Hedge Funds Not Knowing What to Do with Money?

May and June have been brutal for money managers. The volatility and conflicting economic signals made it very hard to stay the course or change the course. On hindsight, it would have been great to be 100% in cash since early May when S&P was at 1200. It's probably not a very good idea to raise cash after the 10% correction. But that appears to be what some of the big hedge funds have done, which has probably contributed to the market volatility and deepened the correction.

Barton Biggs, whose purchase of stocks in March 2009 gave Traxis Partners LLC a 38 percent gain last year (so?), said last week he sold about half his stock investments because of concern governments around the world are curtailing stimulus measures too soon.


“I’m not wildly bearish, but I don’t want to have a lot of risk at this point,” Biggs, who manages $1.4 billion, said in a telephone interview. “I’m not putting my money into anything. I’m raising cash.”


At the end of May, this same Big manager was voicing his opinion that the stock market was set to "pop" in days (yes, in no uncertain terms, "in a couple of days."). Apparently, he has been frustrated by June's continuing declines. But his earlier bullish call was a frustrating call at best. Did he actually know something or was he just wishing for something?

For more comments, see this Bloomberg article.

Nothing to Fear but Fear Itself?

There are a lot of talks about market psychology in recent days as the market went through a deep correction. For instance, the Wall Street Journal has a piece today that tries to argue that "[t]he biggest threat to recovery is the markets themselves." That is, the economic recovery would be back on track if the markets just believe it.

As if to confirm it, the market had a good rally today without any good news.

I do believe there is certain amount of truth in it, although I think there is far more than just investor psychology that's involved.

To a large degree, our modern economy is now very asset-based, in that consumers can spend based on the value of their assets such as homes and mutual funds. So if the markets for these assets are supported either by the Fed, or by optimistic views, we may see very positive effects on consumption and hence on recovery. That in turn may lead to higher asset values.

But that was how we got into the credit crisis, believing for example that home values would always go up. Consumers are now working hard to repair their balance sheets. In such an environment, we need actual income generation to support the economic recovery. That is, jobs.

This is probably why PIMCO's El-Erian thinks that unemployment has shifted from a lagging indicator to a leading one and is warning government policymakers to confront the structural problems in the economy. Eight millions of jobs have been lost since the beginning of the great recession. Despite historically low interest rate and trillions of dollars in stimulus spending, jobs are still scarce and are being added too slowly.

Investors have to ask, why these profitable corporations are not adding more jobs and who are going to lead job creation?

Rail and Retail

Rail traffic has been up over the past two months. Combined weekly traffic for new carloads and intermodal shipments is about 14% higher than a year ago, according to the Association for American Railroads.

U.S. retailers’ sales probably expanded at an average monthly rate of 4 percent in the first five months of the retail fiscal year that began Jan. 31, the biggest gain since 2006, the International Council of Shopping Centers trade group said in advance of its June report tomorrow. This maybe a sign that consumers are overcoming concern about unemployment and depressed home values. Just maybe.

Rail volumn and retail sales are not leading indicators. They're contemporaneous ones. While encouraging, they offer no assurance for the economic recovery.

2Q earnings season is underway. But even good earnings may not be enough to lift the depressed market sentiments. Stocks are cheap, if the outlook of good earnings continues to hold up and perhaps improve. The fear of a double-dip recession, however, has called that into question.

Additionally, the uncertainty around November's mid-term election and consequently the tax policy changes may not give market good enough reason to start its recovery from the recent lows.

Best Time to Buy a House?

John Paulson said he is optimistic on the American economy. "I think we're at the tail end of the credit crisis," he said "We're in the middle of a sustained recovery in the US. The risk of a double dip is less than 10 percent.” Europe, however, “is the one soft spot in the world," he told an audience at the London School of Economics on Wednesday.

"It's the best time to buy a house in America. California has been a leading indicator for the housing market, and it turned positive seven months ago. I think we're about to turn a corner."

The housing market is probably in its worse shape: Both new and existing home sales have plummeted in June to new lows after the expiration of the federal home buyer tax credit. Mortgage rate has been steadily going down, which is an indication that housing demand is weak and getting weaker. All these are tightly linked to the weak labor market: Private job creation is anemic, and unemployment rate is expetecd to stay elevated for years.

The economy is so dark that economist/columnist Paul Krugman has warned that we maybe entering the "Third Depression."

But if you're a contrarian and you believe in the basic soundness of American businesses, then this is probably one of the best times to take a bullish bet, on housing and on U.S. economy in general.

See this article for the contrasting views of the hedge fund manager Joh Paulson and the academic/journalist Paul Krugman.

I've been looking for a house to buy in recent months as our lease was expiring. There are many good reasons to buy. Prices have been dropping over the last two years, and continue to drop. It's definitely a buyer's market. Renting now costs more in terms of after-tax cash flow. It's a good time to take advantage of the historically low mortgage rates and to start building home equity again...

But, there is no hurry! Unemployment is going to be a long hard problem to solve. Without massive job creation, there is very little real pent-up demand for additonal housing.

But, for the same reason, if job creation is getting in gear and we start to see hundreds of thousands of private jobs being created, a housing boom would not be far behind.

Cash Better Than Gold!

Gold prices are retreating. Investors are raising cash, lots of them. We raised some back in May and June, but not nearly enough.

Long rate is heading down. This is in stark contrast to the market expectation at the beginning of the year.

There is one important thing that the markets across asset classes agree on: risky asset prices are heading lower. We're headed to a deflationary environment. And that has been baked into the market expectations, which may become self-fulfilling.

Cash not only will not lose value, it will buy more if you just wait.

Companies, big and small, are holding back. Because they can buy more later.

People who worry about losing jobs don't want to buy homes now. Mortgage rates can't help but to go down. People who have stable jobs are probably better off renting, because they can buy more home later.

Is there value in gold? Not in a deflationary environment and major governments are pursuing austerity.

There is only one entity that can turn this vicious cycle around: The Bernanke Fed.