The reason the market has fallen so much in the last month may not be what you think. Today I spoke with a senior investment strategist for a $1 trillion mutual fund complex. In his view, the market's recent fall has less to do with concerns about inflation and much more to do with hedge fund trading.
Specifically, he thinks that hedge funds -- whose managers Vanity Fair reports are building enormous Greenwich, Conn. spreads -- have been borrowing money to buy commodities such as gold, copper, and oil as well as real estate and emerging markets stocks. They mistakenly assumed that the Fed would continue to act as though inflation was benign.
When Fed Chief Ben Bernanke expressed concern about inflation, the hedge funds' leveraged commodity bets suddenly went sour. The dollar toned up and commodities tumbled -- forcing the hedge funds to cover their leveraged bets by selling their long positions in commodities. Gold has tumbled 19% to $591 an ounce since reaching a 26-year peak in May. The Indian Sensex market index has lost over 25% of its value -- plunging from 12,612 on May 10 to 8,994 on June 13.
This created a downward spiral as further price declines led to more position covering. And it's likely that hedge funds' need to cover their positions led to declines in the broader stock markets as they scrambled to raise cash to pay back their loans.
This dynamic is similar to what happened during the tech stock meltdown of 2000. Investors had borrowed to buy tech stocks. When the stocks fell, the brokers wanted their loans repaid. So the brokers sold the stocks. This created a vicious downward cycle where lower tech stock prices led to more position covering which led to more forced sales to pay back loans and thus even lower stock prices.
This vicious cycle is similar to the one today in commodities. The mutual fund investment analyst told me that the stated reasons for the market tumble -- sudden inflation concerns -- don't make sense since investors have known about high energy and housing prices for years.
The hedge fund position-covering explanation makes sense to him. But it's scary to the average investor because hedge funds are not required to report what they're doing. So they can make their moves in secret -- protecting themselves and their limited partners -- and leaving the rest of the world to twist in the wind.
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Reader Comments (Page 1 of 1)
6-14-2006 @ 3:59PM
David L Gordon said...
So now we know why the markets, both foreign and domestic, have been in such a downward spiral lately. It's those damn hedge funds again unwinding their positions in commodities and emerging market holdings. I lost over 40k during the last month, all on account of these hedge funds. But I don't blame anyone or anything else as much as I blame myself.....I should have had enough common sense enough to sell when all those hedgehogs were selling out and covering their positions. I could have made a bundle as well shorting the markets on the way down.
6-14-2006 @ 4:55PM
Wayne Hetzell said...
David, I also lost a considerable amount and didn't realize that the hedgehogs would have the influence in keeping the market spiraling down for such a lengthly time. Now it is apparent that they can create hell behind their secretive (non-reporting)
methods. Lesson learned.
6-14-2006 @ 4:58PM
Robert Dwyer said...
This is a great theory and makes a lot of sense. What DID NOT make sense was that the market swoon worldwide was the result of a suddent realization by investors that energy and housing costs were high. That was purely the nonsense spewed by the talking heads in the media who are consistantly clueless as to what goes on. When I was on the Street, we used to get calls from one of the TV nitwits (he is still there) asking one of us to explain what went on that day in the market and why. We made up assinine reasons for the market rally/decline and this airhead appeared later in the day with a breathless recap of our absurd story. I think the hedgies were definitely the villains. This was the kind of mindless "sell at any price" behavior that only they engage in. Thanks for some clear insight.
6-14-2006 @ 5:00PM
Robert S. Conrad said...
I don’t think the Global sell off in stocks has to do with US Interest Rates.
1.May 10 was the last Rate hike by Ben, as you can see rates actually changed very little and mostly declined.
US Treasury Bonds May 10,2006
Issue Price Yield
2 Year US Treasury 99 25/32 4.98
5 Year US Treasury 99 12/32 5.01
10 Year US Treasury 95 07/32 5.12
US Treasury Bonds June 13,2006
Issue Price Yield
2 Year US Treasury 99 24/32 5.00
5 Year US Treasury 99 24/32 4.92
10 Year US Treasury 101 8/32 4.96
2. Alarming to me is the more pronounced yield curve inversion. This would actually point to lower rates due to a likely recession.
3. The US Consumer is over-leveraged in declining asset values. The older population has spent down their savings due to low returns on fixed savings and high medical and drug cost, while the younger generation has leveraged inflated home equity to purchase luxury’s that depreciate as well as inflated second and third homes.
Conclusion: All of these factors has lead us to this turning point in United States history.
Why does the Fed stop reporting M-3 money supply.
... so they can run the presses 24-7 for the liquity crash. Maybe.
Why does Gold and Silver decline at historical dailey percentage rates if inflation is the problem.
The problem isn't Inflation at all it is something else... the Bird Flu Pandemic in Indonesia or Iran oil for Euros or Isreal and the Hammas. Maybe.
Why does the US Dollar rise on inflation news?
Flight to safety... where you been.
What will we use to support the US currency and our debts to foreign nations? CORN.
6-14-2006 @ 5:01PM
Robert S. Conrad said...
I don’t think the Global sell off in stocks has to do with US Interest Rates.
1.May 10 was the last Rate hike by Ben, as you can see rates actually changed very little and mostly declined.
US Treasury Bonds May 10,2006
Issue Price Yield
2 Year US Treasury 99 25/32 4.98
5 Year US Treasury 99 12/32 5.01
10 Year US Treasury 95 07/32 5.12
US Treasury Bonds June 13,2006
Issue Price Yield
2 Year US Treasury 99 24/32 5.00
5 Year US Treasury 99 24/32 4.92
10 Year US Treasury 101 8/32 4.96
2. Alarming to me is the more pronounced yield curve inversion. This would actually point to lower rates due to a likely recession.
3. The US Consumer is over-leveraged in declining asset values. The older population has spent down their savings due to low returns on fixed savings and high medical and drug cost, while the younger generation has leveraged inflated home equity to purchase luxury’s that depreciate as well as inflated second and third homes.
Conclusion: All of these factors has lead us to this turning point in United States history.
Why does the Fed stop reporting M-3 money supply.
... so they can run the presses 24-7 for the liquity crash. Maybe.
Why does Gold and Silver decline at historical dailey percentage rates if inflation is the problem.
The problem isn't Inflation at all it is something else... the Bird Flu Pandemic in Indonesia or Iran oil for Euros or Isreal and the Hammas. Maybe.
Why does the US Dollar rise on inflation news?
Flight to safety... where you been.
What will we use to support the US currency and our debts to foreign nations? CORN.
6-15-2006 @ 12:56AM
R.Allen said...
A Quick lesson in Hedge funds!!
In reply to - "Why the markets fell: hedge fund trading could be the culprit"- We need to go back to some facts that will help you understand the myth about what hedge funds are & are not! It is obviously Peter Cohan has been misinformed.
I have worked with several hedge funds that are 1. Using real hedge strategies. 2. With Minimal or no leverage ( See Platinum Cap. Mngmt, Man Investment, FMG Funds etc.). Most funds that claim to be HFs simply are not! If a fund manager positions to buy or sell he always has a hedge to protect against down side volatility (something our mutual fund managers lack the ability or knowledge to do!) Depending on the funds strategy, HF`s maintain a risk adjusted & balanced portfolio that is non-market correlated! This all results in lower volatility and consistent returns. These strategies are effective in all market conditions (see ref. Tremont HF index). Simply put, HFs use an insurance policy that minimizes loss, yes they pay a premium to HEDGE against loss. Same as you do with your auto insurance. We all know this strategy!
It is evident that Mr. Cohan and the "Mutual Fund Mgr." have little or no knowledge of hedge funds and what they do or how they work. And by the way, if you think all this fundamental rhetoric on market movement are because of the FED, Bonds and oil! Look into Elliotwave principles and technical analysis! I have to the tune of 17% annual ROI since Sep 95 - present! In short, do not believe all you read, do your homework and look for answers outside of the U.S. and be objective with our mutual fund managers who on average out-perform the markets 11% of the time industry wide. And ask them if they are invested in there own fund, you may be surprised at the tap dance they do!! It is entertaining!! Good Luck! See you in the offshore markets where wealth presevation is KING!