On Thursday I attended a presentation by hedge fund manager Rick Campagna, Chairman, CEO and CIO of 300 North Capital. Campagna’s fund has impressively returned +39.9% in its 18 months since inception, and the return to risk ratio has equally notable thus far, with low volatility (6% annualized monthly volatility), limited drawdowns (worst month was -1.8%), and consistent compounding (>70% months in positive territory to date).
How has Campagna done it? With a tactical investing approach based on his systematic identification of the current economic or market cycle. In other words, he figures out if we’re in a risk on or risk off environment, and takes his positions accordingly.
Tactical Investment Strategy for Risk On, Risk Off
Campagna looks at the broader secular backdrop, current business cycle, investor sentiment, valuations, momentum, and perhaps first and foremost, the monetary easing environment (we’re looking at you, Fed) to determine if we’re operating in a risk on environment, a risk off environment, or somewhere in between.
If it’s “risk on”, then he’s long risk assets – such as the S&P 500. If it’s “risk off”, he’s long safe havens – such as US Treasuries. For times in between, he may have a combination of hedges in place, or he may be hiding out in cash waiting for the situation to develop.
So his trading strategy shifts from “risk on” (long S&P, short bonds) to a hedged portfolio (a mix in between), to “risk off” (short S&P, long bonds) as fundamentals and technical cycle through.
While some hedge fund managers are drawn towards more esoteric investment vehicles – like Hugh Hendry’s CDS positions on levered Japanese manufacturers – Campagna prefers straight ahead (and always redeemable) traditional flavors. They only trade the most liquid future contracts and ETFs – the major stock indices, government bonds and corporate bond indices, major currency crosses, and the 20 major commodity contracts per the CRB.
This surprised me at first, but made sense when I connected his approach with the fact that since 2007, it’s all been the same trade anyway. If it’s risk on, buy an S&P future contract – and when the scene flips to risk off, close the position…and short another one!
Secular Forecast
Campagna believes “significant structural headwinds continue to dampen global economic activity.” The developed economies are over leveraged (he cites 600% total debt to GDP in Japan!) – which ultimately will reduce growth as the necessary spending reductions and tax increases occur.
The European Union and euro has created imbalances that are not sustainable (more on this later).
China has over invested in infrastructure, and the slowdown may be a hard landing. Their continuing capex boom has blown away all past historical records (booms which also ended badly). And while Beijing’s economic numbers are notoriously polished, he cites slowing electricity production in China as a real-time reliable “uh oh” indicator.
Monetary policy is running out of juice, as the QE sequels have been diminishing in impact. The problem with QE, he says, is that every time they do it, commodity prices skyrocket, which lowers growth.
Markets appear to be in the 11th year of a 15 to 20 year secular bear market, in which he sees them moving sideways at best. Below normal growth levels should be expected for 5 to 10 years until debt levels are reduced into the historical normal ranges
And the financial system is still very fragile. He cites JP Morgan’s $71 trillion of derivatives on its books – five times US GDP, and greater than global GDP! That’s a lot of counterparty balancing faith, more than he’d be comfortable managing Campagna readily admits.
These headwinds all lead to shorter, less robust cycles – with downside risk greater than upside potential. Making capital preservation and tactical asset allocation strategies the way to go when playing these cycles.
Cyclical Forecast
And Campagna sees opportunity in these cycles – to be pursued with a tight stop loss and intelligent hedging, of course.
In comparing this summer with our previous two, he points to have tamer inflation and a stronger US economy in terms of unemployment, housing, and auto sales.
Europe, however, is “basically in recession now” and he believes the Greek disaster may be catastrophic. Spain and Italy are magnitudes bigger than Greece – while Greece represents only 2.2% of Europe’s GDP, Spain and Italy represent 11.6% and 17.0% respectively.
Bank runs are happening in Greece, Spain, Italy, and across the EU, and bank runs could accelerate quickly because you don’t need to physically visit a bank these days – just a few clicks online, or taps on your iPad, and you can clear out your account.
Handicapping QE
He believes the Fed’s decision to do QE3 is totally dependent upon the price of the S&P. At 1200, it’ll happen, at 1320, it won’t. (I have also noticed the Ben Bernanke seems to take more pride in rising stock prices than any central banker since perhaps John Law).
The Fed’s conundrum is evidence that the effect of quantitative easing is diminishing. They engineered a one-year really with QE1, a six to nine month rally with QE2, and a mere three month rally with Operation Twist.
I asked Campagna if he’s increased his trade cycle frequency as the length of QE effectiveness has decreased, and he said he has, noting as well that this phenomenon also increases the chances of a downside event.
Thoughts on Europe and Gold
Of course we can’t have a financial outlook in the year 2012 that doesn’t discuss Europe and gold. Campagna believes the biggest problem in Europe is the rigidity of the labor markets – it’s very tough for workers to move between countries for new jobs, while in the US, it’s very easy to move between states.
He points out that the euro has created significant divergences in labor costs – only Germany has held steady since 1995. The result is that Germany has 20-year low in unemployment, while France pushes to 10%, and youth unemployment in Greece runs towards 50%.
He thinks the euro should go to parity (if it even exists) but will more likely trade in a range of 1.20 – 1.30, explaining that you used to trade currencies based on interest rate differential, but now that all rates are zero, you can’t do that any more. Currencies now trade on balance sheet expansion differential, which is roughly comparable between the US and Europe.
Campagna is more bullish on gold priced in euros – “probably much higher by the end of the year.” He views gold as a currency, has a long-term bullish bias towards the yellow relic, and has not shorted gold in 15 years. He also mentions that China is buying and importing gold like crazy.
300 North Capital Market Commentary
To keep up with the latest with 300 North Capital, you can subscribe to the fund’s monthly market commentary and receive more detailed information by contacting my friend Glenn Cohen at gcohen(at)300northcapital(dot)com or (561) 799-1980.
And be sure to ask Glenn about his epic pickup basketball win later that afternoon.
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