market folly

We're pleased to present the second quarter 2010 commentary from East Coast Asset Management. The letter, penned by Chief Investment Officer Christopher Begg, touches on a number of intriguing and hotly debated topics, including inflation. Some of you will recall that we featured some past commentary from East Coast where they examined the deflation-reflation continuum.

East Coast is decisively in the inflationist camp. They believe that central banks armed with printing presses can only lead to one outcome. Their portfolio is positioned to mitigate the effects of any tail risk events such as hyperinflation, a bond bubble, a spike in interest rates, paper currency debasement, and a double dip recession. You'll recall that Baupost Group's Seth Klarman has also protected his portfolio from tail risk events as a form of cheap insurance.

Summarizing East Coast's stance, Begg writes, "The greatest opportunities to compound capital come from periods where dislocations are being driven more by 'what ifs' than the 'what is'. Fundamentals trump hypotheticals and facts weigh heavier than emotions."

Maybe the most intriguing aspect of their commentary though is the list of consensus views they've compiled. They've outlined 10 areas where there are currently consensus views in the market; areas where East Coast has strafed away from the crowd and into an opportunity with a perceived edge. They see these variant opportunities as a means to mitigate risk away from the consensus. This is a topic we've very briefly touched on in our piece where we examined the hedge fund herd mentality.

Below is East Coast Asset Management's list of 10 consensus views and their corresponding variant perception:

1. Consensus: Everyone is a macro-economist. Variant Perception: Fundamental/value investing and focusing on micro themes is the key.

2. Consensus: Binary extreme outcomes of inflation/deflation. Variant Perception: Individual investment merits based on expected return.

3. Consensus: Flood to fixed income as individual investors chase yield. Variant Perception: Bond bubble. Attractive equity total return expectations.

4. Consensus: Inflation protection via TIPS. Variant Perception: Owning businesses with pricing power.

5. Consensus: Gold - speculators are weak holders. Variant Perception: Own gold for mid-long term as paper currencies are debased. John Paulson started his gold fund for the exact same reason: as a bet against the US dollar.

6. Consensus: Overly bearish. Variant Perception: Bullish on fundamentals.

7. Consensus: Short-term time horizons. Variant Perception: Mid-to-Long term time horizons.

8. Consensus: Low rates will be the norm. Variant Perception: Interest rates will dramatically rise across the curve. (Legendary hedge fund manager Julian Robertson had previously placed a bet on sharply rising interest rates).

9. Consensus: Inferior companies can thrive. Variant Perception: High quality companies have a competitive advantage. East Coast specifically highlights Nestle (NSRGY), Waste Management (WM), Colgate (CL), Coca Cola (KO), Novartis (NVS), and Express Scripts (ESRX). We've seen numerous hedge funds become bullish on high quality companies as well. In particular, Andreas Halvorsen's hedge fund Viking Global favors ESRX. Additionally, we earlier today highlighted East Coast's bullish stance on Beckton Dickinson (BDX).

10. Consensus: Complexity. Variant Perception: Simplicity.

Begg examines each of the ten above listed views in-depth in his most recent letter and ends his commentary by giving us a view of their most recent portfolio construction. We highly recommend reading the entire East Coast second quarter letter embedded below:



You can download a .pdf copy here.

For more from East Coast Asset Management, be sure to check out their recent bullish presentation on Becton Dickinson (BDX) that we posted earlier today. Additionally, those intrigued by the inflation/deflation debate should head to their past piece on the deflation-reflation continuum. For more great investment commentary we posted up Perry Capital's latest letter yesterday as well.