Sensing the British economy was primed for a massive slowdown and interest rate cut, Kaufman began building up a long British gilt position. All throughout the year, he was squirreling away cash. And these moves collectively helped him end 2008 in the black.
So far in 2009, Kaufman is continuing to draw down his equity position. At the same time, despite troubles afflicting municipal and corporate finance, he's selectively adding high quality municipals and short-dated, highly rated corporate bonds.
Because spreads on distressed debt have blown out to extraordinarily high levels, Kaufman is most enthusiastic about establishing a substantial position in a new fund that's targeting this asset class. "Legacy portfolios will continue to be hamstrung," he says, "by continued difficulties valuing securities already in their portfolios."
Moreover, with credit ratings likely to fall still further and cause additional devaluation, he thinks it would be wiser to start establishing a distressed debt position a bit further down the line when markets may be closer to bottoming. Sometime this year, he surmises, valuations may be more transparent and future events may more likely push values higher rather than lower.
U.S. Debt and the Dollar
Asked whether he is concerned about a Treasury market bubble bursting and colliding into his debt positions, he says it's not likely over the next year or two. So long as private sector credit demands remain constrained and monetary policy continues to be accommodating, he thinks the American government will have no problem issuing massive amounts of new bonds.
In fact, he thinks it's premature to talk about a Treasury bubble at all, much less one that's about to burst. "We have a positively sloped yield curve that leaves sufficient room to accommodate market response without causing Treasury prices to break down," he says. And the Federal Reserve's new commitment to buying longer-dated governments should further stabilize prices.
However, in the next year or two, he expects private market credit demands to pick up. These demands, coupled with rising inflation fears and improving economic conditions, mean intermediate and longer-term government bond yields will likely rise, surmises Kaufman.
If this scenario of rising rates does play out, it doesn't sound like it would benefit distressed debt. But Kaufman sees current distressed spreads so wide that they would likely contract (which will result in principal rise and profitability) when the economy begins to expand again.
While record federal spending could drive the dollar lower, Kaufman expects the greenback to remain stable this year and next because there isn't a reserve currency substitute. "The yen doesn't have the depth, and it's geared to an insular home market," says Kaufman. Meanwhile, the euro has been hit by economic and political problems exacerbated by the inability of the currency's member governments to address the crisis.
Kaufman is also worried about the huge levels of debt held by European emerging economies denominated in stronger western currencies. The devaluation of central and eastern European currencies will likely further exaggerate default rates. To Kaufman, this begs the question: "Who's going to bail out Eastern Europe, not to mention the troubled economies of Italy and Spain?"
Given the global stresses, gold would seem a solid bet. Not to Kaufman. "I wish I had clear thoughts about the metal one way or another," he says, "but I don't."