After stumbling a little the first week of the month, both programs gained a solid footing and began a run toward their highs of the year. In the last week of the month, the surge over 1100 and subsequent profit-taking move in the S&P gave us the trading setups needed to post new highs for Monticello and come close in Jefferson.

With one program out of its April–July drawdown and the other close to a new high, it is instructive to consider the risks associated with my programs. This drawdown was completely within what I have come to expect from my models. On an annual basis, we can expect a drawdown of at least 10%. It is uncomfortable, but it is a reality. Deeper drawdowns of 15% or more can be expected every 18 to 36 months. They are an unfortunate component of my programs. However, without these periods, the gains would not be attainable. If I were able to predict when the drawdowns are due, I would certainly step out of the way.

It is also instructive to see how we compared to our peers during this period. The low of the most recent drawdown occurred in May. At the close of May, both programs were still ranked in the top 20 by compound annual return for stock index CTAs on BarclayHedge.com. Of those top 20, all but 2 had deeper drawdowns than either Roe Capital program. With our June recovery, both of our programs return to the top 10 of stock index CTAs, as ranked by 12 month compound annual return. It is my opinion that given our July performance, we are likely to remain on that list for July (once all of our peers report their results). At their worst so far this year, both programs still remain ranked high amongst their peers, as measured by compound return and by risk. I am hopeful they will lead my peers if we climb to new highs.

Nonetheless, we shed some of our new clients in May and lost more funds under management to nervous redemptions. Given the market environment at the time, much of that is understandable. It underscores the importance, however, of being able to withstand losses in a managed futures program. While the market environment was frantic in May, it is nothing we have not seen before (as in the fall 2008). The drawdown was completely within what I have argued is my expectation for these trading models. We will certainly go through it again, perhaps even to a greater degree. But if one is not prepared to weather such a period, managed futures is not the asset class for that investor.

IN FOCUS | August Market Outlook
At the end of June, I shared my fear that the ephemeral summertime/oversold rally had not yet appeared in equity markets. In July, it showed up with a vengeance. Instead of testing support at the 950 level, the S&P surged over 10% peak-to-valley intra-month. As I noted last month, when you hear the cheerleaders on the boob-tube forecasting doom, invoking ‘black swans’ and ‘death crosses,’ it is indeed time to buy with both hands, both feet and anything else you throw into the fray.

However, last month I invoked Sir Templeton’s famous warning that “this time is different.” Do not be fooled by the summertime low volume mischief in the market. The situation has not fundamentally changed. The economic data is still very bleak and getting worse with every release, despite unbelievable spin from the usual suspects. A reminder of the highlights:

• New Home Sales for May were revised down to a 36.7% decline (the worst on record) and June’s decline is the second worst month on record, yet the wise guys (see boob-tube cheerleaders above) applaud the better than expected month over month results—which are only better because of the downward revision in May! Obviously, this is due to the expiry of the new homebuyer tax credit. When will the Keynesian politicians learn that when you artificially spike demand, you create bubbles and crashes, and, worse yet, rob growth from future quarters. The examples are too numerous to list.
• To the point of robbing from future quarters of growth, second quarter GDP came in at its slowest pace in a year. It was dragged lower by deficits, low private sector growth and less consumer spending. It was also artificially buoyed by a 4.4% increase in government spending. First quarter QDP was revised higher, but inventory growth accounted for most of the gain. The depth of the recession was revealed to be more extreme than previously thought, with lower revisions for 2007, 2008 and 2009—and the pundits go back to cheerleading corporate earnings.
• Most companies boasting better than expected earnings were produced on worse than expected revenue, meaning reducing costs accounts for the gains, not growth. And yet, the cheerleaders hail an expanding economy.
• Durable Goods Orders declined 1.0% (+1.0% expected) and again the analysts talk about earnings mitigating the obvious slow down in manufacturing.
• The European bank stress tests used dubious standards for evaluation, ignoring where most sovereign debt exposure lies. Yet, the low failure rate leads analysts to claim a quick and painless end to the sovereign debt crisis.
• The Fed’s Beige Book discusses US economic recovery slowing and the analysts say this is good because it means the return of quantitative easing.

We have gone from a market psychology of ‘the end is nigh’ to ‘happy days are here again’ in 30 days, with nothing but fiction and spin to induce buying. Good news is good for stocks again because the recovery is going swimmingly. Bad news is good news again for stocks because it means quantitative easing, more stimulus and an increased likelihood of a tax reprieve from Congress. It sounds like déjà vu all over again, doesn’t it?

As such, we would look for a top sometime in August. The S&P seems determined to squeeze the shorts back to 1150. Once it gets there, the gas tank will be empty and we will be range-bound awaiting news, which could cause the market to break. I am hopeful that the formation of this market top can lead to an indecisive range-bound market, which can be good for my trading models.

Regards,

John L. Roe

President, ROE Capital Management

www.roecapital.com

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.An investment with ROE Capital Management is speculative, involves a high degree of risk and is designed only for sophisticated investors who are able to bear the loss of more than their entire investment. Read and examine the disclosure document before seeking ROE Capital Management’s services.

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