The Inside Scoop feature at Barron's (see article) is reporting on how Warren Buffett has increased his position in Burlington Northern Santa Fe (BNI). Earlier this week, Buffett bought another 825,000 shares, bring his total position to about 19% of the company. Not only does this recent transaction put approximately one-fifth of the company in strong hands, but Buffett has also recently sold 5.5 million puts in October, with strike prices ranging from $75-$80. The put position effectively places a floor on the stock, since if the past is any indication, the position implies that Buffett is comfortable being a buyer at these strike price levels.

As with the rest of the market, Burlington has fallen over the last month, but not as much as some of its biggest competitors. Since Burlington hauls a higher percentage of coal and fertilizer, as well as other domestic goods, analysts believe they will most likely not be hit as hard by a global recession. Furthermore, any return to higher fuel costs, which will impact global growth, could also help Burlington weather any further downturn as companies continue to shift from trucking to the rails for transporting their goods. As the chart below shows (from BigCharts.com), BNI, the DJIA, and the Dow Transports (DJTA) have diverged somewhat since the beginning of the year.

Source: BigCharts.com

Often the DJIA will follow the transports, but in this case the market sell-off in October has caused the transports to catch-up on the downside with the general market. BNI fared a little better during this time. Each has gained over the last week. Of interest is how the transports are bumping up against resistance levels in place since January, whereas BNI has actually found some support at these levels. If the market can break these levels and continue to build a bottom in November (or even begin to rally), and the six months from November to April do turn out to be bullish after the heuristic-based "sell in May and go away - until November" trades are unwound, than BNI may not only be a potential recession play, but it may also help to lead the market over the next year. Nothing is fool proof, but with the winds of Buffett, energy (coal), and ethanol (fertilizer) at your back, the profit trains could start rolling again for BNI stock holders.

It appears that stars of the hedge fund world, such as Cohen, Einhorn, and Signer are not having any problem raising money at a time when other funds are seeing mass redemption (see Bloomberg article). For established managers, there are a couple of intriguing reasons to raise money at this time. For one, equity prices are depressed, creating opportunity for managers with capital on hand. In addition, the recent sell-off has placed existing clients significantly under their high-water marks, meaning that it may be a while before managers can capture the normal 20% of future profits. New money, on the other hand, is starting fresh, allowing future profits to generate normal fees right away. Apparently, reputation and performance do still matter. Then again, in a down market, performance is all relative. As one person on CNBC was recently quoted as saying "small losses are the new gains." Only during a bear market, and only on Wall Street, would such a statement make any sense.

The Treasury and FDIC are considering a plan to guarantee about $500 billion of bad mortgages in an attempt to reduce the total number of foreclosures, with an estimated cost of about $50 billion to be paid by the bailout package - i.e., you, Joe and Jane taxpayer (see Bloomberg article). The plan would allow banks to restructure as many as 3 million loans into ones that homeowners would actually be able to afford (imagine that). In other words, the mortgages would be restructured based on a borrower's ability to repay, and not their ability to afford the home. If homeowners also took out a home equity line of credit, no problem. The plan being considered would also cover these second mortgages as well. I guess that will teach those of you that recently bought a home within the last year or two and actually put down the "required" 20% down payment. If you live in Florida, California, or Nevada, that 20% is probably gone. Your neighbor, who put nothing down, will now end up paying back what you have left on your loan, which is about 80% of the original value, or 100% of the current value. Their repayment amount could possibly be even less than you if their ability to repay is still not sufficient. I hoped you learned your lesson. Next time buy a bigger house. And of course, don't forget to remodel the kitchen and bathroom while you are at it.

Fortunately, the plan is still being discussed, so hopefully some steps will be put in place to reduce moral hazard, such as having rates and payments increase as the borrower becomes better able to make payments, or allowing taxpayers to recover some or all of the lost and forgiven loan principal once prices recover and loan to equity values become more favorable. Otherwise, no matter how good the intentions are, or how necessary the plan is, the unintended consequences of rewarding bad behavior and poor decision making will cause confidence in the banks and the housing market to take much longer to recover.

The success of the Yale and Harvard Endowments has cause many to consider trying to mimic their asset allocation models (see article, and previous posts here and here). Unfortunately, this offers a few problems. For one, small investors do not have as easy access to alternative investment, whether it be private equity, hedge funds, venture capital funds, or certain types of real estate. Even those that do find that performance suffers when funds that were suppose to be hedged were not. Furthermore, many of the alternative asset classes turn out to be more correlated than expected, especially during market sell-offs.

Studies are also showing that adding the diversification of alternatives to your portfolio may turn out to not reduce volatility in ways normally expected. Morgan Stanley examined the risk and return characteristics of a hypothetical endowment model portfolio that had 40 percent allocation to alternative investments. While the portfolio outperformed a traditional portfolio allocating 60 percent equities / 40 percent for bonds, it did not materially reduce volatility. The performance of US equities alone explained 94 percent of the return.

Another problem is that private investors do not have the same tax advantages of endowments, many of which have access to top-tier funds and other tax-exempt groups. In some cases, seeking an pre-tax return of 10 percent would require an average hedge fund to return 14.5 percent in order to overcome the fees. For a fund of funds, the return is even higher, at 17.1 percent due to the extra layer of fees.

Those of us in the academic world often hear the common retrain from our industry colleagues, "Well, that just the academic theory. Things are different in the real world." At least for mimicking endowment funds, the refrain may ring true.

New York Magazine is reporting that cardiologist in New York are receiving 20% more complaints regarding chest pain - the highest levels since 9/11. “One patient said that every time he sits at his desk he feels chest tightness.” Gastrointestinal doctors are also experiencing more business. Given this market, maybe buying stock in Pepto Bismol maker P&G or Prilosec maker AstraZeneca are the smart investment choices as a sympathy volatility play. Can I sell options on heartburn?

There is an interesting article in the Telegraph UK about how thousands of hedge funds are on the brink of failure as the global crisis unfolds. Emmanuel Roman, chief executive of GLG Partners, and Nouriel Roubini, New York University Professor and long-time predictor of financial doom, have made the recent forecast for the industry. Of interest in the article, beyond the prediction of massive hedge fund failures, is the following quote:

"It's like we're walking blind in a minefield," said Prof Roubini. " Every situation has become risky and no one can trust each other. The banks are too big to be allowed to fail, but they're also too big to be saved."

Unfortunately, the "too big to fail, but too big to save" perspective may be more true than we want to believe or admit. The trust issue is certainly being played out from all directions. Of additional interest is the belief that recent events and a protracted recession will end the financial dominance of the US. While I believe the end of this story is still yet to be written, you have to wonder, "What if this is true?". Who will step into the leadership role of the US? Economies that are still developing and emerging? Economies that reply on crude oil revenues? The European Union? Furthermore, are any of these economies really decoupled? Rocked back on its heels? Definitely. Loss of leadership? Not so sure.

Japan is the latest country to consider trying to stabilize its markets by banning short selling (see MarketWatch article). The move is being considered after the Nikkei 225 has fallen to its lowest level in 26 years. While potentially propping up the market, the long-term consequences of limiting information, hampering risk management, reducing liquidity, and prevent overall market efficiency may prevent the Japanese markets from reversing anytime soon what has become a generational decline in the Nikkei.