1st Qtr 2009 Review and Shifting Outlooks

THE FOLLOWING ARTICLE DOES NOT CONSTITUTE A SOLICITATION TO INVEST IN ANY PROGRAM OF CERVINO CAPITAL MANAGEMENT LLC. AN INVESTMENT MAY ONLY BE MADE AT THE TIME A QUALIFIED INVESTOR RECEIVES CERVINO CAPITAL'S DISCLOSURE DOCUMENT FOR ITS COMMODITY TRADING ADVISOR PROGRAM OR DISCLOSURE BROCHURE FOR ITS REGISTERED INVESTMENT ADVISER PROGRAMS. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

A continuation of the general volatility experienced last year has continued into the first and second quarter of 2009—this is unsurprising. Most markets continue to see large daily swings even though, as far as the S&P 500 is concerned, the intraday ranges seem to have abated since the very destabilizing days of October and November 2008.

Within this environment of ongoing economic and social instability, Cervino Capital’s Diversified Options Strategy managed to book positive performance for the first quarter.

That said, the markets have been frustrating these last few months. What started out as panic selling into March 9th has evolved into a V shaped rebound which has taken the S&P 500 up about 39% from the lows with practically no retracements. The Nasdaq did even better with a 50% run concentrated in its high betas representatives: AAPL, GOOG and RIMM.

In the interim, the US dollar is back on the forefront of the global economic debate as the Chinese are again making waves for the substitution of the greenback as the world reserve currency. The Chinese suggest the new global currency should be modeled after the IMF Special Drawing Rights. Such an idea does not seem to have a chance to become reality anytime soon and such a proposal looks to be more a veiled way by the Chinese to demand additional global policy power in general.

Nevertheless, this renewed debate brings up the future relative value of the dollar. As long as markets remain destabilized the dollar should retain a bid, yet an improving macro situation will ultimately hurt it. In that case, the dollar and commodities will reflect inverse correlation.

It is within this dollar context that commodities are indicating a potential global economic resurgence as crude, copper, aluminum and platinum have started to build a base and move higher. Yet at this juncture, I believe commodities are less relevant an economic indicator, as policy and time remain in my view the two main drivers of any future economic renaissance.

Meanwhile, credit spreads in the corporate bond world (where the Federal Reserve Bank has not intervened) are still historically high and provide competition to equities as an investment choice. LIBOR, commercial paper and other credit measures look better strictly due to the Federal Reserve intervention. In effect, the Federal Reserve is now producing prices for many asset classes and instruments: ABS, MBS, CP, mortgages, Treasuries and so on.

From a macro perspective, there is a case to be made that equity markets may have found a significant bottom—significant being defined as a multi-month trend change. Many analysts have been calling for the formation of a generational market bottom. And it is true that some of the long term valuation metrics have become much more attractive than in the last 20 years (eg, cyclically adjusted P/E ratio, gold/S&P 500 ratio). However, while the market may have looked attractive below 700 it is certainly not as exciting above 900. I believe that a long term bottom will be more function of future global policy (especially a rejection of protectionist forces) and necessary time for the deleveraging process to take its course.

Add to this a shift in the domestic political-economic environment, and that any potential recovery will be cobbled by many fundamental factors (consumer balance sheet repair, commercial real estate loan refinancing, shadow foreclosure inventory, etc.), there is a strong argument that the current situation is not conducive for multiples expansion in equities.

It is within this structural context that we have approached this market. We had expected choppiness and inconsistent price action. Unfortunately, we were recently met with a constant and relentless upside momentum move which we are managing.

The key aspect to recognize about our strategy is that it excels in choppy markets, not momentum markets. We continue to believe that the long-term fundamentals will evolve into a sideways and range-bound market which we can take full advantage of.

- Davide Accomazzo, Managing Director

Epilogue: In the Beginning There was Alpha

Hear then, o Economidae, nymphs of the streams
Of infinitely discussed yet discounted prophets,
Of the story which I sing: the epic of men
And women locked in the battle of egos and coherence,
Precision and relevance, the song for all ages
And peoples to hear and revere the great and poor
Deeds of this tribe of malcontents and heroes...

--The Walrasiad, Prologue

Epilogue:

In the beginning, Man created the markets. The markets were without form and void, and darkness was over the faces of analysts. And Man said, “Let there be Alpha,” and there was Alpha. And Man saw that Alpha was skeptic. So Man created Beta from Alpha so that he may have faith. Thus it was that Beta evolved from the aggregate of individual Alpha decisions.

In time Man affirmed that Alpha is only a derivative of Beta and not unto itself. Thus it was Alpha’s fate to be banished to the farthest corners of the market where it thrived little noticed in the wilds of commodities and forex, and strange unknown strategies.

And so it came to be that Beta ruled the markets for many generations and organized itself around the concept of rational agents and equilibrium. And those who claimed to be Alpha were really leveraged Beta or Alpha corrupted by money flows into exotic Beta. And Man saw it was good.

But alas, Man was not happy in his greed and sought more leverage and converted evermore Alphas from the wilds with the trap of untold assets under management. And thus, Beta's down-fall did come about, as Man did not recognize that faith and greed is cause for disequilibrium. Soon the wisdom of crowds became the madness of crowds, and all was chaos in the markets.

This was the way of the markets when the few remaining Alphas, the true skeptics, whose only heresy was to saith that economic agents are irrational and the natural order of the markets is disequilibrium, returned from banishment and did cause great wealth for their kind.

Thus it was that “true” Alpha in its actions restored the equilibrium. From then on it was said by Man that Alpha seeks madness in the wisdom of crowds and wisdom in the madness of crowds.

Hence, price discovery is yin-yang, as is wave-particle duality. In truth, all Man's philosophies reveal this dichotomy as Man is trapped in the observer effect, prisoners of the box in which Schrodinger placed his cat. Ergo, the universe is akin to True Beta and just a huge mechanism for price discovery on a quantum level. And Man saw that creative destruction was good.

- Mack Frankfurter, Managing Director