Harley Bassman, who used to head Merrill's RateLab, and who was one of the most erudite sellside voices on rate matters, and doubly so on mortgage issues, and subsequently moved to Merrill's prop side, has kept a low profile recently. Which is why we are happy to present his model portfolio for 2011. Bassman is a firm believer in inflation (synthetic or real), and we for one would pay good money to see the redux of the Rosenberg vs Grant debate in 2011 be Rosenberg vs Bassman. Bassman's conclusion, even though obtained in a circuitous way to our own, is comparable to the Zero Hedge thesis that the Fed will have no choice but to eventually create inflation. "In a nutshell, the FED (with the help of the Govt), is going to engineer some type of Inflation to reduce the value of both our Private and Public Debt. Since Inflation is the only solution, it will happen; it is just a matter of time. Since the entire G-7 is in the same boat, trading in Euro or Yen is purely a short-term speculation since all these currencies will be heading south." Where Zero Hedge and Bassman, however, differ, is that we are certain that the Fed will be unable to contain said inflation once it has finally been unleashed, resulting in a complete wipeout of all assets that are directly or indirectly a rate derivative (ref: a very notable reparation paying, post-WW1 central European state), which means all fiat derivatives, leaving only hard assets in the wake.
Bassman's Model Portfolio for 2011
1a) Long "Big Oil" + "Big Pharm" + "Big Tobacco" + etc equities. I am precluded from making naming names, but you know what I like. Mega Cap international stocks with patent and pricing power. P/Es of 13ish (an earnings yield of 7 1/2%) and Dividend of 2 1/2% to 4 1/2%. FED will encourage Retail to reverse out of Bonds and into Stocks.
1b) For "non-stock pickers": Buy the S&P five years Forward at a discount to Spot. Sell Ultra long dated (five to ten year expiry) calls.
2) Buy Brazilian Local Currency Bonds. Yes the "Real" at 1.67 is rich, but the 10 1/2% yield for three to six years will more than offset the Govt's efforts to weaken the Currency. Unlike China or India, Brazil is a "hard asset" country.
3) Buy Russian // Mongolian // Southern Caucus Equities. I want "hard assets", not cheap labor. Yeah, this region is sort of lawless and it is unclear if your legal claim will be upheld. But at some point Russia, etc, will need to bring in Capital and reform is likely. Most importantly, this region is a "negative beta" to the G-7 race to the bottom.
4a) A diverse portfolio of Long-dated Municipal Bonds. You can find a selection of AA bonds in the 10 to 20 year sector that yield 5% or more. Since rates can only rise if the FED is successful in reflating the economy, a higher rate world would tighten Muni ratios. Also, I do not see taxes declining anytime soon. Muni's have a massive negative spread correlation to Treasury rates. Long Muni bonds will simply not sink below 4% on the downside and will start to compress at 5% to 6% on the upside. These "retail" bonds are super sticky at these coupon levels.
4b) Buy Closed-End 35% leveraged Muni Bond funds. Either National or Single State. They trade at a 5% to 8% discount to NAV and sport yields near 6.0%
5) It goes without saying I hate Treasuries, especially 3yrs to 7yrs.
6a) Buy 10yr into 10yr 6.0% swaption payers (puts) at 435bps. This trade is analytically "Positive Carry" for the first three years as 9yr, 8yr and 7Yr payers also struck at 6.0% costs 450bpb, 465bps, and 475bps respectively.
6b) A variation of above: Sell 3y-10y 5.35% payer vs Buy 10y-10y 6.00% pyr for zero cost. This trade is long a 10% delta, so there can be some severe mark-to-market risk. Nonetheless, this trade is a carry monster. Moreover, I do not think we can break T10yr above 4.05% as long as the FED is on hold, which should be sometime into 2012. Pure "roll down" on this package is 175bps for the year and the net delta decays from 10% to 3%.
7) I hate to say it, but I kinda like owning some GOLD. I would execute via either a costless collar trade (buy OTM call vs sell OTM put) or via our famous "Quiet Bull" structure (long call spread funded by short an otm put).
1b) For "non-stock pickers": Buy the S&P five years Forward at a discount to Spot. Sell Ultra long dated (five to ten year expiry) calls.
2) Buy Brazilian Local Currency Bonds. Yes the "Real" at 1.67 is rich, but the 10 1/2% yield for three to six years will more than offset the Govt's efforts to weaken the Currency. Unlike China or India, Brazil is a "hard asset" country.
3) Buy Russian // Mongolian // Southern Caucus Equities. I want "hard assets", not cheap labor. Yeah, this region is sort of lawless and it is unclear if your legal claim will be upheld. But at some point Russia, etc, will need to bring in Capital and reform is likely. Most importantly, this region is a "negative beta" to the G-7 race to the bottom.
4a) A diverse portfolio of Long-dated Municipal Bonds. You can find a selection of AA bonds in the 10 to 20 year sector that yield 5% or more. Since rates can only rise if the FED is successful in reflating the economy, a higher rate world would tighten Muni ratios. Also, I do not see taxes declining anytime soon. Muni's have a massive negative spread correlation to Treasury rates. Long Muni bonds will simply not sink below 4% on the downside and will start to compress at 5% to 6% on the upside. These "retail" bonds are super sticky at these coupon levels.
4b) Buy Closed-End 35% leveraged Muni Bond funds. Either National or Single State. They trade at a 5% to 8% discount to NAV and sport yields near 6.0%
5) It goes without saying I hate Treasuries, especially 3yrs to 7yrs.
6a) Buy 10yr into 10yr 6.0% swaption payers (puts) at 435bps. This trade is analytically "Positive Carry" for the first three years as 9yr, 8yr and 7Yr payers also struck at 6.0% costs 450bpb, 465bps, and 475bps respectively.
6b) A variation of above: Sell 3y-10y 5.35% payer vs Buy 10y-10y 6.00% pyr for zero cost. This trade is long a 10% delta, so there can be some severe mark-to-market risk. Nonetheless, this trade is a carry monster. Moreover, I do not think we can break T10yr above 4.05% as long as the FED is on hold, which should be sometime into 2012. Pure "roll down" on this package is 175bps for the year and the net delta decays from 10% to 3%.
7) I hate to say it, but I kinda like owning some GOLD. I would execute via either a costless collar trade (buy OTM call vs sell OTM put) or via our famous "Quiet Bull" structure (long call spread funded by short an otm put).
8) And of course, CMM vs CMS for 6 months, now offered at 59 3/4bps
SUMMARY: In a nutshell, the FED (with the help of the Govt), is going to engineer some type of Inflation to reduce the value of both our Private and Public Debt. Since Inflation is the only solution, it will happen; it is just a matter of time. Since the entire G-7 is in the same boat, trading in Euro or Yen is purely a short-term speculation since all these currencies will be heading south. The question is: "When will the non-Western USD/EUR/Yen buyers take actions that will defend their longer-term Purchasing Power ?
If you are reading this note, congrats on having survived the Great Wall Street meltdown. As I have noted, this period is nearly identical the last great Financial Meltdown from 1989 to 1994....and I can assure you, it will end in a similar manner: FED steepens Curve to allow banks to re-cap via carry.
SUMMARY: In a nutshell, the FED (with the help of the Govt), is going to engineer some type of Inflation to reduce the value of both our Private and Public Debt. Since Inflation is the only solution, it will happen; it is just a matter of time. Since the entire G-7 is in the same boat, trading in Euro or Yen is purely a short-term speculation since all these currencies will be heading south. The question is: "When will the non-Western USD/EUR/Yen buyers take actions that will defend their longer-term Purchasing Power ?
If you are reading this note, congrats on having survived the Great Wall Street meltdown. As I have noted, this period is nearly identical the last great Financial Meltdown from 1989 to 1994....and I can assure you, it will end in a similar manner: FED steepens Curve to allow banks to re-cap via carry.
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