Hedge Fund Oxymoron?

In a report released on Wednesday, tracking firm Hedge Fund Research said investors pulled $155 billion from the secretive portfolios.

What separates hedge funds from other, better regulated funds and investment vehicles is that hedge funds are chartered to engage in short selling, buying and selling options and other devices designed to "minimize risk." The whole idea behind the concept of hedge funds is that they can weather any kind of market and make money in any environment.

So why did they take - on average - a 19% beat-down in 2008? It seems that the hedges were trimmed when they should have been sprouting new branches. While mutual funds lost an average of 38% last year, the hedge funds should have been in a position to identify the enormous risks in the market and "hedge" accordingly.

But maybe the term is oxymoronic. Maybe the average hedge fund manager isn't any smarter than the guy with glasses who handles your pension plan, and maybe, despite the tools available to them, the hedge fund managers were not any more aware of what the banks were going through in 2007 and 2008, and failed in their charge to ameliorate risk by shorting, buying puts or exiting losing positions in timely manners.

When this ugly chapter of economics is finally unwound by financial historians, it's likely to be revealed that the clandestine hedge fund community was one of the major contributors to the extreme volatility in markets during the final three months of 2008, fleeing financials just like the rest of the duped investors who thought the subprime crisis was "contained" - a la Ben Bernanke - as markets and profits disappeared like the vapid promises of "higher returns."

Greed, an emotion which knows no bounds, is what attracted the rich and not-so-famous to hedge funds in the first place, and it is the same greed (masked as fear of losing their cash hoard) that is fueling the exodus today. Had the hedge funds really been on the ball, they would have profited from the relative ignorance of the rest of the market. Unfortunately, hedge fund managers turned out to be not the "smartest guys in the room," but merely a little smarter than the average broker.

Investing is largely about managing risk, and while the hedgies purported to managed risk better than the average, their losses - and subsequent redemptions - proved their fallibility and the underlying investment risk dictum, "nobody is immune."

Obama Bounce? No, It's a Geithner Gallop; eBay Disappoints

Stocks reversed nearly all of yesterday's losses after the New York Times posted an article with the glaring headline. Hearing Over, Geithner’s Confirmation Is Expected minutes before noon.

Stocks started out full of steam, but had surrendered most of their gains before that bastion of journalistic integrity asserted that Timothy Geithner's problems with not paying taxes on time would be sufficiently swept under the rug and he would be confirmed as the new Treasury Secretary. Such an appointment virtually assures more bad behavior on both Wall Street and in Washington, DC. The banks will continue to receive hefty sums of taxpayer dough from the Treasury without recourse nor accountability.

Tra, la, la, life as a bankrupt banker must be good with a capital G.

Dow 8,228.10, +279.01 (3.51%)
NASDAQ 1,507.07, +66.21 (4.60%)
S&P 500 840.24, +35.02 (4.35%)
NYSE Composite 5,273.9902, +215.93 (4.27%)

The advance was broad-based with gainers beating losers, 5011-1567. New lows retained their 14+ month edge over new highs, 278-10, notable in the minuscule number of new highs on such a large point gain. Volume was solid, a very optimistic indicator.

NYSE Volume 1,737,111,000
NASDAQ Volume 2,109,177,000

IBM's strong 4th quarter results also contributed to the sanguine tenor of the day. The computing giant returned impressive results after the close on Tuesday.

Commodities also got in on the rising price action, though oil's gain of $2.71 resulted in a closing price of $43.55, quite tame by recent standards. Gold continued to trade under pressure, losing $5.10, to $850.10. Silver gained 15 cents, to $11.33. Natural gas was also higher, gaining 12 cents, to $4.75 mmbtu.

After the close, eBay released 4th quarter and full year results. The company's 4th quarter returned lower revenue and earnings, and the stock sold off after-hours. Here [PDF] is a link to a graphical presentation.

Ebay-related revenue took a large hit. The largest revenue production came from PayPal, as the company struggles through a troubling transition in their core auction and fixed-price business. Essentially, the company has largely neglected the individual seller in favor of catering to larger enterprises. This has caused nothing short of a seller exodus over the past few months. Ebay executives put most of the blame on poor global economic conditions rather than taking the heat for their failed turnaround of a business that didn't need changing.

At this writing, ebay was trading at 12.52, down 0.76 in after-hours trading.

Roubini: "systemic banking crisis"; Obama: "the time has come"

As Washington, DC became a grand celebration with the inauguration of Barack Obama, the 44th President of the United States of America, a far different mood was spilling out of the stock exchanges and broker/dealer offices of Wall Street.

The juxtaposition of moods and emotions could not be more stark between the Capitol and the Big Apple. While Obama was reminding us of the nation's greatness, Wall Street was dealing with the current reality of a systemic banking failure. Speaking in Dubai, New York University Professor Nouriel Roubini, who has been one of the leading voices predicting the global financial crisis, said that US banks are "effectively insolvent," adding that total financial losses could reach the staggering sum of $3.6 Trillion.

There is no doubt that the economy will be the stiffest challenge presented to the newly-minted President. Obama, in close contact with the congress, is already working on a financial rescue package which will total over $800 billion in tax breaks and incentives over the next two years. Whether the medicine spooned out by Washington will cure the sick patients of Wall Street is still suspect. The wheels, however, will turn, for better or for worse, and business will continue, in whatever form it takes.

As President Obama made his way to the Capitol to take his oath of office, markets around the world were reeling. The Dow Jones Industrials quickly sank below 8100, the fourth consecutive session in which it has declined beyond that mark. The catalysts for the decline were the same as they have been throughout: the banks and financial institutions that continue to write down massive, unpayable debt, begging for help from stunned legislators while destroying investor confidence and trust in markets.

So it was that the new president was greeted with a massive loss on US equity markets, which ended the session with the worst losses of the new year.

Dow 7,949.09, -332.13 (4.01%)
NASDAQ 1,440.86, -88.47 (5.78%)
S&P 500 805.22. -44.90 (5.28%)
NYSE Composite 5,058.0601, -329.44 (6.11%)

Advancing issues were overwhelmed by decliners, 5655-833, one of the most lopsided showings in months, even though the past few months have been nothing but an endless string of declines in the broad markets. New lows arched ahead of new highs, as expected, 328-18, expanding both the number of new lows and the margin of lows to highs. Volume was once more light, considering the loose selling all around, but, as mentioned in earlier posts, smaller volume figures are more or less going to be a fixture for some time to come. Small investors have been spooked, hedge funds are largely out, and big brokerages (are there any left?) have trimmed their positions significantly.

NYSE Volume 1,718,511,000
NASDAQ Volume 2,014,633,000

On the commodities side, oil, which began a new futures contract today (March), gained from the closing February contract, up $2.23, to $38.74. Gold rebounded sharply, adding $15.30, to $855.20, while silver slipped on profit-taking, down 4 cents, at $11.18.

Up this week are tech heavyweights - Apple, eBay, Google, AMD, and others - reporting 4Q earnings. Of particular focus is eBay, which seems to have lost a lot of momentum lately, due to CEO John Donahoe's commitment to "disruptive thinking," the idea that eBay must change to grow, or, in his own words, "create a vision of the future so people could let go of a very successful past." Apparently, Mr. Donahoe never heard of IIABDFI (If it Ain't Broke, Don't Fix It) before embarking on changes (like tripling fees in some categories) that have resulted in vociferous complaints and a mass exodus of mid-to-small sellers.

The movement of sellers has been so abrupt that one site, Bonanzle, has gone from zero to just under 1 million listings in about six months time. Other niche and general sites have experienced enormous growth during Donahoe's tenure. Ebay reports after the close on Wednesday. Look for the first of many disappointing quarters. The stock should sink to under $10/per share (currently hovering around $13-14) in short order (no pun, nor hint, intended).

If today's action was any indication, President Obama's task is not going to be an easy nor a pleasing one. Rescuing an economy that has been buffeted by years of abuse and neglect will take time to repair. This is not a condition which will be cured overnight. And, as the President has been reminding us, it's likely to get worse before it gets better. How much worse only time will tell.

Oil, Natural Gas Prices Slide

With US equity markets closed in observation of Martin Luther King Jr. Day, there was little to report except on select commodity markets.

In futures trading, oil for February delivery fell $2.84, to $33.67. The February contract closes on Tuesday, Jan. 20, and trading was thin as compared to the March contract.

Also feeling the impact of decreasing demand was natural gas, which is used to heat nearly 1/3 of all US households. The March contract fell 26 cents, to a seasonal low of $4.56.

Both prices reflect supply surpluses in US stocks and slack demand as the economy reels from deflationary pressures, job losses and the nation's worst recession since the 1930s.

Our regular report will be posted shortly after market close, later today, as Americans and the world will be focused on the historic inauguration of President Barack Obama.

Inflation, Deflation and Financial Engineering

Stocks finished he week in fine fashion, ignoring the most obvious bad news: Bank of America needs another $20 billion and needs the Fed or Treasury to backstop even more huge potential losses; Citigroup is breaking up from the pressure of bad debts on its books; industrial production for December fell off another 2%, capacity utilization for the same period fell from 75.2% to 73.6%, and, deflation is alive and well, with the CPI dropping another 0.7% in December.

Noting that those aforementioned figures are supplied by corrupt, inept, spendthrift federal government agencies, the real condition is probably worse, though everybody loves the deflation idea. Everybody, that it, except the government and the Federal Reserve, both of whom are hell-bent on re-inflating the economy. They've been trying hard for months, however, to no avail, throwing money at banks and failing financial institutions, auto manufacturers, insurance companies and anybody else who seems in need of an additional $5 billion or more.

It's not working, and it won't. Here's why. Most of the money spent on bailing out banks and other businesses has been carefully squirreled away to enhance reserves, pay down some debt or other or fund continuing operations. For the money to actually result in inflation it needs to be put to new uses, or loaned, i.e., multiplied. Currently, the banks aren't interested in making new loans to anybody. They've been burned too badly by getting too close to that subprime fire, and now they're worried about other loans going bad, like credit cards, equity lines of credit, commercial real estate loans, to say nothing of the massive amounts (more than $2 trillion) of Alt-A and ARM mortgages due to reset in 2009-10.

The Fed, the government and Treasury, if they had an honest bone between them, would do what really would make the economy zip along: cut the payroll tax, institute usury laws (limiting the maximum interest rate chargeable by law) and let the failing banks (and other companies) be sold off in pieces and have new operators start over.

To get an idea of how one-sided and wrong the government help has been, consider that of the $350 billion already doled out via the TARP, all but $15 billion has gone to banks, financial firms and insurance companies (most of that to AIG). Today, electronics chain Circuit City announced that instead of reorganizing, it would liquidate, in effect, changing its bankruptcy status (filed in November) from Chapter 11 to Chapter 7, or, end of story for the company.

So, while the banks are "too big to fail," what about the 34,000 employees that Circuit City will furlough? And the leases that will not be paid on the huge space that each of the 571 stores it plans to close occupies? Those employees are out of work, the landlords are left with empty space. Too big to fail? Consider that at just an average of $23,000 (just a guess), those 34,000 out-of-work Circuit City employees will cause $782,000,000 in wages to go out of circulation over the course of the year. That's money that will not be spent in local economies, on rent, food, mortgages, utilities, gas, car payments, movie tickets, etc. The ripple effects from those 34,000 people being unemployed may be a lot worse than say, Citigroup going belly up, which, despite mountains of handouts from the feds, it did.

The bailouts are a bad idea made worse by the money going in the wrong places, to the wrong people. It's the working class that needs the money, that greases the wheels of the economy, that keeps America rolling. They've gotten nothing. Well, they'll get unemployment insurance (most of them), again, paid for with taxpayer dollars. If they had been bailed out and kept working, they'd be paying taxes, not draining the treasury.

Still, investors seemingly still believe in the big business that is Wall Street and the stock markets, which are dead, or at least dying. Looking over some charts of the Dow and S&P, in particular, there's a real possibility that stocks could decline much further from current levels. Try to wrap your mind around the Dow at 4000 and the S&P holding tight to a valuation of around 450.

The operative time period seems to be right around 1985, when Reagan tax policies began to take hold and the era of Wall Street greed took off in full flight. On January 2nd, 1985, the Dow opened at 1211.57, the S&P began the year trading at 167.20. At the peak in 2007, the dow was over 14,000, the S&P sailed as high as 1550.

Just a back-of-the-envelope calculation would conclude that the 30 stocks comprising the Dow increased in value over the 22+ years from 1985-2007 by a factor of 11.5. The more modest S&P companies only would have grown 9-fold in the same period. Are these companies worth 11 1/2 and 9 times what they were in 1985? Doubtful. Besides that, many of the losers have been taken out of the indices and replaced with more healthy firms. To get an idea, here are just some of the companies which were part of the Dow in 1985, and are no longer there: American Can, Bethlehem Steel, Eastman Kodak, General Foods, Goodyear, Inco, International Harvester, Owens-Illinois Glass, Sears Roebuck & Company, Westinghouse Electric, Woolworth. The entire index is periodically, carefully re-engineered to reflect a growing economy, when, in fact, companies coming into the index are growing by largely eating the remains of the companies being shown the door. Similar changes occur periodically in the S&P and other indices. It's all part of the Wall Street shell game.

So, even if these companies are worth 3-4 times what they were in 1985, which some may be, they are still, as a group, overvalued. Prior to August, 2007, they were massively overvalued. Today, they are only slightly overvalued, maybe by 35-60%. Still, as the year of 2009 drags onward and profits collapse, valuations will come back to reality.

The financial engineering which began in the Reagan years, took off during the Clinton era, soar and crashed in the Bush years, was a highly profitable venture for the insiders and those who traded smartly. Those still chasing profits today are, as they say, out of luck. The 9000 level on the Dow won't be seen again for another 3-5 years, at the earliest. By June, 8000 will look like a long way up. Stocks need to revert to reasonable, sustainable levels. And they will.

Nonetheless, investors saw to it to boost their fortunes (or bury them in more malinvestments) pumping stocks higher on Friday.

Dow 8,281.22, +68.73 (0.84%)
Nasdaq 1,529.33, +17.49 (1.16%)
S&P 500 850.12, +6.38 (0.76%)
NYSE Composite 5,387.50, +39.75 (0.74%)

On the day, advancers beat declining issues, 4020-2505. New lows were ahead of new highs, 163-20, which was less of a margin than yesterday. With no more trading prior to Inauguration Day (Monday is a holiday), stocks may get a temporary boost for a few days, though the news flows of poor corporate earnings are sure to keep any such Obama-rally brief.

Volume on Friday was the best seen in weeks, most likely tied to options expiry.

NYSE Volume 1,617,226,000
Nasdaq Volume 2,273,921,000

Commodity traders also got on the inflation fantasy train on Friday. Oil futures gained $1.11, to $35.97. Gold skyrocketed $33.60, to $839.90, while silver was also a star, gaining 78 cents, to $11.22. We knew silver was a good buy under $11, but we didn't think the payoff would come so soon. We'll be buying more at any price under $10.80, actually hoping it goes lower, because inflation is, at this juncture, a pipe dream.