market folly

Hedge fund Ellington Management recently delivered their 2010 equities outlook and we wanted to touch on some of the talking points from their presentation. But first, some background. Ellington Management Group is a hedge fund founded by Michael Vranos in 1994 that specializes in mortgage backed securities (MBS) and equities. Before founding Ellington, Vranos was head of MBS trading for Kidder Peabody. In a separate post today we'll also cover Ellington's bullishness on housing.

To frame their portfolio strategy, Ellington first starts with a recap of their previous outlook where they expect that the US economy will significantly outperform. They see domestic US assets outperforming and international stocks underperforming. Also, they believe the 'short the US dollar' trade has been wildly crowded and could potentially see a massive unwind. The following joins our ever growing compendium of hedge fund investor letters and attached at the bottom of this post is an accompanying slide-deck.

What was interesting to us is the fact that they actively check 13F filings to see what trades other funds have on. While undoubtedly many funds do this, it was cool to see them reference this candidly in a presentation and confirms that despite the timelag from the filings, the information can prove to be resourceful. We enjoyed this because, of course, a large part of Market Folly's existence stems from our coverage of hedge fund 13F filings to get a glimpse into their portfolios.

Back to Ellington's notion of a crowded trade that they originally outlined in December '09, we've already seen signs of a stronger dollar throughout 2010 so they've been correct there. This brings us to their other fundamental views where they believe that the US should outperform all other European nations and that this viewpoint does not rely on crisis in the troubled countries such as Greece, Spain, Portugal, etc. Possibly their most intriguing point was their observation that, "Productivity differentials between US and Europe are a secular not a cyclical trend." And additionally, "Correlations between US$ and risk asset markets are less negative, but still significant. Crowded trade likely partially, but not fully unwound."

As such, Ellington believes that US multinationals will face currency headwinds in the second half of 2010, as well as pressure from Obama's tax proposals. This point is intriguing because many other hedge funds have argued the bullish case for US multinationals as they are undervalued, often have solid dividends, and their multinational exposure will help you hedge anticipatory inflation. Ellington also believes that the risk of a short-term market correction remains higher than normal. Just last week we highlighted how Jim Rogers was starting short positions and noted some other contrarian indicators as well.

Turning to commodities and emerging markets, it was good to see a hedge fund arguing that gold has long-term bearish fundamentals. After all, we've seemingly been inundated with a wave of bullish sentiment toward gold on the site. You can head to our post on gold as an insurance policy to see all the various hedge funds that are bullish on gold. Ellington believes that the 'doomsday trade' can help gold in the short-term (i.e. sovereign crisis) but point out that it is one of the most crowded trades out there. If you hadn't noticed yet, Ellington likes to go against the grain here as they've identified multiple crowded trades as possible plays for explosive unwinds.

Focusing specifically on the US, Ellington believes that a new normal or jobless recovery are unlikely. They see excess growth for sectors with cyclical or secular tailwinds (housing, smartphones, infrastructure) and in-line growth from the consumer sector with high-end consumer names outperforming low-end consumer names.