Famed scientist Liberty Hyde Bailey was quoted as saying, "Every decade needs it own manual." What does the investment manual say about this decade? It says we have gone from one bubble to the next with each burst leaving us worse off than before. Tech hasn't even recovered half of its value from Nasdaq 5,000 nine years ago. Most of the financials (NYSEARCA:XLF) have been decimated 70%-90% because of the lending/housing bubble. Now we are seeing the fallout from the commodity bubble. How long before the automotive industry recovers? How about airlines? Will agriculture stocks like Potash (POT) or Agrium (AGU) ever regain their bubble inflated highs? Such consequences have not been good for the broad market; the ten year return on the S&P 500 is an anemic 4%.
So what is the cause of this short sighted investment euphoria? The cause can be traced to the hedge funds. PerTrac reports that over the last ten years the number of hedge funds has increased from 600 to 13,600. Assets under management have skyrocketed from $100 billion to an estimated $2.2 trillion. Hedge funds have become mainstream in a way that was never intended. On any given day 25%-60% of global trading is handled by these unregulated funds. Knowing that each of these hedge fund managers are forced to cope with +20% return expectations you can see why momentum has become more indicative of future stock price than fundamentals. These managers need quick returns and they'll go to any length to satisfy investors. Their use of leverage, long, short, and derivative positions during volatile times has caused this decade to feel like the wild, wild west.
As oil (NYSEARCA:USO) continues to drop and we deal with the bursting commodity bubble the question on investors minds is-will we see another bubble? As long as hedge funds exert this kind of influence on world markets you better believe we will see more momentum mania. For the time being, the momentum play is to pick off the weak financials. Once the SEC removed the temporary ban on naked short selling it was all systems go to profit from the demise of Lehman (LEH), Washington Mutual (NYSE:WM), and whoever will be next. Reaching a bottom to the credit crisis only happens with industry consolidation and the Fed's already set the precedent that consolidation will wipe out shareholder value. As a result, the market bears remain in control.
While this current action keeps everyone busy, other market cycles are beginning to emerge that have set the stage for the next hedge fund bubble. Struggling overseas economies combined with the steady climb of the US dollar leads us towards US equities. Record amounts of cash are being pulled from oil and other commodity funds along with the international outflow. That cash needs a place to go. The stock market will heal before the US economy, as is common during recessionary times. Certain sectors within this market will separate themselves to become like their own asset class, just like oil has done.
Stay tuned for part two of this article as I analyze which sectors will receive the coming boost. In the meantime, check out our stock and option LEAPS picks at www.lonepeakportfolios.com. This is a key market moment as we consolidate financials and phase into the next bull market. Many investors are feeling the fatigue of a difficult 2008, don't worry, there have been many positive developments in the midst of the rough times. Those positive developments are close to revealing themselves as investment winners.
Disclosure: Short USO, Long UUP.