Thursday, October 23, 2008
(Cont'd from above)...

Is this just the chaos of a volatile market, or is there something deeper going on?...

These late-day moves are a symptom of the disease that's killing this market...

And the disease, behind the scenes, is poorly-run hedge funds... of billion-dollar proportions that didn't see the slowdown coming, and bet heavily, and incorrectly, on stocks that have been killed, ever since China dropped off the map.

In today's Sell Block, I want to analyze what's causing the selling... to explain the forces that are controlling this market. "Who is this selling?" has become the single-most asked question out there... Even by the biggest guys, the CEOs, the hedge fund managers that I talk to... and, tonight, for you, I have the answers.

The most important question in this environment is who saw the global slowdown coming? We ask all our CEOs that. I know one cohort who did not see the slowdown coming... the hedge funds.

The hedge funds are still waiting for China to come back after the Olympics. Now, one look at the Baltic Dry Index... look at this thing, will you... this is one of the biggest declines... this is shipping... this is the shipping to China... Or how about the Shanghai Composite Index?... I use this too as a measure.

These are both great barometers of China, and both keep getting worse...

So it tells us the snapback is not going to happen...

The communists may not be able to infiltrate the State Department, but they infiltrated our hedge funds, and the plot to destroy America is finally working!...

How do these late-day swings connect to weak hedge funds and the overall weakness in the market? This is what you need to know... It all comes back down to the forced selling at hedge funds, that all made the same lousy bets on minerals, oil, service, and agriculture... all the big movers... and borrowed a bunch of money from the brokers that do it.

Part of the reason we see these late-day swings is that, at about 2:45pm... the hedge funds begin preparing for the next day's redemption. Right here (pointing to a downward trend on the chart, at about 2:45pm), this is where they're selling so that they're ready to send money back to you... or avoid a margin call tomorrow. This is what they do... they sell, sell, sell. That's when the hedge funds that bought stocks on margin, and borrowed money and lost money, have to sell to pay back the money they borrowed from the brokers but, more important, to their investors.

It's not the least of it...

These funds that are down big, and concentrated in a bunch of stocks that need worldwide growth to work, they try to hedge by shorting the stock market. They take their long position, and they short the S&P 500... The hedge doesn't work, because the junk they own does worse than the S&P 500... which is chock full of utilities and food and drug stocks that are more resilient than what they own... so these guys are net losers every day, particularly on days when the S&P goes up, and their stuff goes down... which, given the deflationary environment we're now in, happens quite often.

What they are short goes up. What they are long goes down. They are the stupid funds that... well, what they used to accuse the mutual funds of being... they're getting killed.

But, often, they can juice their performance by pushing the market down toward the end of the day with more sell orders. That's definitely a part of what also happens. It didn't happen today. It happened yesterday.

Knocking the S&P down makes them look better each night, because they're short the S&P... they're betting against it. So they do it to save their skins, at least temporarily.

Now, take a look at this (pointing to a chart of the Dow)... look at what happened yesterday, okay... a 500-point decline in the Dow was caused, in part... and I did a lot of work behind the scenes... by two hedge funds that liquidated... two hedge funds that blew up and had to get out of the business. One was what's known as a large "quant" fund. "Quant" is Wall Street jibberish for using computers to figure out which stocks are cheap, and which stocks are expensive... Then they sell the expensive ones and buy the cheap ones. It doesn't work anymore, because the traditional valuations, as I tell you every night, don't matter in this market. This is just a really moronic way to run money. But they keep doing it, because it used to work.

The other firm was an outlying fund of funds for closing some funds and sending their clients back large withdrawals. Today's post-3pm rally happened, because still one more hedge fund finished selling...

We don't know this stuff. That's the problem. You and I don't have it... We have it after it happens. The liquidations happen right near the end of the day and, when they're over, we get these kinds of big rallies, like today's 440-point bounce from the lows in the final hour of trading... or the 200-point rally from the lows yesterday afternoon. Very light volume, sellers finish, and a relatively low number of buyers can move the market up a lot now... there's not that much. They are afraid to wait for the bell, the sellers... you see, these sellers cannot afford to wait until here... they're afraid to wait, because they want to be sure they're done selling with a few minutes to spare. So that's why this is a concentration of selling right there (i.e., around 2:45pm). They can't wait until the end and take advantage of that bump... That bump is only created by themselves finishing...

Back to the fund-of-funds guys, because they're actually at the heart of the problem... I call them the "aorta"... they're the heart of the problem with this market. The reason for the wild late-day swings and the market's general downward arch... they're just as much a threat to the health of this market as the communist Chinese who stopped importing things and brutalized our hedge funds.

What is a fund-of-fund?...

In the last decade, a group of what are essentially middlemen have cropped up, between hedge fund managers and their rich clients, and they're called "Fund of Funds Managers." They solicit rich people, and place their money with hedge funds, taking a 1% to 2% cut.

The thing about fund of funds money is that it's not locked up...

Typically, if you invest in a hedge fund, you can't just call and ask for your money back. You can only pull out at certain times, called "lock ups."

Fund of funds money doesn't play by those rules...

That money isn't sticky, it's slimy... These fund of funds managers will call you in the middle of the day and say, "We want our money back because our clients are desperate." The hedge funds that relied on these guys for their money have no choice but to give it back. It's not locked up. And that's a huge part of the forced selling.

How do I know about this? I used to run a hedge fund. I actually kicked these guys out of my fund, the fund of funds guys... I totally hated them, because they made me think too short term, because I was always worried they were going to pull out their money at the end of the day, and create that kind of selling pressure I just showed you...

As soon your hedge fund starts to do badly, the fund of funds managers will pull their money out. Their only job is to monitor who's doing badly, so they can pull it really quickly. Otherwise, they can't justify their 1-2% vig, unless they satisfy their investors.

They are pulling triggers left and right in this market, and forcing hedge funds hands daily... That's a huge reason behind this selling... probably the most important one. I always felt the fund of funds guys were scum-sucking pigs but, these days, I'm a diplomat, and I just think they're attacks on the system... and, as long as the market goes down, it will keep going on...

You need to end the forced selling before you can end the selling...

We're in a bear market. Make no mistake about that. And a bear market only ends, either where yields are around 6%, or you get a bottom, and the only left in a stock in the market, are the ones that ones who never sell, or ever pay any attention to their stocks.

So take a look at the Nasdaq bear market. This is the operative one. I'm not using 1932. Remember, all the money that all the different banks have gotten has taken the "Great Depression 2" scenario off right now... but this is what I fear more...

This is the Nasdaq bear market... This was a brutal decline (pointing to the chart from 2000 to 2003). This was an 85% decline, okay... You know, we hear all the time guys saying, it's cheap, it's cheap, it's cheap... Can I tell you, having lived through this decline... everybody would come on over and over and over again, saying, it's cheap, it's cheap, it's cheap... so you've really got to be careful.

This ended, again, when nobody was left standing except the braindead, and those who never ever sell, let alone ever look at their 401k's... And, only then, do we catch a definitive bottom. Of course, we have a lot more stocks with dividends in the S&P than the Nasdaq, but that's not a lot of solace, given how hard the Nasdaq fell those two years.

Some of us think it would have gone down 95%, if Alan Greenspan (former Fed chairman) hadn't taken rates down to 1%. Many companies in the Nasdaq... well, frankly... either don't exist, or still haven't come back.

Don't kill the messenger...

I'm just trying to give you the true, sober picture. And, everytime we get a rally like today, people say, it's over Jim... the selling's over... I always say, fine. That's fine... I'm glad you think that... I mean, people felt great conviction today, at the end of the day... It's all over, Jim. The market's resilient... Okay, fine. Keep saying that... that's fine. It's not what my work says...

The bottom line...


The bottom line!:     We're not even close to that point. I've checked, and mutual funds haven't really even seen that many redemptions yet. People haven't started asking for their money back in droves yet... other than the funds (for) rich people (i.e., hedge funds). I think that's going to change when regular folks take a look at their October statements, see how much money they've lost, maybe panic, and get out of their mutual funds... which forces those funds to sell too. That doesn't mean there aren't buying opportunities. You know we like the defensive plays... the newly-high-yielders... the stocks that are selling through their cash (i.e., they are actually selling per share at a price lower than they have cash on hand per share)... but it does mean we won't bottom until the forced selling is done. So you've got to be prepared to take some pain, and buy on the way down, because the one variable we never know is when the forced selling is done.

[verbatim recap]

Read Jim's next Segment here