Phase 1 : August 1985-December 1985 183 experience again? Hopefully not. Perhaps we have learned some- thing from past mistake$. The fatal flaw of a free market system is its inherent instability. The belief that financial markets are self-regulating is simply false. Fortunately, Secretary Baker is aware of this fact and the administration has behn to exert active economic leadership since he moved to the Treasury. Certainly it is not laissez-faire that has brought us to1 the threshhold of a new golden age of capitalism but a concerted economic policy designed to counter- act the excesses of a free market system. It remains to be seen how well we have learned our lessons. In any case, the benefits of the new golden age are very un- evenly spread. It is in the nature of capitalism that the gap be- tween winners and losers is rather wide. Large segments of the population, especially in the financial, technology, service, and defense sectors, are flourishing. Others, especially in the older industries, agriculture, and the welfare sector, are suffering. For- tunes are made in financial deals and shareholders wield more power than at any timk in the last fifty years; at the same time, bankruptcies are also at a fifty-year high, in both size and num- bers. Debtor countries are wallowing in depression and a whole continent, Africa, is starving; at the same time China is converting to a free market system with all possible speed and the Soviet Union is on the verge of moving in the same direction, albeit much more cautiously. Why the Reagan administration has been so successful in achieving its objectives is a fascinating question. To all intents and purposes the Democrats have been reduced to the party of losers, as manifested by the fact that it is the Democrats who push for protectionism in Congress, while President Reagan has an un- questionable gift for making Americans feel like winners. But the improvement in sentiment has been achieved at the cost of con- siderable deterioration in the underlying reality, as manifested in our national indebtedness. Frankly, I have been surprised by the vitality of resurgent capitalism. I considered the Imperial Circle as a temporary ex- pedient that was bound to break down. Seeing it replaced by a new arrangement that can be described as the Golden Age of Capitalism, I must acknowledge the adaptability of the system and its ability to survive. It remains to be seen whether policy- makers succeed in containing its weaknesses: the inherent in- 184 The Real-Time Experiment stability of financial markets and the iniquities caused by 4 instability. P.S., MONDAY EVENING, DECEMBER 9,1985 I have decided to move forward the date of switching from bonds to stocks. I am influenced partly by the prospect for "the Dec. 9,1985 Closing % Change Closing % Change 12/9/85 from 3216 12/9/85 from 1216 DM 2.5345 - .9 S&P 500 204.25 - 3.7 % 203.55 - .7 U.S. T-Bonds 8218/32 - 1.6 E 1.4575 + 1.0 Eurodollar 91.87 - .5 Gold 316.20 - 1.9 Crude Oil 27.51 - 4.3 Japanese Bonds 97.00 - 2.2 QUANTUM FUND EQUITY $890,000,000 Net Asset Value Per Share $5,998 Change from 12/6/85 + 2.7% Change from 8/6/85 + 37.0% Portfolio Structure (in millions of dollars) Net Net Change Change (21 PI Investment from Net Currency from Positions (1) Long Short 1216 Exposure (6) Long Short 1216 Stocks DM-related 693 - 36 US Stocks 739 (66) +21 Japansse Yen 828 +2 US Index Pound Sterling (115) +4 Futures 277 -91 US Dollar (516) +53 Foreign Other Stocks 270 - 1 Currencies 45 + 12 Bonds (3) US Gvt. Short Term (4) 90 Long Term 717 + 56 Japanese (5) 253 - 47 Commodities Oil (157) -7 Gold Phase 1 : August 1985-December 1985 185 bull market of a lifetime" that I have just articulated and partly by more practical considerations. A cut in the discount rate may not follow immediately upon agreement on Gramm-Rudman. Markets are firm and the Federal Reserve is cautious. The statis- tics for December may lbok quite good, partly because the Christ- mas shopping season is crowded into fewer days and partly because investment orders may be placed before the end of the year to beat the changes' in taxation. The next advance indicators may also look good because they include stock prices and money supply. In these circumstances, bonds may be vulnerable and stocks may offer better prospects on the upside. The thesis I have just formulated is beginning to enter investors' ccneci~usnscses, yet caution is still prevalent. The year's end is seasonally a strong period: we could have some fireworks in the next four to five weeks. FUND'S NET ASSET VALUE PER SHARE RELATIVE TO MARKETS Phase One: 8/19 to 12/8 1985 40% 35% 30% 25% 20% 15% 10% 5% 0% -5% -10% Aug19 Sep2 Scp 16 Scp 30 Oct 14 Oct 28 Nov 11 Nov 25 FUND'S PROFITS AND LOSSES Aug19 Sep 2 Sep 16 Scp 30 Oct 14 Oct 28 Nov 11 Nov 25 Notes: (1) All prices are calculated as percent change over the first day shown. (2) EAFE is Morgan Stanley's Capital International Index in U.S. dollars for European. Australian, and Par Eastern stock markets. (31 The Oil and the Government Bond prices are the closing prices of the ncamst futures contracts. (4) Currency profits and losses include only forward and futures contracts. P&L on foreign stocks includes the currency gain or loss on the positions. CURRENCY PRICES Phase One: 8/19 to 12/8 1985 CURRENCY PRICES Phase One: 8/19 to 12/8 1985 NET CURRENCY EXPOSURE (Line represents fund's equity) 2.0 . '1.8 ,111,1111,111 1111 Aug 16 Aug 30 Sep 13 Sep27 Oct 11 Oct25 Nov 8 Nov 22 Dec6 Deutsche Mark Yen 0 Pound *ling Fish Other 0 US. Dollar Notes: (1) Prices in U.S. dollars shown as percent change over the first day shown. New York closing prices are used. (2) Net currency exposure includes stock, bonds, futures, forwards, cash, and margins, and equals the total equity of the fund. A short position in U.S. dollars indicates the amount by which the currency exposure exceeds the equity of the fund. (31 Currency exposure shown as of end of week. U.S. STOCK MARKET Phase One: 8/19 to 12/8 1985 U.S. STOCK MARKET POSITIONS 1.4 1 I ____".' f""""'. Auk 19 & 2 Sep 16 30 O& 14 0g28 Nov 11 Nov 25 U.S. Stocks B U.S. Stock Market Index Futures Note: (1) Total U.S. stock market profits and losses include stock positions and index futures. & FOREIGN STOCK MARKETS Phase One: 8/19 to 12/8 1985 - European Stock Markets Index (in U.S. dollars) - Japancse Stock Market Index (in U.S: dollars) FOREIGN STOCK POSITIONS 280, Continental Eumpean .">3 Japanese - British B Fih Far Eastern FOREIGN STOCKS P/L Notes: (I) Total foreign stock market profits and losses include foreign exchange gains or losses on foreign stock positions. (2) Far Eastern positions include Hong Kong, Korea. Taiwan. Australia. and ~hgPfand. -10% +",-", Aug 19 Sci COMMODITY PRICES Phase One: 8/19 to 12/8 1985 COMMODITY POSITIONS 80, I -220 Aug19 Sep2 Sep16 Sep30 01x14 Oa28 Nov11 Nov2.5 Oil Gold [...]... over the brink It will be bailed out, along the lines of Continental Illinois Bank, and depositors will be protected Depositors may not even panic, but the stock market may The strength of the market, combined with the amount of credit involved in futures and options trading, makes the market extremely vulnerable to a 203 Control Period: January 19 86- July 19 86 Feb 21,19 86 I Closing DM Y E Gold 2/21/ 86. .. miss the market: I merely failed to take maximum advantage of it I remained largely inactive in currencies The only thing I did was to build up the DM/£ cross position further I recognized that the nature of the currency markets was, once again, changing: the spirit of cooperation that emerged from the first Group of Five meeting was weakened in the second and the authorities were losing control over the. .. and margins, and equals the total equity of the fund A short position in U.S dollam indicates the amount by which the currency exposure exceeds the equity of the fund (3) Currency exposure shown as of end of week U.S.STOCK MARKET POSITIONS U.S Stocks I IU.S Stock Market Index Futures I U.S STOCK MARKET PROFITS AND LOSSES &9 DL23 ] &6 jai 20 Fib 3 Fcb 17 -U.S Stocks -U.S Stock Market index Futures Mar3... deleveraging until the next set of Federal Reserve figures become available Instead of selling the Eurodollar futures I bought, I sold some S&P 500 index futures because I considered the stock market more vulnerable In the course of the day, the decline in energy prices accelerated until it turned into a veritable rout By the end of the day, stocks, bonds, and currencies have all recouped the day's losses... that some kind of oil-denominated security will be offered to disguise the concession that Mexico needs and to prevent it from spreading to other debtor countries What is more difficult to fathom is the reaction &the markets An orderly settlement would reinforce the bullish trend, but doubts about an orderly settlement would test the market At present, the odds are that the market will pass the test, but... Gold 259 +6 (224) -67 most important was a strong employment report that convinced the market that no discount rate cut is to be expected The measures taken against Libya also had an unsettling effect-there were various unconfirmed rumors about Arab selling of stocks, bonds, and dollars I used one of these rumors to unload my currencies The stock market may also have been affected by the 198 The Real-Time... chances of making money by trading currencies did not justify the trouble and aggravation Holding the position was more comfortable than changing it and my lack of convictions put me in a good position to reassess the situation when necessary Then came Preston Martin's resignation and the behind-thescenes struggle over interest rates came out into the open The 2 06 The Real-Time Experiment market responded... vnluc of japancsc Govcrnmcnt Bonds had the same volatility as roughly $66 .2 million in 30-ycar U.S Covcrnmcnt Bonds We havc not adjusted for this diffcrcncc (4) Positions shown as of end of wcck CONTROL PERIOD: JANUARY19 86- JULY 19 86* SATURDAY, JANUARY 11,1986t The stock and bond markets suffered a nasty break and I have been caught badly I had taken on my maximum exposure in the stock market at the. .. losing control over the market The dollai -was moving faster and lower than the authorities desired Both the Japanese and the Germans were getting worried The American authorities were divided: Volcker shared their concern while the rest of the administration felt that the Japanese squirming was a welcome sign that the lower dollar was beginning to bite The dollar was falling of its own momentum and... no reason to allow the federal funds rate to trade up from the present level either Equally, I consider the constitutional challenge to Gramm-Rudman immaterial -the process will be working by the time the issue is decided If this view is wrong, I shall have to revise my position at a considerable loss Until then, I intend to hang in there I expect the maximum pressure in the bond market to be felt tomorrow: . the amount by which the currency exposure exceeds the equity of the fund. (31 Currency exposure shown as of end of week. U.S. STOCK MARKET Phase One: 8/19 to 12/8 1985 U.S. STOCK MARKET. I considered the stock market more. vulnerable. In the course of the day, the decline in energy prices accelerated until it turned into a veritable rout. By the end of the day, stocks,. 2 36. t Charts showing the posture and performance of Quantum Fund from Dec. 9, 1985, to Mar. 31, 19 86, follow p. 207. The key for the parenthetical note refer- ences (1) through (6) in the