Tactical Short 4th Quarter 2018 Recap
with David McAlvany and Doug Noland

David:Hello everyone. Thanks for jumping on this afternoon’s call. As always, special greetings to our account-holders, and we are honored to work with you. Building long-term client relationships is our motivation, and keeps us working hard, as we do each day. As I usually do, I will introduce the call, just so you know the flow of today’s events, if you will. I will introduce the call, Doug will make his observations, share some insights with you as we look at 2019, what we have titled, The Long and Difficult Road Ahead, and then we will open it up for Q&A.

We have a number of questions which you have submitted ahead of time and we also have the ability to take some questions live using the chat application, and I have a couple in queue. As we proceed, if there are things that you would like for us to clarify, or that come to mind stimulated by the conversation or the discussion today, feel free to send us those and we will do our best to answer them.

I will begin with general information for those who are unfamiliar with the Tactical Short. More detailed information, if you are interested, is available at mwealth.wpengine.com/tacticalshort. The objective of Tactical Short is to provide a professionally managed product that reduces the overall risk in a client’s total investment portfolio. We do that while providing downside production in a global market backdrop of extraordinary uncertainty, and as we believe, extreme risk.

This is a strategy which is designed for separately managed accounts. That provides the investor with the best transparency, the greatest flexibility, and allows us to deliver a product with reasonable fees and no lock-ups. So the separately managed account structure is what we chose for Tactical Short. We will short securities, we will short stocks, ETFs. We will also, on occasion, buy liquid listed put options. These are all tools in the toolbox, and at various points in a market downturn they will be more appropriate, and so some of those we will pull out and use at different phases of the down cycle.

Shorting entails unique risks and we are set apart both by our analytical framework, but also by our uncompromising focus on identifying and managing risk – very critical – and Doug will share a little bit of that with you here in a few minutes. Just some of the things that we observed as we went through the 4thquarter of 2018 and even in the first few weeks of 2019. We tactically adjust the short exposure, thus the name Tactical Short. We expect to generally target exposure between 50-100% short.

For instance, our current short exposure is 65% of account equity. Especially after the market’s recent recovery, we see downside risk. At the same time the recent market trading dynamics confirm our view of an extraordinary environment with ongoing elevated risk, for those who are on the short side. So that risk is absolutely imperative.

As we stated in the October conference call, we believe that the risk versus reward calculus for shorting has fundamentally improved, so there in October as we launched into the 4thquarter we knew something had changed, and as we experienced in the 4thquarter quite a bit of volatility, which again we will address in our comments today, as confirmation of that shift from issues remaining at the periphery and clearly moving to the core.

We don’t recommend placing aggressive bets against the stock market. We do, however, continue to see a highly unstable environment. You have myriad risks, some becoming more visible in 2008 and they demand a disciplined approach to risk management. So I want to repeat what we stress in every call, that remaining 100% short all the time – and that is what most short products do, that is how they are structured – in our view that is risk indifference, and risk indifference is a problem, especially on the short side when you have acutely uncertain environments.

We structured our product, Tactical Short, to ensure the flexibility to navigate through even the most challenging market conditions. Being fully short, as you could see in the 4thquarter, was very rewarding. But the cost became much more apparent here in the first few weeks of 2019. The cost of a risk-indifferent approach was on display here in 2019. I will review that as we look at our performance, and also look at a number of our competitors, and how they have done in the last little spell.

Before I start on performance, I do want to let you know, if our comments strike a chord with you today, both Doug and I are available in the coming weeks to explore options of how this may complement your overall portfolio allocations, and you can expect a call from our team sometime in the next several weeks just to follow up and to get your feedback, both on the quality of the call and perhaps your level of interest in considering Tactical Short.

As to performance, Tactical Short accounts, after fees, gained 8.96% during Q4. The S&P 500 returned a negative 13.52. So Tactical Short captured 66% of the S&P’s decline. That is what we structured it to do, and it did do that. As for 2018, the full year performance, Tactical Short, after fees, returned a positive 1.64% versus the 4.39% negative return of the S&P 500. We regularly track our performance versus three actively managed short competitors and we will talk a little bit about, again, what we view as a risk-indifferent approach, and what that looks like, both for better and for worse.

First, the Grizzly Short Fund, which gained 15.01% during the 4thquarter. For the full year, Grizzly returned a positive 50 basis points.

The Ranger Equity Bear Fund, another of our competitors, gained 14.54% during Q4, a 7.5% gain for the year, doing quite well last year.

Federated Prudent Bear, for those of you who know Doug’s background, spending 16 years with Federated, this is an interesting one to always look at. Federated Prudent Bear Fund in the 4thquarter gained 10.6, but lost 5.96 during the full year, 2018. Since our inception, April 7, 2017, inception through year-end 2018, Tactical Short has returned a -1.53%. Compare that to the positive S&P returns of 10%, and relative again to our peer group, on average we had outperformed our three competitors by about 1000 basis points.

So for 2018 Tactical Short outperformed two of the three bear funds, and I think it is worth noting that the third fund’s 2018 outperformance [unclear] wiped out during the first three weeks of 2019. And I believe it is fair to say that Tactical Short would have significantly outperformed most of its competitors had the market advanced in 2018.

Doug is going to join us and begin his comments. Again, when he is finished we will follow up with Q&A. Feel free to submit any of those online if you would like to and we will take those in the order they are received.

Doug, thanks for joining us.

Doug:Thank you, David. Hello, everyone, and thanks for jumping on today’s call.

We use a mosaic of indicators in investment analysis, along with risk and trading disciplines to manage the size and composition of short exposure. That’s what we do. We started 2018 at 22% short, took exposure down to 16% last January. Short exposure ended February at 38%, March at 52%, and then closed June at 62%. Exposure was taken as high as 64% in mid-August, and cut to 56% by late that month. Exposure ended September at 59% with increase to 68% by mid November, ending the year at 66%.

My biggest regret, and frankly, a mistake on my part, was not having purchased put options early in Q4. I could offer a long explanation, but to be concise, I was overly cautious. We had posted disappointing losses during a strong Q3 market advance and our risk discipline imposes tight risk control when we have lost money. I made the decision to wait until losses were reduced before taking on more risk, and by that time the price of put options had jumped, making the risk versus reward less appealing. I apologize for missing a good opportunity. I would much rather apologize for missed opportunities than for outsized losses.

This is a good segue to portfolio composition where a high-risk environment for shorting has beckoned for disciplined risk management. I have been doing this for a while, managing short exposure going back to 1990. My investment philosophy on the short side has been to build a well-diversified portfolio of short exposures with positions that are underperforming the general market. I have managed through bull and bear markets, speculative melt-outs, intense short squeezes and financial crises.

I’d like to think I’ve seen about everything from the markets, but the current market environment is unlike anything I have experienced, and I am sure many seasoned managers, including highly successful hedge fund operators, would agree. I wouldn’t feel comfortable with the risk profile of a short portfolio of underperforming equities because algorithmic trading strategies may suddenly trigger buy programs for such stocks, and resulting outperformance would then incite additional buying from this colossal community of aggressive momentum traders, where the algos and the [unclear] players would suddenly target stocks in the short position sparking a panic short squeeze.

At the same time, there are various derivative strategies where dynamic hedging can lead to aggressive self-reinforcing buying, and even upside market dislocation. Add to this that the hedge fund industry, generally, including some of the most successful long-term managers, have performed poorly and face redemption pressures. This creates added uncertainty within the short stock universe.

The bottom line – we’re operating in a highly abnormal market environment, one that has shifted away from traditional analysis and active management, to highly speculative, passive, trend-following strategies, algorithmic and high-frequency trading, and sophisticated derivative structures. We manage overall short exposure cautiously, starting with a very disciplined approach with portfolio beta for the expected volatility of our exposures. The imposition of risk control to mitigate losses is fundamental to our investment process. It is an objective of Tactical Short to avoid outsized losses.

In an environment prone to abrupt upside market reversals, situations tend to be very difficult to anticipate, individual company and sector short positions turn volatile, as well as highly correlated. This can lead to what I refer to as an upside beta problem. As performance and bear products in early 2019 demonstrate, losses can add up quickly. In today’s environment, it is difficult, if not impossible, to accurately gauge potential upside beta risk which is associated with a portfolio of short exposures. We will remain focused on avoiding short squeezes and minimizing risks associated with expected volatility and violent rotations.

Let’s dive deeper into Q4 performance. I want to shoot straight with everyone. I’m disappointed with Tactical Short performance during the quarter. I expected better. I expect better in the future. We would typically seek to be more opportunistic during significant market declines, increasing overall exposure and broadening our short exposure to include sectors and stocks where we view a favorable risk-versus-reward calculus. And while we saw favorable reward opportunities on the short side, the problem, as already noted, was the risk backdrop. I viewed the quarter, despite market weakness, as a high-risk environment for shorting. Trading conditions were highly unstable, at times chaotic.

Beyond acutely unstable markets, the quarter presented three key market junctures – the mid-term elections on November 6th, the Trump/Xi meeting on December 1st, and a pivotal FOMC meeting on December 19th. All three had potential to provoke disorderly market rallies. As it turned out, in each case markets were left disappointed. In particular, lack of a dovish post-meeting Fed statement, coupled with Powell’s comments, created acute market dissatisfaction. We were positioned to ensure we could withstand sharp rallies without outsized losses.

Let’s shift to top-down analysis. I titled my year ago issues 2018 Credit Bubble Bulletin, Market Structure: A decade of unprecedented monetary stimulus that includes zero rates, trillions in central bank liquidity, along with so-called central bank market puts, fundamentally altered market structure. Most obvious is an ETF complex approaching 5 trillion in assets, the majority dedicated to so-called passive bets on equities and fixed-income indices. Hedge fund assets are in excess of 3 trillion, with unknown trillions of additional levered holdings that have gravitated to aggressive momentum trading strategies.

There is also a globalized proliferation of derivative strategies, including booming options trading, institutional and retail. Zero rates have incentivized what surely are trillions of sophisticated levered currency and fixed income carry trades spanning the globe. In sum, structural change created an unprecedented pool of trend-following, performance-chasing global speculative finance, integral to what we view as extreme and mounting systemic risk.

Think back one year ago. Global markets began 2018 strongly. The emerging markets, in particular, saw enormous inflows, strong market gains and highly speculative market conditions. Our view holds that a historic global bubble was pierced in 2018. The initial crack came with a short vol blow-up last February. We titled today’s call 2019 Secular Shift: Beginning the Long, Difficult Road. We believe global markets, international finance, and the world economy are in the throes of momentous changes, none we find comforting.

To help put our analysis in context, let’s briefly review where we have been, where we are currently, and the direction we believe things are heading. First, where we have been. In a few months it will have been ten years since I first warned of an inflating global government finance bubble – gone by quickly. Early on I referred to the granddaddy of all bubbles. Bubble dynamics have spanned the globe, developed and emerging markets alike, across asset classes – sovereign debt, equities, EM currencies and securities markets, investment-grade corporate credit, high-yield, leverage lending, M&A, real estate, private equity and so on.

And quite importantly, bubble dynamics have debased the very foundation of global finance through a reckless expansion of central bank credit and government debt. For three decades we have witnessed serial bubbles, each new reflation bigger than the last. Looking forward, the source of the next bubble is not all that clear. There is a solid argument that we are reaching the end of the road with central bank-induced reflationary tactics and bubbles.

The global government finance bubble was unleashed in a desperate, coordinated policy response to the bursting of the mortgage finance bubble. The mortgage finance bubble evolved from reflationary measures following the collapse of the so-called tech bubble. Recall that the near doubling of NASDAQ in 1999 followed the Committee to Save the World response to the Russian and long-term capital management collapses in the autumn of 1998, the year following the Asian Tiger Bubble collapses.

When global central banks in 2008 resorted to the government printing press and zero rates, I warned of a slippery slope. I never imagined that this bubble would inflate for a decade, but at that time it was unimaginable that central bank balance sheets would expand by 15 trillion, that central banks would resort to years of negative interest rates, that interest rates around the world would remain near zero into 2019.

When the Fed in early 2011 released an outline of their exit strategy, I titled the CBB, No Exit. History teaches us that once monetary inflation is unleashed it becomes extremely difficult to rein in. Having inflated their balance sheet from 860 billion to 2.3 trillion, I doubted in 2011 the Fed would be willing to tolerate the dislocation associated with pulling back on monetary stimulus. I don’t believe anyone at the time contemplated the Fed, in a few years, doubling its balance sheet to 4½ trillion.

With Europe in crisis in 2012, global central bankers resorted to whatever it takes, which was essentially adopting a policy of kicking the can down the road. The surge in global QE fueled a historic inflation – markets, economic activity, and incredible bubbles in China and the emerging markets. China’s vulnerable bubble faltered in late 2015, early 2016, the global bubble hanging in the balance. In response, China resorted again to aggressive stimulus. The ECB and BOJ further pushed the limits of QE, and the Fed postponed the start of normalization.

Those efforts were reminiscent of the Fed’s Benjamin Strong and his infamous coup de whiskey shot of stimulus back in 1927 that unleashed a fateful speculative blow-off that ended with the great crash of 1929. I believe historians will look back at the 2016-2017 period as a fateful period of egregious monetary stimulus stoking dangerous asset inflation and bubbles. This period saw roughly 150 billion monthly QE along with near-zero interest rates, all in a non-crisis environment.

A year ago in January 2018 global markets were surging. The emerging market ETF hit an all-time high last January 26, having gained almost 90% from early 2016 trading lows. The Shanghai Composite gained a quick 9%, trading to two-year highs by late January. In the U.S. the VIX traded down to 9 on January 5, 2018. A month later on February 6ththe VIX spiked to as high as 50 in the so-called short-vol blow-off. I have likened selling volatility to writing flood insurance during a protracted central bank-induced drought. Why not speculate in rising markets with low-cost insurance so readily available?

At the time I drew parallels between the short-vol blow-up and the collapse of the two Bear Stearns structured credit funds back in June 2007. While it took 15 months to evolve from dislocation at the periphery to a systemic crisis at the core, the subprime eruption marked a critical inflection point in risk-taking, speculative leverage, marketplace liquidity, and financial conditions more generally.

It wasn’t long after last February’s short-vol blow-up that EM currencies and markets began to weaken. From January 29thhighs to February 9thtrading lows the Shanghai Composite dropped 14% on its way to losing a quarter of its value last year. Both the Argentine peso and Turkish lira began weakening in the spring and dislocated in August, setting in motion de-risking, de-leveraging dynamics throughout the emerging markets. By summer, financial conditions had tightened dramatically, with contagion and crisis dynamics engulfing the global periphery. EM debt markets were under intense selling pressure, with growing concern for EM dollar-denominated debt.

Similar to crisis dynamics back in 2007-2008, risk aversion and illiquidity at the periphery initially supported excess at the core. Recall that in the face of a bursting mortgage finance bubble, U.S. equities ran to all-time highs in late 2007 and triple-A mortgage securities rallied right into the 2008 crisis. We believe the global bubble was pierced last year beginning at the periphery, yet instability at the periphery initially spurred strong flows into out-performing U.S. security markets, fuel for a speculative blow-off right into the face of deteriorating fundamentals. My analytical framework integrates what I call periphery-to-core crisis dynamics. Tightening global financial conditions and contagion effects made their way to the core U.S. markets during Q4. After trading near-record highs on October 3rd, U.S. security markets reversed course and then faced serious liquidity issues as the tumultuous 4thquarter came to an end. Last year’s tightening of financial conditions has begun restraining global economies, notably, in China and EM. I believe major speculative bubbles in U.S. markets, foremost in equities and corporate credit, were pierced during Q4. There were large ETF outflows, junk bonds, and small cap stocks in particular. I have referred to the concept of moneyness of risk assets, the central bank-induced misperception of safety and liquidity for equities and fixed income ETF securities. This fallacy of moneyness is now being questioned, hedge fund losses and de-leveraging.

I believe sophisticated market operators recognize that the global environment has changed. Pressure to de-risk and de-leverage with negative ramifications for global liquidity, will be ongoing. Q4 experienced ominous episodes of derivatives-related selling overwhelming the markets. Now, the higher cost of reduced availability of market protection weakens the incentives for risk-taking. Our analytical framework views unfolding crisis in terms of a process.

Typically, years of excess culminate with disruptive speculative blow-off dynamics. These melt-ups ensure manic expectations, perceptions of liquidity abundance and inflated prices along with a widening divergence between bullish expectations and the reality of late cycle deteriorating fundamental prospects. At that point, markets become increasingly vulnerable to sharp and destabilizing reversals. Markets have come to expect, to demand, some type of policy response to bolster waning market confidence.

With increasingly unstable markets by mid December, raising the likelihood of a response, our risk management focus dictated that we went into the December 19thFOMC meeting with a tight rein on risk. I was not necessarily surprised that that Fed statement by Chairman Powell at his press conference avoided the dovish shift markets were demanding. Powell surely appreciates how the Fed and central banks over the years, having repeatedly come to the markets’ defense, only emboldened the speculator community and promoted market distortions and bubbles.

My view is that Powell would prefer to let markets begin standing on their own. Yet, just two weeks following the FOMC meeting Chairman Powell made an abrupt dovish U-turn. I believe rapidly deteriorating market conditions forced his hand. The previous day, on January 3rd, markets were moving toward dislocation with a collapse in treasury, bund and JGB yields; acute currency market instability; a so-called flash crash; widening credit spreads and risk premiums – including a 19 basis point surge in Goldman-Sachs credit default swap prices; along with collapsing crude prices.

So where are we today? I recall thinking back in December that explaining why I remained focused on controlling risk would be a challenge to explain during this call. The markets rallied sharply to begin 2019. In the first 13 sessions of a year the S&P 500 gained 6.5%. Broader indices significantly outperformed. The small caps surged 9.9% in just 13 sessions, with the mid-caps up 9.3%. After 13 sessions the average stock gained 9.7%, the banks surged 13.7%, the brokered dealers 11.3, the biotechs 16.1, and the oil services index gained 22.3%. A powerful short squeeze and unwind of hedges surely played a major role in the rally. The Goldman-Sachs Most Short Index jumped 13.6% in the first 13 sessions of the year.

Things turn crazy at the end of cycles. We will continue to assume really crazyat super-cycle inflection points, will manage short exposure expecting more wild volatility, chaotic trading conditions and powerful short squeezes. This backdrop continues to create major challenges on the short side. I’ll note that the actively managed bear fund that out-performed Tactical Short last year lost 9.7% in 2019’s first 13 sessions. A fund we out-performed lost 9%. We will simply not position our short exposure where investors will lose 9% or 10% of their money in what we consider a typical rally in the context of a most exceptional market environment. These types of rallies must be anticipated, the great challenge, of course, being their timing. They typically come right as systemic risk escalates, usually incited by some policy response.

Where do we go from here? The 2019 secular shift beginning the long, difficult road. With a historic global bubble having been pierced, anticipate momentous changes. We believe we are now in a global backdrop of hopelessly distorted securities and derivatives markets, along with deeply maladjusted economies. We believe the consequences of a decade of unprecedented monetary stimulus include profound structural maladjustment throughout global markets, credit systems, and economies.

The world has commenced what could prove the most protracted and synchronized bear market in decades. I fear financial and economic crises are unavoidable. Burning money, kicking the can, and inflating bubbles were never going to end well. A decade of monetary inflation has created market and economic dependency on loose finance and uninterrupted abundant market liquidity. Especially during the past few years, massive QE liquidity fomented speculative leverage and unstable dependency on ultra-loose financial conditions.

With all major central banks pulling back from QE, global markets now face a changed liquidity landscape and we saw the impact of the altered backdrop mid-year at the periphery as those markets faltered, then in Q4 with illiquidity penetrating the core. An unprecedented liquidity backdrop that for years favored leverage speculation has turned inhospitable. I believe we are in the initial stage of what will unfold into a prolonged period of de-risking/de-leveraging, market instability, and resulting liquidity challenges.

Acute global market fragilities ensure a long, difficult road ahead. We believe we have commenced a secular shift in policy-making, risk-taking, and speculative leveraging. This portends a fundamental tightening of financial conditions with far-reaching ramifications for risk premiums, corporate credit availability, securities market performance, and asset prices more generally, along with, of course, economic prospects. With markets out of the block so quickly in 2019, talk of a fundamentally altered liquidity environment might sound over the top, but that is a big part of the predicament.

Markets fueled by short squeezes, the unwind of hedges, and aggressive trend-following trading create the illusion of liquidity abundance. It is not until a bind subsides in selling and hedging resumes that illiquidity re-emerges as an issue. I will add that the bigger the bear market rallies, the more problematic reversals will be for fragile securities and derivatives markets. The Fed intervened a few weeks back to reverse the markets and I fully expect that global central banks will at some point in the future see little alternative than to again resort to desperate measures, including QE.

On January 3rdtreasury yields sank to 2.54%, bund yields to 15 basis points, and Japanese yields to a negative 5 basis points. It was the same session that saw an ominous 8% inter-day move in the Japanese yen versus the Australian dollar. A decade of QE and zero and even negative rates spawned global monetary disorder, the most acute consequence being inflated securities markets and asset bubbles. With bubbles faltering globally in 2018 we see a secular shift in the nature of monetary disorder.

We believe the world has commenced a period of highly unstable, likely chaotic global securities and currency market trading. Over time we expect a crisis of confidence in the markets generally, along with a loss of confidence in policy-making. At this point, faith in central banking remains high. Markets responded strongly to Chairman Powell’s comments. But this is an important part of the process. Faltering markets have experienced their first leg down. There has been a policy response and a significant market rally. Confidence has quickly bounced back. While timing is uncertain we expect the market’s next leg lower to be more problematic. Participants will begin questioning market structure and soundness. Reassessing the market outlook, participants will also take a dimmer view of economic prospects as the cycles downside gathers momentum. At that point, it will likely take more than words to reverse increasingly illiquid markets. I believe central banks will initially be hesitant to resume QE and there is little room to cut interest rates. I do expect more QE, but in response to serious market dislocation. At that point, I believe enormous quantities of QE would be required to absorb the unwind of speculative leverage. For the markets, it may prove too little, too late.

As the late economist Kurt Richebacher would say, there is no cure for a bubble other than not to allow it to inflate. In the end, bubbles are mechanisms of wealth redistribution and destruction, although these destructive forces remain largely hidden throughout the bubble inflation period, the bursting of bubbles unleashes powerful forces. The up-cycle’s expanding pie fosters cooperation, integration, and strong alliances. As the downside commences, many illusions are shattered. The darker new view takes hold – a shrinking pie and zero-sum game world. Fragmentation, disintegration and alliances fraught with growing animosity, hostility and confrontation.

The collapse of the mortgage finance bubble ushered in a period of social angst, a deeply divided country facing heightened social and political instability. Massive monetary stimulus inflated markets, inflated perceived wealth and economic activity. Now, the comeuppance. The bursting bubble will now expose only deeper social, political, financial and economic fault lines. Worse yet, a collapsing global bubble will inflame smoldering geopolitical flashpoints. Hopefully, the U.S. and China can successfully negotiate a trade agreement, but this will hardly settle a plethora of issues between the world’s rival superpowers.

China faces an acute situation. After repeatedly prolonging history’s most spectacular bubble, Beijing now faces an incredibly bloated and vulnerable financial sector, massive manufacturing overcapacity, and extreme economic structural maladjustment, along with a historic real estate bubble. So far, Beijing has been hesitant to resort to full-fledged monetary and fiscal stimulus, likely appreciating that this would only worsen their housing bubble, heighten financial system fragility, and further raise the likelihood of a destabilizing devaluation of their currency. A deflating Chinese bubble is integral to the long, difficult road ahead.

Bubbles burst and the harsh reality is that the more they are prolonged, the greater the resulting dislocation. I would argue that a banking system that balloons from 8 trillion to 40 trillion in a decade, as it has done in China, is an accident in the making. I worry greatly about the circumstances surrounding China’s faltering bubble. Chinese finance has come to play a major role globally in the U.S. and Europe, but especially in the emerging markets. Since the last crisis, booms in China and throughout the emerging markets have become closely interconnected. I suspect enormous amounts of speculative leverage have accumulated in higher-yielding Chinese financial instruments over recent years.

At this point, markets maintain faith that China’s policymakers have things well under control. Over the years, similar misplaced confidence morphed into nervousness, fear, and then panic. China’s communist government will be loath to accept responsibility for mismanaging China’s financial system and economy. The U.S. will be the primary scapegoat, rather straightforward finger-pointing with the U.S.’s tough stance on trade. With their military expansion in the South China Sea and tough talk on reuniting Taiwan, it would appear Beijing is well into preparations for a scenario of fraught relations with the U.S.

We believe the long, difficult road ahead includes a deteriorating post-bubble geopolitical landscape, a weakening global economy and troubled markets. We believe the U.S. bubble economy suffers from unappreciated deep structural maladjustment. Deflating stock prices, tightening general financial conditions, corporate credit issues, and faltering real estate markets will expose system fragilities. Tighter corporate credit availability will significantly restrict the types of financial engineering that have seen stock buy-backs and M&A greatly inflate equities prices. I expect that tremendous numbers of enterprises that owe their existence to ultra-loose finance will face rude awakenings. We believe deficits do matter and expect our country’s perilous physical outlook to become a serious issue.

Market illiquidity will expose structural flaws in the booming ETF and derivatives complexes that have flourished during a decade of ultra-loose money. While the hedge fund industry suffered a tough 2018, they avoided large redemptions. I would expect major outflows with the next leg lower in global markets. We would not rule out a scenario of system illiquidity and a seizing up of global markets. We believe it is extremely unlikely that a decade of reckless monetary stimulus doesn’t end in a global crisis. With the global bubble having been pierced, it is time to get prepared for a problematic and deteriorating market, economic and geopolitical environment and we very much hope that things are not as dire as we fear.

David, back to you.

David:Doug, a number of things stand out from your comments that I want to come back to and just focus a little attention on. When we talk about rapid expansion of credit, and you illustrate China’s markets growing from 8 to 40 trillion, I don’t know that there is any historical precedent for that kind of credit growth. But one thing we do know from history is that massive increases in credit are commensurate with all the best bets possible being made. So that there is a come-uppance in that 40-trillion stock of loans is a real issue, and that is what our concern is, as we look at China.

The other issue that you raise with China is something that we have talked about for a long time, the idea of what we have called the crisis domino theory, where you have an issue in the world of finance which then has implications within the large economy, the second domino to fall. That creates political tensions and problems. Policy solutions are offered – sometimes they work, sometimes they don’t – and if they don’t, you end up with the final domino to fall, which is a geopolitical domino. This again, is where you are focused on the relationship between China and the U.S. We can look at it simply from the trade aspect, and that has enough prickly issues associated with it, and we are hopeful that there is some agreement that is arrived at.

The challenge from the Chinese will be to redirect negative energy, and it doesn’t have anything to do with trade, it has everything to do with a faltering banking system and credit excesses. So to look for that geopolitical implication, I think is, again, something that brings a certain amount of uncertainty into the financial markets. As you say, many of the things that we are seeing are all part of the process and so to see the Fed step in and support the markets verbally in the last several weeks – not uncommon. It’s not a surprise to us.

The first question that I am going to start with ties into that, so keep this in mind. I have a few more comments, but the question is – is this a dead cat bounce? If so, is it almost over? And we’ll get to that question in just a minute, because I think one of the key things that you and I have been discussing and that we have been sharing with our investors is that the issues show up in the weakest spots first. This is the periphery-to-core concept where it is the outlying, weakest hands that begin to fold first. You begin to see evidence of stress in the financial markets in those peripheral countries where balance sheets are weaker and then it moves toward the core. And so 2018 really was a significant confirmation for us in that periphery-to-core migration. I just want folks to remember that as they leave the call.

The last thing I would say is, this idea of liquidity, and because 2018’s theme dealt with market structure, and again, for those of you aren’t familiar with Doug’s work in the Credit Bubble Bulletin, I think this is a really critical piece to take away from today’s call. We have an illusion of liquidity, and the abundance of liquidity, the appearance of liquidity is there in large part because of the things that we take for granted – the ETF structure, growing to 5 trillion dollars.

Mr. Bogle, just passing within the last few days – may he rest in peace – has altered the financial landscape and the way that many approach the markets. You don’t buy companies today, you don’t invest in value, you simply buy an index, which is not really investing at all, it’s speculating, for sure. But that is what has developed, speculative trend-following with everyone in that world assuming that they can hit the click, with the click of a mouse, and get liquid. But the underlying assets still have to be liquidated and that is where I think we find that we really don’t have the infrastructure in place to provide the liquidity that is assumed within the market structure that we see today.

So Doug, I’m going to start with that first question for you. Again, in many ways you have answered the question, but maybe you can be very specific here:

Is this is a dead cat bounce? And if so, is it almost over?

Doug:(laughs) As you said, David, we’ve seen the initial policy response to market instability, and we’ve seen the markets rally. And I don’t like to try to predict the end of a rally. Certainly, the systemic issues haven’t disappeared at all, and I continue to have major concerns – short-term, intermediate, and a long-term – for market prospects, and the secular shift has commenced. And of course, there will be ebbs and flows, but the overall backdrop I would still look at as deteriorating, and we’re just in the initial phase, which I think will be an unusually deep and protracted bear market with a high probability of financial crisis.

Sometimes we can get lost trying to gauge what I call the market squiggles and lose focus on the big picture, and I think right now it is just important to have your framework set as far as how you think this will unfold over time, and less focus on a day-to-day direction of the market. But we certainly haven’t seen even hardly the beginning of the bear market.

David:Part of my set of influences comes from Pepper and Oliver and their book The Liquidity Theory of Asset Prices, which in a nutshell is that if there is more liquidity in the system than there needs to be, asset price inflation occurs, and when that liquidity begins to disappear, then asset price deflation occurs. So one of the things that you highlighted was, what we had in 2016 and 2017, a monthly infusion of liquidity of 150 billion dollars from the global central bank community is now gone, and in fact, this idea of normalization and shrinking balance sheets with the October date being very significant back in 2018 when the ECB stopped completely their interventions and buying of assets, specifically, corporate bonds within the Eurozone. This is a change in liquidity dynamics which leads to a change in price dynamics. And so, I want you to address Terry’s question which is taking kind of a two-year view for the U.S. investor:

Things have not turned that sour here from an economics standpoint, but what is your prognosis for the next two years for the typical U.S. investor?

He has a couple of more questions, but let’s start with that one.

Doug:Looking at a two-year time horizon, I think the probability of financial crisis in the next two years is high, so it’s a troubling prognosis and I worry that investors have really bought into this notion that markets always recover, just buy and hold, which essentially equates to disregarding risk. So today there is little appreciation for the variety of risk being taken by market participants. As you mentioned, David, the view is that the U.S. economy is in decent shape so the markets will be fine. Yes, the U.S. economy data today looks reasonable. It doesn’t look that bad. But that misses the point that the crisis is unfolding in global finance, is starting at the periphery. So I don’t think the U.S. economy is a very good indicator of market direction. So over the next couple of years I think central banks don’t have it under control like the assumption is today, and I fear that there are a number of misperceptions and fallacies that will be coming to light over the next couple of years, unfortunately.

David:I want to go back to one of your comments about the Bear Stearns hedge funds which were folding in 2007 and were roughly 15 months in advance of some of the significant market dislocations in the 2008-2009 timeframe because you could not have said it’s the economic indicators which are giving us an idea of what is ahead. It was in the area of finance and then you saw evidence of a decline within the economy. But the economy is not a real leading indicator. They do post mortems and usually assign recessions long after you have been in one.

But let me go to the next question here, which is:

Are the credit markets signaling a downturn now, or in the near future?

Doug:Let me briefly touch on your comment about 2007, David. We recognize the critical importance of 2007 and said at the time that we believed that was the piercing of the mortgage finance bubble because we had a pretty good understanding of the structure of finance and how when Bear Stearns funds got in trouble that was an inflection point for risk-taking and mortgage credit growth, home prices, etc., and that would start a decline that would then spread to the core. Candidly, I didn’t, at the time, think it would take 15 months, but that was part of the learning experience, I guess.

Credit markets have somewhat stabilized along with equities since Chairman Powell’s January 4thcomments, but again, on January 3rd, credit and currency markets were signaling a rapidly unfolding market dislocation. So after the recent rally, I would say that signals in credit are somewhat mixed, corporate risk premiums are signaling near-term concerns, no doubt about that, but not necessarily an imminent downturn. I would say treasury, German and Japanese bond yields, though, are clearly indicating elevated global systemic risk, and this is confirmed by the meaningful rise in bank credit default swap prices over the recent months. And the junk bond market recently saw no issuance for over 40 days, so that is a clear indication of a significant tightening of financial conditions with negative economic ramifications.

I would say the important credit market fragilities have been illuminated, which creates vulnerability. I expect the next round of re-risking, de-leveraging, and rising risk premiums and fund outflows to be much more problematic. Liquidity issues and investment-grade corporate credit would be a key signal of imminent economic vulnerability. We’re not there yet, but I don’t think it would take much for more systemic liquidity issues to erupt within corporate credit.

David:One last question. Part of the answer of the question is Tactical Short, but perhaps you can mention a few others.

What investment strategy would you advise for weathering a coming downturn in the equity markets?

Doug:Another good question. My view is that investors would be well served avoiding risk assets, stocks and corporate credit in particular. At the same time, I believe the risk/reward of holding treasuries and government debt more generally is not especially appealing. Ten-year treasury yields were at 5% back when the crisis started to erupt in 2007. Today they are at 2.7%, and I expect already large fiscal deficits to turn increasingly problematic.

So another important challenge today is that safe havens don’t come easy. We understand that many investors cannot simply shun risk and liquidate security holdings, and we would strongly recommend incorporating sound hedging strategies. We believe that Tactical Short is a good option for helping reduce the overall risk of an investment portfolio. But there are other products, as well.

We also believe in allocation to precious metals offers an important element of protection in the unfolding highly uncertain environment. So there are important things that we can do in this environment.

David:On that issue, one of the questions asked is:

Do we recommend owning gold? Is that a part of this strategy?

While precious metals are not a part of the Tactical Short strategy, it is something that we recommend, as Doug mentioned. A part of that is, you’re dealing with a crisis as we expect it to emerge at the heart of money and credit. This is government finance. And what that implies is that you are testing a different kind of confidence level. When you can’t trust government, when you don’t trust government’s money and what government has done with their money, you have a whole different set of implications, and I think gold actually does very well. It does well during periods of financial dislocation. It also does well during periods of political volatility when people aren’t getting along. Frankly, it does well in periods of time when there is a tremendous amount of uncertainty. So whether you are looking at financial uncertainty, economic uncertainty, political uncertainty, geopolitical uncertainty, you’re talking about market psychology, which is favorable to people opting out of traditional assets and getting to the sidelines, either in the form of cash, short-term treasury bills, gold – these are all things that have been classic safe haven investments. So we do see that as having a play.

Another part of that question reads here:

If so, what form of ownership would you recommend? Numismatic coins, stocks, bullion?

I would say, frankly, in a well-diversified portfolio there may be a place for each of those. Bullion is very straightforward. We launched a program with the Royal Canadian mint, to own kilo bars directly with them, our Vaulted program, which is, I think, worth looking for, for a bullion or cash alternative, if you will, if you just want to denominate ounces that way. Coins – we have many people – I had this dialogue just yesterday with a gentleman who wanted something in his physical possession, was not interested in having something stored elsewhere in Canada, Switzerland, or anywhere else. And so, there is a conversation to be had about what is the perfect allocation for that, between gold, between silver, between platinum and palladium and things like that. So not just with numismatic coins, but anything that you are more inclined to take delivery of.

And stocks – there are actually two questions in here. I’ll answer them both at once:

What are your thoughts on precious metals mining stocks, and then this, as well, dealing with metals stocks?

How should I say this? 90% of the time you don’t want to own them, 10% of the time you do. And the physical metal is going to do well. They tend to do extraordinarily well. For instance, 2016, when gold finally turned off of the $1050 lows, what you saw was a 20-30% gain in the price of bullion, and between 100-160% gain in the companies that mine those assets. So in terms of leveraged upside, it is not exactly the same vehicle as physical metal. You’re talking about a growth dynamic versus, say, asset protection. But I think, again, in a diversified portfolio, perhaps all of those have a place. And we do think that gold will ultimately benefit from the current distortions in the global financial situation.

Doug, the next question is:

What is the primary consequence of central banks continuing to prop up their economies with liquidity?

And in a sort of sub-question, there is a little bit of a skeptic here, I think, asking:

It’s been going on for over 30 years now.

Doug:That is has. I followed developments closely for those 30 years, chronicling developments on a weekly basis for the past 20 years, so I know it all too well. But that is why I speak of a historic global bubble across virtually all asset classes that has made its way to the very foundation of international finance to the heart of money and credit. We have seen this unprecedented inflation of central bank credit and government debt. With 30 years of history it is understandable why people would be skeptical and they would believe that central banks have the answers, that they would continue to prop up markets and economies indefinitely.

History, though, for many of us who have studied, informs us that prolonged monetary inflations have dire consequences and they don’t last forever. Bubbles inevitably burst. And we say this. Things turn so crazy, excesses go to such egregious extremes that bubble dynamics become unsustainable.

I refer to the terminal phase of excess where you see credit growth and speculative excess, price inflation and financial and economic maladjustment. They create unsustainable dynamics. Ask yourself why the tech burst in 2000. Well, start with an almost doubling of the NASDAQ and manic excess in 1999. Why did sub-prime blow up in 2007? Well, you had lending that became so reckless in 2006, and you had a trillion dollars’ worth of sub-prime mortgage CDO issuance in 2006. I argue that systemic risk expands exponentially during this terminal phase where there is expanding growth of credit of rapidly deteriorating quality.

This is clearly the case today in China and elsewhere. Measures to sustain a bubble will only lead to greater financial and economic system impairment. And eventually the predicament becomes more apparent, ushering in a backdrop of the self-reinforcing risk aversion, de-leveraging, waning liquidity, and faltering markets. Could global central bankers step in once again to prolong this bubble? Yes, that is certainly possible. But the result would only be greater monetary disorder and a more perilous bubble. You don’t want to throw more liquidity at this dysfunctional system we have.

What we should glean from the past decade is that there is no cure for bubbles. This is the harsh reality that the world is going to have to come to terms with and adjust to. I assume central bankers are today less confident in the long-term benefits of QE and zero rates. Arguably, systemic fragilities are as great as ever.

David:I think that is a good segue to a question that came in online, and this again deals with the Fed, it deals with emerging markets, central banks. Evan asks:

In your mind, does the Fed’s and other developed market central banks’ need to return to QE impact their currencies’ traditional safe haven status? And if so, how would this be different than Japan’s experience to date in which years of QQE and runaway debt have not dented the end status as a “safe” asset?

Doug:Excellent question, Evan. I think the treasury market – JGBs, bunds – and markets, especially throughout Europe, are signaling that there will be more QE. The markets don’t know when that QE will come. I certainly expect QE to come, but it will be in a crisis environment, and this clearly is at risk for currency market trading for the value of currencies generally. We think that is one of the reasons why gold is increasingly appealing.

I tend to look at Japan as a unique case. I don’t think we should extrapolate what the Bank of Japan has done with their balance sheet and think that central banks all over the world could do that. They, over the years, have run big current account surpluses, they have international reserve holdings, very strong manufacturing base. They have a lot of things going for them, even though they have made a mess out of their finance, even though there will be a huge day of reckoning in the Japanese debt markets. So I don’t think at this point the global central bankers can just add liquidity into the system and expect that to stabilize the markets. In fact, I think we will see highly unstable currency markets generally as new liquidity has one effect, de-leveraging has another, and the whole thing turns into just a difficult period of instability in the markets.

David:Doug, do you have any comments on sector strategies – EEM, FXI, short or long? Bob would like to know.

Doug:I tend to not have strong views right now on sectors because of this violent sector rotation we are seeing, the short squeezes. It is interesting, over the last three months, the emerging markets have significantly out-performed the developed markets, significantly out-performed the S&P 500, for example. No one would have expected that at the beginning of October.

Why did we see that? One of the reasons we saw it is because everyone got on the wrong side of the boat. Everybody was long the S&P and they were short the emerging markets. And all of a sudden, the troubled markets make it to the core and U.S. security markets start to sell off and hedge funds have to unwind longs and shorts so they are caught overly long the U.S. and short emerging markets. All of a sudden they have to buy back their shorts in the emerging markets, the emerging markets start to out-perform, and then the trend-following money jumps in the emerging markets, and we’re in a situation today where people are bullish again on the emerging markets.

Because of economic prospects? No, because of price action, because of market technicals. So I think this is a disjointed market and on a day-to-day basis, and especially on this call, I wouldn’t feel comfortable with having a bullish or bearish view on an individual sector.

David:And again, following up from Michael:

What does the Tactical Short team expect to be the catalyst that changes the U.S or global economy from a bull market to bear? How does this affect those who have invested in the product thus far? How will it impact the product until that change occurs?

Doug:Hopefully, my presentation sheds some light on this. My analytical framework emphasizes financial conditions, so I believe global tightening of financial conditions portends a deteriorating market environment. I have seen that dynamic work for over 30 years. So I see expanding speculator losses and resulting de-risking, de-leveraging as a bear market catalyst. I look at the leveraged speculators. They are like the marginal source of liquidity for the markets. If they are putting on leverage, taking risks, the markets are going to be liquid. If they reverse course and de-risk, de-leverage, illiquidity becomes a problem.

Today we are at 65% short. A year ago from about now we were 16% short, so obviously we have seen a significant change in the market environment. We have responded to that change and we could continue to increase our short exposure. As a bear market unfolds I would expect to be more opportunistic, employing put options, broadening our short exposure. But, as I keep repeating, there are major uncertainties in the outlook. We have U.S./Chinese trade negotiations, domestic global monetary policies, Washington politics, Chinese policy-making, the performance of U.S., Chinese, global economy, Brexit – we have a list of things. There will surely be unexpected challenges, so we have to just be prepared to act as things unfold.

And I will also say, David, it is tempting to use an analogy of a marathon runner. We have trained really hard and have prepared for a long and challenging race, and we’re carefully guarding against sprained ankles and early exhaustion. Maybe I’ll put it that way.

David:This last year I ran my first marathon and I was told by veterans over and over again, don’t come out of the gates too strong. You have to go the distance. Don’t start too strong.

There is a question here about:

Is there an investment option for people with less than $100,000 to invest?

I’ll take that. That would be the non-correlated, which is a mirror to the Tactical Short and uses slightly different vehicles to get similar results, within about 50 basis points of performance in the non-correlated with the numbers that we shared earlier, marginally better with the non-correlated for whatever reason, in this particular timeframe. That is $50,000 and is specifically for IRA assets, or there are certain jurisdictions globally that will not allow for margin accounts in the United States and this allows for us to manage international accounts in any size, but with a minimum $50,000 for U.S. investors on the IRA, Individual Retirement Account, side. But we can manage global assets with that in mind, where there is the limitation for margin accounts.

Another question for you, Doug:

How do you reduce counter-party risk of leveraged ETFs?

Doug:I don’t like leveraged ETFs, long or short, so we don’t use them. Especially on the short side, I prefer lower beta to high beta and some of these double index ETFs can lose upwards of 20% during a 10% market move. In today’s unsettled market environment the market can rally or sell off 10% in short order. So I would just avoid them and their potential counter-party issues. Recalling the wisdom of Nancy Reagan – “Just say no.”

David:(laughs)What is your protection against the Federal Reserve following the Bank of Japan script and their purchase of equities? How do you protect against a direct intervention like that?

Doug:That is a great question, something that we have to focus a lot on. Being disciplined risk managers and diligent analysts will help guard against various scenarios. We expect, and we are going to have to navigate around policy responses as the bear market unfolds. I have done that my entire career. I don’t think the Fed wants to go down the path of buying stocks, and going forward I expect very close scrutiny of policy measures that would be viewed as directly benefitting Wall Street and the wealthy.

In the event of a market collapse we wouldn’t be surprised if the Fed supports equities, but in that environment they will have to spread their buying between treasuries and mortgage-backed securities, corporate debt, probably even leveraged loans, derivatives. So I don’t, at this time, anticipate stock purchases, certainly in the trillions. But I’m going to keep an open mind and follow developments closely as they unfold. That is going to be imperative.

David:Maybe this goes without saying, but the structure of Tactical Short is that we can reduce our exposure. Again, back to the primary difference between what we do and what the constantly 100% short all the time, what we described as risk-indifferent at the outset, the contrast between what we do and other organizations out there with comparable products – it’s not comparable, because we can go from 65% to 100%, or down to 16% or zero in terms of our short exposure. So it’s not as if we have to be short in the event that these things begin to unfold, and that is a part of our risk management mandate.

Another question here, Doug, is:

Do you trade volatility? And if so, what are your instruments?

Doug:No, we do not trade volatility, and I’m down to my final two brown hairs, and I’d like to save them.

David:(laughs)

Doug:So I find managing short exposure amply challenging. On occasion we will buy listed put options which could be a bet, both on rising volatility and lower market prices, but I don’t anticipate trading in and out of options, especially the VIX variety. I’m just pretty disciplined about the risk profile of individual positions.

David:This kind of builds on some of our comments on Tactical Short performance for the 4thquarter:

How do we operate in a period of bull market, when the market is marching higher?

Maybe you can address, again, your weekly reduction of exposure to the market in response to strength as it emerges. We don’t have a philosophical position here such that we must be right. There is a pragmatism in your mosaic of indicators that allows for you to reduce exposure and do that in the event that the market starts to accelerate to the upside. Maybe you want to expand on that a little bit. Yes, we had a great 4thquarter, but what does it look like in a period of a bull market where prices are increasing?

Doug:You mentioned ego, and I think my ego was crushed decades ago, so that’s not going to be an issue.

David:(laughs)

Doug:First of all, no outside losses, that’s rule number one. If the market is going against us, if our position is going against us for the market, if we’re losing money we get smaller. Again, a year ago right now we were 16% short, potentially moving toward zero. We could have gone to zero. I think this is the way to do it. It’s not easy. This is one heck of a challenge, but what we want to do is, when financial conditions are tight, or tightening, we want to look to be more opportunistic and have more short exposure. If they are loose, or loosening, then on balance, benefit of the doubt to the bull market and we will be more cautious.

We have to come in every day and gauge what we think the risk/reward of the marketplace is. We have a mosaic of indicators, just trying to get an edge. And I often say, it’s kind of like we are professional speculators in a way, and we’re trying to read the cards every day to get whatever edge we can to ensure we have more exposure when the environment is favorable for shorting, less when it is unfavorable. We will just go forward day-to-day, week-to-week with that basic philosophy. And if it is a bull market, then over time we are going to get a lot less short.

David:I have another question from the online platform. Chad asks:

As the sovereign debt bubble starts popping more around the world, what is your prediction about the relative strength of the U.S. dollar, and how that will influence the monetary metals, thinking about the next 18-24 months?

Doug:That’s a great question, Chad. The dollar is a big unknown. We’re talking about the world’s reserve currency. We are talking about something that became King Dollar again. It reminded me of the late 1990s. Why was it King Dollar? Because of our out-performing securities markets. Well, that started to change. Our securities markets are not out-performing. So now there might be a little bit more scrutiny of constant current account deficits, huge fiscal deficits, economic imbalances and such, questionable policy-making out of Washington, not targeting the administration, I will just say Washington politics generally.

So the big surprise could be everyone, hedge funds in particular, got long the dollar, and now if the dollar reverses, what does that mean? What if the market starts to turn on treasuries? We saw indications of this not that many months ago. Treasury yields were rising, even in the face of global instabilities, so I would not be surprised by the scenario where we get a surprising sell-off in the dollar and that puts pressure on treasuries, which puts more pressure on U.S. securities markets and the U.S. economy – a very unstable environment.

But there is also another scenario where we could go back in to a real de-risking, de-leveraging environment in the emerging market currencies that could give a temporary boost to the dollar. So these trading dynamics will be challenging, but I think the underlying fundamentals for the dollar and treasuries are ominous.

David:There is an argument for using gold as a plumb line rather than the U.S. dollar, in which case the movement in the price of gold and the monetary metals has more to do with weakness or strength of the underlying currency. And you begin to see that when you look and say, gold in the end-terms, being near all-time highs, versus gold and the dollar today not near all-time highs, as the dollar weakens it reflects itself in the price of gold. So to put a bow on that question, we think the monetary metals, over the next 18-24 months, in that environment of a weaker dollar, would do well. It might do well even with a stronger dollar, just from supply and demand functions, but certainly, we could see it reflecting a lower currency, too.

There is another question, and this will be the last unless anything else comes in online. There are many approaches to speculating in the markets today. Doug, I have read the Credit Bubble Bulletin for over a decade before we started our partnership with the Tactical Short, and both of us share an interest in global macro-analysis, and it certainly informs some of our thinking. There is also this idea that what we are doing is providing a hedge, which we do. But then, there is this question:

How do you compare the Tactical Short strategy against particular hedge fund global strategies?

He mentions Crescat which received nice accolades from Bloomberg for 2018 performance. But again, it is a hedge fund, which is different from what we do as providing a hedge, although the words are similar. And it is a global macro strategy which only shares in common with us that we do look at the global macro as a part of that mosaic. Maybe you want to expand on that answer.

Doug:I’m not familiar with this particular fund. I went to my handy Bloomberg terminal but I was not able to pull up their holdings, so I can’t really comment. I see they have put up big numbers and quite a bit of performance volatility, so I will assume that they are active in the derivatives markets, which a lot of hedge funds are. That can be a key part of their strategy, a lot of the macro hedge funds. I know back in 2006-2007 I was familiar with some of the positions that some of the hedge funds were putting on to benefit from the likely bursting of the mortgage finance bubble, and I remember at the time saying that I would be very cautious with that strategy because in that environment you might not get paid. You might have counter-party risk issues in the derivatives markets. That wasn’t necessarily the case in 2008. I think it could be the case going forward.

So one of the fundamental differences we have to a lot of hedge fund strategies is, not only do we structure this with full transparency and flexibility, reasonable fees and no lock-ups and things, but we are very focused today, and will be as this unfolds, on systemic risk and protecting our liquidity, protecting our investors’ money, and they are going to be able to watch our every move along the process.

David:Well, that wraps up the Q&A. I just want to come back around to where we started, which is what we are doing with Tactical Short is in an effort to build long-term client relationships and to complement what you may be doing with other financial firms on the long side, so we would love to know how we can fit into that picture for you if you are not an existing client. And for those existing clients, thank you for your confidence and trust, and we endeavor to do our very best for you every day.

It is a fascinating time to be in the financial world, and my hope is that between the Credit Bubble Bulletin, out every weekend, the Weekly Commentary that we do each week, and the market wrap-ups that we provide at the end of the week on Friday, that we are providing information, insight and analysis that helps you appreciate the context that we are in, and to make wise choices. Sometimes that may be letting the horses run as we head into a strong growth phase. Other times that may be reining in those horses and mitigating risk. We want to help with the analysis piece and we give a lot away.

Doug has been writing the Credit Bubble Bulletin for over 20 years. The Weekly Commentary here in the next few weeks goes into its 11thyear of weekly audio commentaries. Hopefully, that is helpful to you. We hope that the service is, as well. I look forward to being in touch in the next few weeks and having a direct conversation with you. If you prefer to set up a time feel free to contact our staff here in Durango and we will set up a call and have it pre-scheduled. Thank you for your time and attention today.

Doug, thanks for your comments and for all those who are asking questions, we appreciate your curiosity, and look forward to visiting with you on the next quarterly conference call.

Doug:Thanks, David, and thanks, everyone. Good luck, and be careful out there.