to happen. Quite frankly it's hard for me to be convicted as the solutions have been obvious for months - in housing and credit - but the Three Blind Mice (Administration, Congress and Treasury) lack creativity and are all characterized by policy inertia.

Nick: I'm not sure there are solutions outside of time and price.

Remember, the grand experiment of financial engineering began after the tech bubble and manifested through 9/11, Iraq, the elections. There is a big difference between a legitimate economic recovery and credit-fueled growth.

The DNA of this market is vastly different than during any other time in history. Debt destruction, while painful, will ultimately allow for a sustainable foundation for future growth.

Unfortunately, it could take up to five years for that to fully flush though the system.

Toni: I agree that in magnitude the current mess is unlike anything in the past – after all the you-know-what is really hitting the Fannie.

We're currently at write-downs of $400 billion and counting – and one of the most credible credit analysts extant, Bridgewater Associates, issued an apocalyptic report last week that the aggregate losses in our world's financial institutions might exceed $1.5 trillion.

The investment and economic worlds are today characterized by either Cassandra or Pollyanna – though I'm a skeptical short seller, I lie somewhere in-between.

Rarely does an automobile experience four blow outs at the same time on the Long Island Expressway – maybe two but never four! Similarly, hard-hitting solutions, even within the context of the massive credit mess, seem possible, if not probable. The Treasury plan to save Fannie Mae and Freddie Mac are a case in point.

Whether or not you agree with it, the perception of a government backstop might shift perception.

Nick: I agree that perception is reality in the marketplace-in fact, while I foresee risk to S&P 1050 and understand the sharpest sell-offs occur in an oversold condition, the trader in me is looking to buy into further weakness, particularly select financials, for a trade. Downside tail-risk, by definition, is a low probability affair.

That's my short-term sense and it's offered with the understanding that our Recipe for a Market Melt was shared less than one month and 1000 DJIA points ago, in addition to our offering a steadfastly bearish equity posture for some time.

Through a larger and more problematic lens, we must remember that we've shifted from a manufacturing to service to finance-based economy and that has ominous implications at the beginning of a multi-year deleveraging process.

While you'll surely hear choruses of "the coast is clear" on the other side of the if-and-when rally, we would be wise to remember this conversation after it arrives.

Trades, as they say, are made to be taken.

Toni: Well Carnac, my crystal ball is murkier than yours – I would prefer at this point to play the role of Ed McMahon rather than Johnny Carson and be less anticipatory than I normally am.

With so many moving parts of the credit problem and solution, I have grown less convicted and more reactive in my investing. I want to let the market dictate my investment strategy in the months ahead. As to trading, it's another story as the volatility is providing facile traders one of the greatest backdrops I can remember.

By contrast, most investors and traders should probably err on the side of conservatism by keeping positions at levels that are far smaller than they're accustomed to.

It's funny (well not so funny!) that neither of us has even addressed the headwind of higher crude oil - as if credit alone is not enough.

Nick: I agree that this is one of the most difficult investing junctures ever and for investors, capital preservation, debt reduction and financial intelligence are core components of any investment strategy.

While I understand your thinking in adapting to the market, I would be careful being too reactive as the market is a forward-looking discounting mechanism.

I'm hearing war stories on the hedge fund front and that's causing forced flows. The ability to wait for your pitch and take a proactive (and disciplined) cut will differentiate returns. Not many people are currently in a position to do that.

As for crude, it's the other side of the double-edged sword (with credit). While geopolitical risk (Iran) remains, I'll again offer that this bubble will follow the path of, real estate and China. It's always different until it isn't.

What will be different, I believe, is the equity reaction when precipitously lower prices arrive. My sense is that, after a knee-jerk rally, it will be more endemic of slowing global demand.

Alas, that's what makes markets my friend-I look forward to continuing these conversations. Thank you once again for your hospitality and I wish you a speedy recovery on you torn ACL!

Toni: That's probably a good stopping off place as the sun is shining and Georgica Beach beckons. Until next week, Nick – it's been fun (the polemic as well as your week's stay in my home)!


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