Client Confidential – June 20, 2017

Client Weekly Update:

Dear investors,

This is the first of what will generally be brief weekly updates on my thinking and developments in managing your accounts.  I am excited to have Tactical Short operational.  We believe this is a timely juncture to begin positioning for extraordinary opportunities on the short side.

While we see some encouraging fundamental developments, the bottom line is that it remains a highly challenging environment on the short-side. We believe the Treasury market, the U.S. dollar and some commodities have reacted to the deteriorating fundamental backdrop.  So far, however, “risk on” holds sway as equities markets continue to fixate on extraordinarily loose financial conditions in the U.S. and globally.

The overarching thesis is that global markets are in the process of putting in a major market top.  For the most part, the backdrop is consistent with this thesis – as well as showing similarities with previous important tops I’ve experienced in my career.  Akin to late-1999 and late-2007, fundamentals have begun to turn bearish, though the aged bull market is in no rush to succumb to fundamental developments.

Important to the macro thesis (see recent Credit Bubble Bulletins), the world has now passed peak monetary stimulus.  The Fed has commenced rate normalization, a process than many global central bankers plan to follow. While first-half global QE has been enormous (estimates $1.5 TN), most liquidity injections now come from two central banks, the ECB and BOJ.  The ECB is to wind down its program near yearend, and the Bank of Japan is also under pressure to craft a strategy to end its massive bond buying program.  There is considerable uncertainty regarding the monetary backdrop a few months out.

In China, officials are attempting to rein in an out of control credit bubble.  Global markets, confident Beijing has things well under control, greatly underestimate the myriad risks associated with a tightening of Chinese finance.

Despite the VIX near 24-year lows, it is a high-risk environment for financial markets.  Typical of major tops, the degree of complacency is extreme.  Market tops are notoriously unpredictable and problematic on the short-side. Over a long bull market, the bullish side accumulates most of assets and market power.  The bear community is shrunk down to minimal market impact.  With a dearth of sellers, it’s not difficult to push stocks higher.  As we’ve seen so far in 2017, markets have turned very speculative.  This creates significant uncertainty and risk on the short side.

In general, while the opportunities on the short side are increasingly enticing, the risk versus reward profile for shorting remains less than favorable. The strategy of squeezing the shorts has been so profitable that it has attracted many adherents.  The hedge fund industry in general continues to struggle with performance issues.  This is a significant issue on the short-side, since the hedge fund industry accounts for the majority of short exposure. The actively managed bear funds continue to struggle, trading to all-time lows last week.  The strategy of shorting stocks remains problematic and is not yet bearing fruit.

For now – and things can change quickly – the high-risk environment dictates cautious positioning of short exposure (currently about 13% short overall – with no put options).  But I maintain a daily readiness to boost exposure in the event of favorable developments.  I am nothing if not disciplined, and I hate to lose money.  So I’m keeping short exposure low, sticking with low beta short exposures, avoiding shorting individual companies, and avoiding heavily shorted sectors that are prone to abrupt reversals in the event of a change in markets environments (i.e. “risk on” to “risk off”).  Currently, the most attractive risk vs. reward short positioning is in highly diversified and liquid equities indices.

EEM – Emerging Market ETF