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MarketThoughts Special Update

(August 21, 2008)

Dear Subscribers and Readers,

Our regular guest commentator for this mid-week commentary (third Thursday morning of each month), Rick Konrad (author of the excellent investment blog “Value Discipline,” and founder of “Value Architects Asset Management”) has been at client meetings in New York and Long Island earlier today so he didn't get a chance to finish his guest commentary.  No matter – Rick will be back at full strength tomorrow and you will have Rick's insights in your mailbox by early Friday morning!

In the meantime, I want to provide a special update of not only the financial markets, but also an update of my long-term career plans.  Let us first talk about the latter.  As most of you know, we (my partner, Rex, and myself) have been consistently running since 2004.  I have been investing and trading stocks ever since I was 19 – and was fortunate enough to catch the end of the technology bull market and to turn around and short the top as well (by mostly buying LEAPS put options on large cap technology stocks such as Intel, Cisco, Oracle, etc.).  I also got my CFA charter in 2003.

At the time, I did not think about managing a portfolio in an institutional environment – preferring to have the flexibility to manage my own portfolio and believing I could start my own fund down the road.  In the aftermath of the technology bubble, I also lost a tremendous amount of confidence in our nation's asset managers.  Since the middle of this decade, however, many things have changed in the investment management industry.  The latest credit crisis aside, the proliferation of global capitalism and the tremendous amount of demand for “alternative asset classes” by global institutions have made the industry much more interesting than it ever was.  My last two years of experience as an institutional investment consultant in Los Angeles has solidified my interest and aspirations to work on the buy-side.

As a result – and as some long-term subscribers already know – I have decided to go back to school and get my MBA.  I will be attending the UCLA Anderson full-time MBA program, with a focus on finance (investments), accounting, and corporate strategy.  I have been grappling with this question for a long time.  Obviously, there is some opportunity cost (such as tuition, lost income, etc.) but as I see it, the benefits to getting an MBA at a school like UCLA Anderson far outweighs the costs:

  1. Obtaining the MBA is somewhat like a “rites of passage” for those who are transitioning to the buy-side.  While two years of work experience at a reputable buy-side firm is more valuable than the MBA degree in itself, both the recruiters and your new co-workers would prefer to hire those who have put in the work and sacrifices to getting their MBA degrees.  In addition, the more MBAs (and CFAs) a buy-side firm has, the better for marketing purposes.

  2. The UCLA Anderson program provides great hands-on experience to its aspiring investment managers.  For example, there are two student-run investment funds – the Student Investment Fund and the Anderson Student Asset Management – which actually run a portion of the business school's endowment.  Both these funds also have a great program where they bring in great speakers, visit reputable investment managers across the country, and of all things, visit Warren Buffett at Omaha.  Obtaining a place in either of these funds would give one a huge “leg up” – not only because of the practical experience but also because of its prestige and the connections as well.

  3. The UCLA Anderson program offers a top-notch faculty, great courses, and the flexibility to take electives in other schools and programs.  In terms of the finance and investment courses – taking them would not only allow me to brush up, but add to what I already learned – such as taking courses in Behavioral Finance, Game Theory, Options Markets, Real Estate Securitization, and Business Strategy.

  4. Labor statistics all around the world have shown that the level of formal education is directly related to employability and income levels throughout one's career.  Obviously, I intend to succeed in the investment management field at (virtually) all costs but in getting my MBA, I am also playing the odds as well.  I have never been a gambler and I never will be.  The trend of obtaining more formal education and credentials in each successive generation is still in place.  A decade from now, a much greater proportion of students in the world would be obtaining their Masters degrees, if not their PhDs.  Having an MBA would not only open up more career and entrepreneurial options going forward, but would also elevate my employability in a recessionary/depressionary environment as well, should that ever come to pass.

  5. Connections, connections, and connections.  Not only is the domestic network excellent at UCLA Anderson, but so is the international network.  The entering class of 350 students is among the largest in the world, and so is the foreign composition of the class (fully one-third of the class is composed of foreign students).

Over the next two years, I would continue to work on as usual, and will attempt to stick to our current publishing schedule as much as we can.  If anything, I would be able to devote more time and more resources to improving the site – as I would have access to a tremendous amount of data, research, and knowledge feedback through UCLA Anderson.

For now, my goal is to get into either the Student Investment Fund or the Anderson Student Asset Management in January, and subsequently obtain a great summer internship at a reputable buy-side firm (e.g. a mutual fund or a hedge fund) from mid June to early September of next year.  I will keep all of up-to-date on my progress, of course.

Let us now discuss the current state of the financial markets.  As I am typing this on Wednesday evening, I have to say that I am disappointed on the “weakish” bounce of the US stock market earlier today, given the short-term oversold conditions in the aftermath of the declines on Monday and Tuesday.  That is not to say this current rally from the mid July lows is over yet.  In fact, given the record bearish sentiment just three weeks ago, the tremendous amount of investable cash sitting on the sidelines, and the dramatic decline of protectionist sentiment between both the Democratic and Republican parties over the last couple of months and heading into the US Presidential election on November 4th, chances are that this rally still has more room to run.  For those who haven't read about Obama's economic advisor and his policies, I highly recommend reading this article, titled “Obama's Geek Economist” on MIT Technology Review.  It is definitely a must-read, especially for those who really want to know Obama's true views on NAFTA and what he sees as the true growth drivers of the US and global economy going forward.

My sense is that the “true test” of the stock market will come when (not if) the US Treasury decides to bail out Fannie Mae and Freddie Mac by directly injecting capital into these two entities.  As a subscriber pointed out to me, the yield spreads of both agency MBS and agency debt declined today, even as the prices of the common and preferred shares of the GSEs continued to plunge.  This means that more investors are now seeing (and pushing) the US Treasury to bail out the GSEs.  It will be difficult for the GSEs to roll over the $223 billion of debt that is due between now and the end of September without relying on Treasury for support.  It is definitely an understatement to say that the GSEs have blew it.  Just three weeks ago, the GSEs – in light of the naked short-selling ban and the Treasury's announcement that they will backstop the GSEs – Fannie and Freddie could still have raised at least $15 billion of capital between the two of them (many asset managers with substantial amounts of capital were saying to us as recently as three weeks ago that Fannie Mae was the best buy out of their entire buy lists).  True, it would have been hugely dilutive, but it would have allowed them to survive, and possibly to thrive in the new mortgage monopoly.

Alas, it was not to be.  My guess is that the Treasury will inject a minimum of $30 billion in equity (this is Bill Gross' number), with a potential to reach $40 billion or $50 billion.  At these higher numbers, this would not only allow the GSEs to survive, but would also allow them to buy more mortgages on the secondary market and to flood the mortgage market with new loans as well – thus putting a cushion on the decline in housing prices and potentially the financial markets as well.  At this point, my sense is that this could happen as soon as immediately after Labor Day Weekend.  Whether this rally has more legs will depend on the market action and the appetite for risk after the bailout.  For now, we can only sit and wait.

Yours truly,

Henry To, CFA

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