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Bandwagon jumping Hedge Monkeys: how a new species of simian explained the market to me

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March 15, 2010 – Comments (12)

You guys know me as a guy who does ok at stock picking, writes an ok blog,  made a great call on financials a year ago, and a so-far bad (and very poorly timed in any case) call on a small cap airline late last year (RJET).  What you probably didn't know about me is that in my spare time i am a wildlife explorer.  Just this morning I hopped a plane to Africa and ran out into the bush and discovered a brand new species of monkey. 

Its a really interesting species of monkey, its primary characteristic is spends part of its time standing around looking everywhere, apparently not sure what to do, and the other part of its rime rushing in giant packs all in the same direction to do the same thing.  So dramatic is the tendency of these apes to follow each other that as I stood there observing them, the entire clan ran directly into a tree, in fact into the exact same tree, and each of them suffered bruises and facial scrapes as a result.  At another point in the day a baby monkey started crying, which led to its mother crying, which led to the entire pack crying and sobbing hysterically.  Half an hour later they were all laughing and dancing.  What one monkey does, the rest of the monkeys soon do as well.  Its not clear how this "all monkeys do the same thing" phenomenon begins, that will require further study, but once a trend in the pack begins it becomes universal in minutes. 

It lives in small hedges, which provide it fruit (in fact 2% of the weight of those hedges are berries and in a good year with alot of rain the hedges can convert 20% of the weight of rainfall into more berries). To my considerable amazement, these monkeys can speak english, follow wall street, and have an extremely interesting outlook on the financial markets.   Its not clear at this time how they get their stock quotes, as I couldn't find anycomputers or blackberries laying around, but somehow they do. 

In talking with the pack of Hedge Monkeys, I learned a few things.   As I myself am fairly new to wall street, and am still learning the tricks of the trade and the facets of the marketplace, this was quite informative.

One monkey pointed out that, on wall street, people don't like to short stocks into an uptrend.  Rather, they like to short stocks once a downtrend has established itself.  The monkey suggested that I start reading iBankCoin a bit, because its fairly funny and its interesting to read the thoughts of The Fly and the other contributors.  A common theme on that site, says the monkey, is that one should not short stocks until the market shows weakness.

The monkey also said that I'm a fool if I have not been reading RealMoney Silver over at thestreet.com.  He says that same advice is constantly given.  Constantly.  By chartists and TA guys it is UNIVERSAL:  buy stocks moving up, sell stocks moving down.  By Rev Shark and Cramer (two guys who seem to have some significant momentum investing talents).  Few people there, Doug Kass being an exception, along with a cuople of deep value guys (Melvin and more) seem to like stocks more as they crash.  Most of them, the monkey pointed out, are momentum guys who short stocks with "established downtrends" and buy stocks with "established uptrends".  

And, the monkey points out, there is good sense to this.  Shorting stocks into an uptrend is wildly risky.  Witness, the monkey points out, the incredible pain suffered by many caps game players shorting stocks in 2009 and predicting a crash or the end of the uptrend.  

Markets, the monkey said, quoting Keynes himself, can remain what you consider "irrational" alot longer than you would like them to.  So, the monkey noted, trend following tends to be a rewarding manner of investing.  

From there, the monkey observed that once a trend is begun and many people are following it, it tends to go alot farther than is reasonable, at least sometimes.  The traders then get ready to head for the exits at the first sign of weakness.  Follow the trend, but once its over get out quick.  

This tends to create a new trend:  a down trend.  

The monkey then ran off, screaming and flailing his arms into the air, only to smash his face directly into a tree.  He came back, bleeding a little bit, and gave me his hypothesis on the markets over the last 2 years.

In 2008, the monkey observed that many stocks had fallen out of favor due to high valuations and problems with real estate and banks.  However, commodities had been in a general uptrend since 2000...  So the traders all piled into the thing with the uptrend (commodities) and piled out of the things with downtrends (everything else).  This resulted in an extraordinary run into a bubble for basically everything commodity related. One day the party ended and stuff started crashing, then panic hit the system, commodity stocks like everything else entered a downtrend and the traders ran for the exits.

The downtrend was so strong in early 2009 that the traders all started selling and selling and selling until, said my new monkey friend, wall street had hit an all time (by far) record level of short interest at the bottom in 2009.   Short selling from mid-february to early march was like free money, the monkey observed.  Then Vikram Pandit authored that memo, which scared a few traders into covering.  This created more covering until eventualy an uptrend was established and traders began piling into that uptrend.

I was curious at htis monkeys take on it all, and was about to ask him a question when one monkey started laughing and barking and dancing.  Soon my monkey friend joined him, dancing and laughing and barking away.  An hour later when the pack settled down I found him again and asked my question:

"But, dear monkey, Charles Biderman of TrimTabs research has said that to move the S&P from below 670 to over 1100 would require 100's of billions of dollars, probably 500-800 billion dollars of new money coming in.  Yet equity mutual funds had outflows in 2009, not inflows, so where could the money come from?  Isn't there some kind of conspiracy or something?"

The monkey replied "no, you foolish human, its simple.  The hedge fund industry has more than $1 trillion under management (the monkey estimated about $1.5 trillion) and operates with typically 25% leverage (75% long, 50% short, ratios subject to variance)".  

He continued "that means that the hedgies control more than $2 trillion.  At the market bottom in 2009 Doug Kass at RealMoney silver said that the hedge fund industry was at record levels of short interest, the mutual fund industry at record levels of cash.  Indeed, the market itself was at record levels of short interest, plus, probably, vast quantities of additional naked short interest that can't be tracked.  If the hedge funds were 50/50 long/short then and 60/40 long/short now that alonewould provide $400 billion of "buying", if the hedgies were net short at the bottom, which the monkey thought they were, a move from 60/40 net short to 60/40 net long would result in $800 billion of net buying.  Cover $400 billion, buy $400 billion"

"Throw in", the monkey continued, "mutual funds lowering cash levels and increasing long exposure and even some reblaancing from pension funds and there you have it:  more than enough money to raise the S&P by 70% per Bidermans thesis"

The monkey then ran off to get involved in a poo-flinging contest with the rest of the pack.  

I realized I was going to miss my flight home to my couch if I didn't take off, so I headed out.  I wonder if I will ever see those hedge-dwelling, bandwagon-hopping, trend-following monkeys again?  I wonder if the scientific community will credit me with their discovery?

On the flight home I thought about what the monkey had said and...  I came to hold this hypothetical structure of the last few years as reasonable:

-hedge funds got huge early in the last decade.  While mutual funds were blowing up in the crash, they, ever trend-following as they are, rode it down and made money or broke even while long-only suffered.

-the repeated preposterous valuations in various asset classes throughout the '00s was the result of this massive amount of hedge fund money (and probably mutual fund money also) chasing trends.  Trend chasing is what chartists do, its what seems to be the most common tactic among pro's from my reading on the 'web and listenign to discussions.  Witness preposterous bubbles in casino stocks, in REITs, in commodities and commodity stocks, and the just generally retarded valuations that existed at the top in 2007.  Hedgies were record long, mutual funds had record low cash.  One trend and bubble just flowed into another as the first one popped.  Out of real estate into commodities... Out of commodities into shorting after lehman, out of shorting into long after Vikram's memo and the march bottom.

-Simple rebalancing at hedge funds probably provided enough money to move the market this far.  Simply covering shorts and increasing net long positions probably was enough to get us here.  At the bottom RCL had 30 some percent short interest, lol.  DIN had 30 some percent (still high 20's a while ago), ASH, ACAS, XL, YOU NAME IT, all of the stocks that I owned had massive, massive short interest.  All last year bears cried and whined and pouted about how "trash" stocks were moving up the most, not quality stocks.  I simply suggest that massive waves of short covering (from massive, massive, record levels) in everything that was out of favor at the bottom (when the momentum following nature of hedge funds was maximally short the maximally out of favor names).  

This shorting whats not in favor / covering into any uptrend explains the wild, runaway, wanton volatility in all of the "out of favor atht ebottom" names.  It explains it in casinos (MGM down to $1.xx, up to $12.xx, down to $5.xx, up to $14.xx), financials, consumer discretionaries, cyclicals, the works.  

-The market keeps moving up, by and large, because plain and simple this rally is so hated, so reviled, and so a product of short covering into low volume -vs- bargain hunters stepping in that alot of people are still on the sidelines.  Eventually they semi-capitulate and pile into momentum stocks to try to make a few bucks.

and...

-we have one more round of "the trade coming off" in commodities before this is all over.  ...  A great many commodities are currently seeing prices propped by the massive pack of bipolr momenum-following hedge monkeys that is wall street and the hedge industry.  I think some point where many commodity prices are substantially lower than today is probable.

and...

-I don't think too many people make much money selling short, including the hedge-monkey industry.  I think its far easier to make money long, and I think in general this fact combined with the fact that the hedgies are basically at heart just interested in making money ... will provide buoyancy to the market.  

-I think the presence of the hedge fund industry in all of its trend-following glory will tend to increase market volatility and lead to increasing bubble/bust behavior.  The hedgies will blow up bubbles to make money long, and when a crash really sets in they will pile in to short only if the trend is clearly established.  THEY MAKE MORE BEING LONG, ... ,

Frankly, I think the next 3-8 years will see one more cahnce to poke at an actual, real asset bubble (stocks right now are hardly at bubble valuations) and one mor chance to buy actually cheap (stocks right now are hardly in bargain basement territory).  And a whole lot of actionable trend changes and buyable dips in between.  

The rise of the bipolar hedge monkeys may explain a great deal of the markets insanity over the last 8 years ...  and we may not be done with that insanity.  And I doubt that the market crashes soon.  

The bipolar hedge monkeys rebalancing from net long to neutral or net long to net short or net short to net long is enough to, apparently, per bidermans estimates, cause monstrous swings in the market.

The low volume is becaue mutual funds don't have that much $$$ to work with as its still flowing out, and individuals are sidelined and playing with bond funds...

 

12 Comments – Post Your Own

#1) On March 15, 2010 at 7:52 PM, checklist34 (99.71) wrote:

Also, the recent turbulence in the markets creates a situation where people get scared easily.  Witness how 1 down day can send the VIX soaring and the bull/bear surveys rampaging into bear territory.

That fear and the loss of 2008 when everything was blowing up at the same time (except treasuries) will INCREASE momentum following behavior with quick stop-losses and INCREASE panicked flights to the exist when things turn south and INCREASE volatility.

The pain of shorting in 2009 will increase hesitation to do so in the future.

Volatility in markets, via this installation of fear, breeds more volatility in markets.  

We aren't done yet.  This secular bear has one more interesting chapter...

but, and here's a prediction..  we never go remotely even anywhere slightly clsoe even ballpark remotelyc lose to teh march 2009 lows again.  Our next cyclic crash takes us from somewhere higher than here to somewhere higher than July 2009 bottom.

1970's redux

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#2) On March 15, 2010 at 8:55 PM, jinchoice (99.69) wrote:

Very well done, sir.

Are you missing the thrill of their doom-mongering rhetorics as I am? Things are so much more boring now :)

 Good luck.

 

P.S. RJET - I told you so. Sorry, can't resist. 

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#3) On March 15, 2010 at 10:30 PM, checklist34 (99.71) wrote:

I'm holding RJET for now, I think it closed today 12% below my cost basis.  Whats really amazing (not in a good way) about RJET's behavior lately is this:

I bought RJET in earnest in August after they won the Frontier auction on grounds of valuation.  Price/sales would have been <0.1, price/book <0.4, price/earnings potential <3 and so forth.  

RJET then went on a gradual run from August to October where alot of the biggest holders, including David Einhorns Greenlight Capital - the biggest holders - added largely to their stakes.  So apparently they all agreed and...

Since around that time in August...  UAUA is up almost 200%, LCC  is up almost 150%, DAL is up about 90%, AMR is up 55%, LUV is up 45% and...

RJET is down slightly (down dramatically from its peak of up 80% a month or so later) and AAI is down 25%.  

So RJET seems to have moved up as existing large shareholders increased positions, and gone straight into the crapper since.  AAI and RJET completely missed the move in airlines...

Long the other guys, short these 2 is a theme in the market maybe?  Short interest in RJET has been increasing, and the dramatic pop over a couple days a week or 3 back looked like a short squeeze...

We'll see!  its 6% of my portfolio right now and was 8% at its high (it tanked and I added a bit a month or so ago), its not going broke, and its extremely frugally valued down here...

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#4) On March 15, 2010 at 11:59 PM, jinchoice (99.69) wrote:

k, maybe I should have looked at their finances before I said I told you so. I think you're right in that they are cheaply valued.

That said, I would still hesitate to add positions because I still don't think they have a great long-term (5+ years) future. I think UAUA and co shares increased a lot because they started off with much cheaper valuations to begin with.

I think there's 60%* chance that you're right and that the shares will soar. It's just not high enough for me. Good luck. 

* don't judge my record by my CAPS picks - CAPS is like my notepad, nothing more

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#5) On March 16, 2010 at 12:17 AM, starbucks4ever (97.95) wrote:

Peak: S&P 1400, through: S&P 1100, and then finally a 17-year secular bull to S&P 6000.

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#6) On March 16, 2010 at 12:57 AM, checklist34 (99.71) wrote:

zloj, that is about what I was thinking...

a scenario like this:

A)  valuations at the bottom (for 2010 earnings based on 2009 bottom) were about 8-9ish.  Based on trailing 12 months the p/e at the bottom was whatever it was, its pointless due to AIG, GM, F, insurance, mark to market, etc.

B)  we'll run considerably higher than today at some point and...

C)  the ultimate "end bottom", like 1981/1982 -vs- 1974 will be far higher than the ultimate "final bottom" (ala 1974) and...

D)  the next crash will happen during much better earnings and the mega-bears will get their p/e of 10ish.  

So crash to 1100 with earnings of $100 the next year some time in the future, probably a few years.  

And then, yes, a long and protracted bull market in which we see commodity prices NOT rising (this is one of the key components to historical bull markets, btw) and the S&P probably going up ... 

1942 to 1972 (30 years!  arguably this bull ended in the late 60's, still 25 years) saw the S&P rise not quite 10 times.  

!982 to 2000 bull (much shorter) saw the S&P rise almost 15 times, a much faster rate of return. 

The next bull is likely to be more conservative than the last one...  but nonetheless, S&P 6000 in 17 years would be reasonably conservative probably...

 

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#7) On March 16, 2010 at 1:02 AM, checklist34 (99.71) wrote:

jinchoice, I have outperformed my caps game picks in real life also.

RJET is/was cheaper than any of its airline peers I believe...  I think estimates have been rising for others and falling for RJET.

RJET is surounded in uncertainty...  the market hates uncertainty.

we'll see, ... I will say I can't easily think of an upside catalyst over the next several months

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#8) On March 16, 2010 at 2:38 AM, checklist34 (99.71) wrote:

estimating my return from the march bottoms, which isn't as simple as division...

Say I had $12.6 in october of 2008, $2.6 of which was witheld for taxes, meaning I had about 10 bucks

Say that at the march bottoms $2.6 of this was still witheld for taxes, so I had about $7.40 or about a 26% loss from my original $10.

But, say... $2.40 of that was at that timeinvested by professionals and not myself.  I sold that $2.40 for about $3 when the S&P was about 810.  I then slowly reinvested that $3 myself...

So filtering out all that BS, I had about $5 at the march bottoms.  The $3 that I reinvested has turned into about $7ish and I have about $38 dollars total.  I spent about 75 cents on some stuff over that time, so I'd have about $38.75

That $5 fromt he march bottoms is now about $30, or about a 500% return, 6x my money.

Largest positions at hte bottom:

1.  ASH

2.  XL

3.  ACAS

4. GNW

5.  Other BDCs (ARCC, ALD, MCGC)

6.  Other insurers and financials (HIG, LNC,BAC, WFC, USB, C)

7.  TCK

8.  short puts on GE.  I, perhaps mistakenly, still held GE in "absolute blue chip" status at hte time.  Worked out in the end. 

9.  Trash I sold out of and reinvested from april-july.  All in from July until jan 2010.

Not too bad.  Not too bad at all.  I wonder if I can hit 50-100% in 2010?

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#9) On March 16, 2010 at 2:44 AM, checklist34 (99.71) wrote:

up about 10% so far in 2010, not a promising start if my goal is big returns once again... 

and my best idea is low beta dividend aristocrats...  not alot of potential for 50% gains in share prices there...

hmmmmm....

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#10) On March 16, 2010 at 7:47 AM, JakilaTheHun (99.94) wrote:

I'd say outperforming the market by more than 10% on a normal year is pretty good, so not turning out a 100% gain this year is no biggie.  You've got to take what the market gives you to some extent. 

I didn't do quite as spectacularly as you did in '09, checklist, but still came out very well.  I only started investing in '08 and was still learning the ropes in late '08 and early '09, which I felt limited my gains, but I still had about a 100% return for the year. 

With the knowledge I have now, I probably would've been even more bullish on insurers (dipped my toes in on GNW, but it was one of my smaller positions).   Also, should've taken more risks, but due to my lack of experience, I used a more heavy diversification strategy (which I felt would help offset my gaps in knowledge).  I can't complain too much, though --- 100% is a nice return and I learned a hell of a lot.  

My portfolio really stalled from about September '09 to maybe January of this year, but it has taken off again in the past two months; I think I'm up about 30% for this year, but I'm heavily concentrated in REITs, small commercial banks, and energy/natural gas. Honestly, I'd be pretty happy to finish the year up 30% - 40% (assuming that the S&P is only up 10% - 20%).  My only major goal is to try to outperform the S&P by 10% every year. 

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#11) On March 16, 2010 at 1:28 PM, jinchoice (99.69) wrote:

Haha, I know your performance is better than mine checklist - no need to brag ;)

Going back to RJET, I think the airline industry has a few companies with great management - e.g. SouthWest, RyanAir, etc. I don't know RJET that well, but it sounds like you have confidence in their management and I'm inclined to believe you. But this advantage is nullified if their competitors also have great management. It also brings in to mind a Warren Buffett quote.

"When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact. "

That said, I believe you in that the stock is still probably cheap. Hope it works out for you. Good luck.

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#12) On March 16, 2010 at 3:55 PM, anchak (99.87) wrote:

Brilliantly written piece......I think we have a contender against FB now in CAPS!

That piece Tasty did on "Why you need to invest in asset bubbles" and this logic - pretty much sets the tone for investing paradigm.

With the hedgies involved - market will always have a way of figuring out the path of least resistance - because that's how the quick-profit maximization works.

 

 

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