When The Scamps Get Together
FREE email from MoneyWeek
Discover the latest profit opportunities and understand what’s really going on in the investment world with our punchy daily email. CLICK HERE
This genius investor does dizzying levels of research to uncover...Half Price Shares!
They may not be able to spell it, but they sure display it. The financial press is bursting with Schadenfreude at the current malaise in hedgefundland. The Wall Street Journal goes with "Hedge funds stumble even when walking" while the FT's coverage is more nuanced ("Hedge fund rush to offload assets buffets markets"). A mention in dispatches, by the way, to The Independent, whose front cover abandons any sense of dispassionate analysis with regard to the apparent UK slowdown. Did anyone say reflexivity?
When the history of our extraordinary times comes to be written, the rot will be deemed to have set in during early May, which is when the corporate bond market revealed that it wasn't wearing any clothes. The two biggest corporate events to hit credit markets this year, and which are likely to mark an inflection point in the entire credit cycle, occurred on the fourth and fifth of the month. On Wednesday 4 May, billionaire investor Kirk Kerkorian bid to raise his shareholding in General Motors to 9%. This triggered a wave of follow-my-leader purchases and a vicious, though perhaps wholly temporary short squeeze in GM equity. On Thursday 5 May, ratings agency Standard & Poor's downgraded General Motors' credit rating to junk. The downgrade was barely a surprise - the competitive challenge and the healthcare and pensioner cost load facing Ford and General Motors has been a matter of public debate all year - but came sooner than market expectations, triggering a fall of 10% or so in the value of longer-dated GM debt.
There is no particular reason why the broader equity markets should have been much affected by the Kerkorian 'bid' and indeed they haven't been: US, UK and European equity indices have moved by around one percent in the subsequent period, and during that time have had to adjust to deteriorating economic newsflow, particularly in the UK. But the S&P downgrade of General Motors has had a more insidious effect on credit markets: US Treasury yields have fallen in what is laughably called a 'flight to quality' (S&P estimate of US sovereign borrowing this year: $800 billion, so no danger of a scarcity premium there), while corporate spreads have blown out amid a general crisis of confidence in the sector. In this respect at least, current bond market conditions are indeed reminiscent of those in the aftermath of LTCM and the Russian default in 1998. Bloomberg's Hamish Risk reports that the cost of insuring against investment grade bond default has risen for six days out of seven. Merrill Lynch has cut estimates on Deutsche Bank's adjusted earnings per share by 4% on the back of the rise in default-swap prices; Citigroup last week suggested that losses for hedge funds and banks could be more substantial still. Any entities on the wrong side of 'the credit trade' have been hit by a sudden slap of volatility, the impact of which has been reinforced by panic selling surrounding what in some cases are the vaguest presumptions about hedge fund exposures to the credit market.
The opaqueness of the hedge fund world is hardly helpful in the cause of an objective assessment of likely market damage, but to an extent knowledge is redundant. In a sign of what happens when 100 elephants try to stampede in short order through a mousehole, bad money will drive out good, both horrible and profitable positions will be liquidated to fund anticipated redemptions, and within a couple of months we'll know who's been swimming with no trucks on. Some will inevitably know before us. One wonders whether what Uma Thurman says in 'Pulp Fiction' might be relevant to traders in the prime brokerage world: when you scamps get together, you're worse than a sewing circle. In a fragile market driven by rumour, the prospect of information leakage from prime brokers, purely internally as much as externally, raises some intriguing ethical questions. Loose lips sink ships, as they used to say. When real money and perhaps even corporate solvency is on the line, one wonders just how robust Chinese walls are likely to remain.
(Article continues below)Advertisement
A world awash with liquidity evidently creates perverse valuations given perverse incentives to buy. As one credit specialist suggested to us yesterday, government bond markets aren't necessarily 'wrong', but trying to rationalise yields at current levels requires some pretty heroic assumptions about bond market returns (or the paucity of economic conditions) for the future. Oh, and before conventional fund managers and the next misguided captains of industry launch the second wave of their popular tirade against hedge fund managers, they can perhaps declare to what extent they're invested in their own vehicles - shared ownership being a powerful inducement to concentrate on capital preservation at least as much as on absolute return.
So far, an obviously and spectacularly overvalued asset class - dodgy debt - has been astonishingly revealed as imperfect, along with the risk management of those who've elected to pile into it on a 'hedged' basis. As our credit specialist friend suggests, the next step in this global dismantling of lazy investment assumptions will be when government bonds lose their shine too - which would leave only cash (and precious metals) as a legitimate safe haven. Until that happens - and we all know the Keynesian line about irrational markets and solvency - given the dramatic turnaround in the domestic interest rate outlook, shares in UK banks and insurers might expect to enjoy a re-rating upwards. Those not unduly exposed to hedge funds, that is.
Tim PricSenior Investment StrategisAnsbacher & Co Ltd.
FREE! For all our latest advice on making profitable investments, claim your 3-week FREE trial of the MoneyWeek website and magazine now.
Money Morning is the FREE daily email from MoneyWeek
– a punchy round-up of the latest investment news and profit opportunities.
DON’T MISS IT!
