The Dow lost 385 points this week with a 315 point election day rally on Tuesday, two consecutive days which totaled 929 points down, and a Friday rally of 248 points. Did the market rise on hopes of a McCain upset only to fall due to disappointment that Obama won? Did the market rally Friday because the 6.5% unemployment rate was not as bad as expected? It could be, but I doubt it.
More likely, the markets are moving because of the trading behavior of endowments, pension funds, and hedge funds. They make decisions for very different reasons. But some reporting on daily market movements looks like a joke -- nobody knows why the market goes up or down, but commenters use price movements as a daily barometer of the national mood. So how do endowments, pension funds, and hedge funds move the markets? Here's how:
- Endowments. Big university endowments, such as Harvard's, are desperately trying to unload billions of dollars worth of illiquid interests in venture capital and private equity firms. Harvard is reportedly trying to dump $1.5 billion worth of such interests into a market where there is likely to be very little interest. Not only that, these private equity firms are demanding that endowments fork over the money they committed to them so they can make new investments. And with the S&P 500 down 36.6% so far this year, many endowments are selling anything liquid to meet these commitments and to pay shorter-term obligations -- such as paying professors and keeping the lights on.
- Pension funds. Pension funds have limits on what proportion of their portfolio they can hold in illiquid securities such as private equity and venture capital funds. For instance, the largest pension fund, Calpers, can only hold 10% of its portfolio there, but with the decline in the stock market, that figure has risen to 13%. To lower that percentage, pension funds are trying to take steps to sell those illiquid interests and to raise the proportion invested in other asset categories.
- Hedge funds. Hedge funds are also losing massive amounts of value. They got involved in money-losing trades and their brokers are forcing them to come up with cash to cover those losses. And they are facing demands from investors to get their money back which hedge funds are meeting by selling stocks and other more liquid assets. For instance, the $18 billion Citadel Investment Group is down roughly 40% this year and its brokers are calling for cash collateral to make up for those losses. Where does the cash come from? One place might be selling stocks.
Unfortunately for investors, these comments are mere glimpses into what is going on rather than a comprehensive picture. I believe that the media ought to focus on the flows of capital into and out of stocks as a way to explain market movements. But it can't do a good job if these big investors are able to operate in the shadows due to flimsy reporting requirements.
While many investors have checked out of stocks after seeing them lose so much value so suddenly, we can hardly expect the public to return to stocks if they do not understand why they go up and down.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter
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