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Vega Capital Group is moving
We are moving our headquarters to downtown San Francisco. Our new address, beginning May 15, 2005 will be (also see map on the right):
Vega Capital Group
100 Bush Street, 16th Floor
San Francisco, CA 94104
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Overall Market Outlook
At the first glance, the market's action was decisively negative in the first quarter of 2005, with both equities and bonds registering negative returns. Yet, for those of us who are following the market every day, it was a roller coaster ride—with negative January, positive February and dismal March. The reasons for the market moves also seemed obvious at first—yet, we feel that it is exactly when the causes for market moves seem obvious, the real reasons are most complex, those first impressions being just a hazy reflection of reality—just as myth is often a reflection of some real historical events. So, it is fair to say that the jigsaw pattern of the market is a sign of information overload, a state of Wall Street when investment myths become so interwoven with reality that hordes of traders are driven from one extreme to another by nothing more than a hint of a developing pattern.
The modern Wall Street mythology is so diverse, that at times I am completely puzzled as to what myth is to be applied to a particular set of circumstances. This is exactly the type of market we are in now. Indeed, if you browse through a month worth of major financial newspapers' latest headlines (or, if you are into wasting your time in an even more efficient way, listen to some talking heads on CNBC), you'll get all kinds of "sure" extrapolations, raging from typical doom-n-gloom to rosy. Following my analytical inclinations I recently ventured into taxonomy of the modern stock market myths and here is a sample of the most recently popular ones (with my comments on their sagacity):
The mighty dollar myth. This one implies that the strength of dollar is indicative of future stock market returns.
Reality: In fact, there is zero correlation between these two. Even the most recent two years shows a dollar decline by a record 30% against euro while S&P 500 index has an almost 50% positive return.
The rising interest rates doomsday myth. One of the most popular among doom-and-gloomers, this myth postulates inverse relationship between interest rates and equity levels.
Reality: In real life as opposite to the minds of the doom-and-gloomers, the rising interest rates environment is usually a symptom of Fed's reaction to overheating economy—and with Fed's current openness policy, carries very little surprise for the stock market. That is, the rising interest rates is pretty much "old news" and has already been factored into equity prices.
The runaway deficit myth. This one is puzzling to the economist in me—so puzzling that I suspect that this myth was artificially introduced to Wall Street by left-leaning politicians hoping to score some points against now all-conservative legislature. This one is about record deficits somehow being bad for the stock market.
Reality: the deficit is a way to finance treasury budget; it has nothing to do with equity markets, yet this myth proves to be extremely persistent, and is reincarnated every time it is beneficial for some political force—my favorite example is the bashing of "Reaganomics" in 1980s.
The cash flows explosion myth. We have not heard this one for a while—since late 1990s, in fact—when rapidly rising corporate cash flows were used as a predictor of raging bull market.
Reality: Record cash flows are indicative of great past performance; no statistical analysis ever found any autocorrelation in the YoY cash flow increase time series, and thus, should have no effect on the future of the stock market.
The squandering consumer myth. Fueled by the fact (is it really?) that consumer spending comprises 2/3 of US economy, this one associates big consumer spending with great prospects for equities.
Reality: this one makes so much intuitive sense that it is really hard to dismiss, yet time and time again market crashed right at the peak of consumer spending (most famously in 1929, 1987 and 2000), thus annihilating any possible correlations (in fact, if you run linear regression, you actually get a negative number—but this is worthless because the data set is so far from normally distributed that our statistical tools break down).
Even more myths deal with oil prices, corporate earnings, Fed policy, housing market, etc., all bearing virtually no connection to market realities. Yet we believe that none of these will influence the markets in a significant way—and for now, we just have to wait and see how the true economic landscape will shape in the nearest future. For now, the indications are so mixed that we refrain from making any predictions.
First Quarter Performance Review
With the market in the jigsaw pattern, we struggled to keep our exposures to various risk factors balanced, staying fully invested in order to capture market upside, yet avoiding bets that would cause increases in overall portfolio volatility. This allowed us to limit our exposure to some of the risk factors that dragged down major indices. Our average Equity+ portfolio was down just over 1%, and Equity* portfolio lost just over 1.7%, net of all fees, as compared to S&P 500 and Dow that both lost 2.6% and Nasdaq that was down more than 8%—see table below.
| Q1
2005 | Year
2004 | Annualized Rate
of Return | Max
Drawdown | Return/Risk
Ratio | Beta | Excess
Return (α) |
|---|
| Vega Equity+™ | -1.03% | +12.05% | +18.90% | -3.60% | 5.20 | 1.10 | +6.01% |
| Vega Equity*™ | -1.72% | +17.58% | +22.80% | -5.10% | 4.50 | 1.30 | +8.03% |
| S&P 500 | -2.59% | +8.99% | +13.68% | -10.20% | 1.30 | 1.00 | 0.00% |
| NASDAQ | -8.10% | +8.61% | +21.20% | -10.70% | 2.00 | 1.70 | -0.48% |
| Dow Jones | -2.59% | +3.15% | +12.73% | -11.30% | 1.10 | 1.20 | -4.96% |
Strategic Direction for the 2nd quarter of 2005
Yielding to our uncertainty about the current trends in the stock market, we are shifting our model's stance one notch towards a more conservative. Yet this does not mean that we are in any way giving up on the market; we still see quite a bit of value when it comes to equities. Instead, what we are saying is that the current jitters generated by coming economic uncertainty are there to stay for a few months at least, and we do not feel that taking our investors' money to the more risky assets is now warranted. We still keep our portfolio fully invested with a target beta of 1.0, though our sector bets may decrease somewhat, giving way to a more diversified approach.
Vega Fixed Income Strategy Update
Not much changed on the fixed income front since early January when I wrote that 2005 would not be a good year for fixed income. Indeed, the spreads are thin, and the rates are rising. The aggregate averages such as Lehman Aggregate Bond Index slipped approximately 1% during the first quarter of 2005, with benchmark 10-year Treasury raising by as much a 3/4%. The Fed's policy statement looks frozen, and the market pretty much priced in another 5 quarter-point rate increases over the next year on top of 7 that already happened. This may sound like a bad news for bond investors, but it really not—unless you want to make money by speculating on the bond yields. For our Vega Safety and Vega Wise portfolios the higher interest rates will just mean that despite some short-term volatility, the yields are bound to increase from the current 4% for investment grade and 6.5% for high yield portfolios.
Vega Alternative Strategy Update
For the information on performance of our hedge fund products please contact us directly as by SEC rules we are not allowed to make such information publicly available. In general, however, our hedge fund strategy follows the same guidelines as our equity portfolios enhanced with additional instruments such as short positions and derivatives.
Yuri Drozd, Chief Investment Officer
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