Clearly someone has had a chat with Fed Chairman Ben Bernanke. I don’t day trade, but I still have a number of colleagues on the floor of various exchanges who do. And the best day-trade of the 3rd quarter of 2008 and the 1st quarter of 2009 was: when Bernanke was scheduled to speak the next day, short the market the night before. It worked like a charm.
Was he being shrill then or telling the truth? Whichever it was, members of Congress and, clearly, the new Administration, became concerned that Bernanke’s comments were a factor in exacerbating market declines. Since March, he and all other government spokesmen have changed their tune completely. Which time was he telling the truth? Or did the facts on the ground actually change enough to warrant this opinion swing?
Well, there are facts and there are facts. Is I wrote here, the April unemployment numbers created a stellar rally because the job losses were “ ‘less than expected.’ Less than expected by who? Pollyanna? These are lousy, dreadful, abysmal, horrendous, rotten, atrocious, and awful numbers. And I only wish they were true. In fact, the BLS gets to add or subtract a ‘delimiter’ based on some computation known only to them (though well-placed sources say they call it something like ‘flipping a coin’) that determines how much of that loss is ‘merely seasonal.’ ”
I then showed how this heuristic plus the national government’s ability to hire temporary workers whenever they like can easily skew the numbers to a move favorable conclusion. And, of course, a month or six weeks later, those numbers are usually buried on page 6 because most investors have short memories and have already moved on to some other news that they believe can or will move the markets.
I am no conspiracy theorist. I don’t believe there is some vast, controlled scheme to fool the investing public. But I do believe the pendulum has swung far to the other side in reporting because both well- and ill-meaning analysts, researchers, government statisticians, talking heads and leaders in industry and government wish it so. How else can they, with a straight face, trumpet a corporate loss as a win because they lost another $2 billion but it was “less than expected.” Today, earnings estimates from corporate management to analysts have been slashed well below what they see as worst case so they can “beat the estimate.” It isn’t a conspiracy, it’s job-and-bonus-preserva... It isn’t a conspiracy, but it is manipulation.
Given that the estimates no longer bear a close working relationship with reality, is it really good news that losses are mounting, even if they are “better than estimates?” .As I wrote here, “If I am in a car that has lost both brakes and steering, and is careening down a 30% grade toward a cliff, even if the grade becomes a downgrade of only 20%, it’s still going to go over the cliff. It’s time for me to exit the vehicle.”
Never forget: for every buyer, there must be a seller. Always ask: who’s selling and who’s buying? Well, we can tell by the volume and the time-and-tape tracking of the size of the trades (discounting for institutional algorithmic and dark pool trading as best we can) that the public is doing a lot of trading. Are we buying and selling from each other? It’s possible but it is more likely that we are taking a lot of the hedge funds’ mistakes off their hands.
In the January 2009 issue of Investor’s Edge ® I quoted Jim Rickards, a friend who is legal counsel to a number of hedge funds. He explained something to me that he says many hedge fund managers didn’t even understand prior to the current troubles. Here is my introduction to that January discussion and his response:
[JS: This month I present…Jim Rickards … on the hedge fund “redemption” overhang. I still expect a honeymoon rally in the first quarter of 2009, but Jim’s thoughts below give me concern about the timing and duration of the next decline.]
JR: “The hedge fund non-redemption scenarios are real inside baseball and not understood at all outside the industry (and scarcely understood inside the industry). The basic idea is to achieve equity between those who want out and those who stay. In ‘normal’ markets this is easy; withdrawing investors get cash and those who stay own a larger pro rata share of the portfolio.
“But in distressed markets the dynamic is completely different. The early redeemers get cash and the last guy out gets ashes. Everyone knows this so they all want to get out at once… The ‘solution’ is to call a ‘suspension’ and stop ALL redemptions so that the portfolio can be unwound in an orderly way and all investors get a pro rata share of the cash less whatever costs or losses were incurred in the unwind. Now everyone gets a little cash and spoonful of ashes. So far so good.
“What people don't understand is that once you suspend, you are no longer a going concern. (Some managers think they are but we have a name for that -- denial). This is because investors who put in redemption notices which are not honored are no longer investors. By operation of law and accounting rules they are ‘converted’ to creditors for the unpaid redemption. The manager of an insolvent fund has a strict fiduciary duty to creditors which is higher than the duty owed to limited partners.
“As a result, the manager is now on one side of the market only. He can sell (and use the proceeds to pay redemptions in drips and drabs) but he cannot buy (because that is at odds with his obligations to his new ‘creditors.’)
“So what do you call it when you have ALL sellers and NO buyers? Suspension is not a license to trade your way out of a hole; it's just a way to give you more time to liquidate. Now, as a trader in this situation, you would do the same thing I would do. Wait out the declines and sell into rallies as long as you can. By the way, the manager still collects his 2% management fee on the ‘suspended’ fund. So the manager has some incentives
to take his time but he can't take forever or he'll be sued by his creditors (formerly investors).
“What you are left with is an enormous overhang; all on one side of the market.”
I can’t say with certainty that Jim’s concerns will drive the market lower. I can’t say with certainty that the market will go lower, for other reasons. But there are a lot of bankers, brokers, hedge fund managers, CEOs, CFOs, government leaders, and talking heads out there who are trying to pipe sunshine into our lives. As far as I know, rain has not been banished from the planet.
DISCLOSURE: June may be different, but the “incredible rally” of May has been mostly manipulation of news, management of numbers, and smoke and mirrors. In fact the market is virtually unchanged from a month ago! (And has yet to close higher than it was on May 6.) We got in to the current rally on 3 March (article here) and out on 17 April (article here) when the Dow went from 6726 to 8131. I’m OK missing a rally that took 5 additional weeks to climb 350 points as long as our clients are sleeping well, safely tucked in to: 90% cash and short-term bond funds and 10% gold ETF GLD, and inverse ETFs like EUM, SH, SEF, REW, and PSQ.