Agora Financial’s Rude Awakening

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Laguna Beach, California

· Dow plummets another points –de-leveraging reignites,
· Credit crunch chic: Is recession really the new must-have fashion item?
· Four funds journey from the penthouse to the doghouse and more…

Eric Fry, reporting from Laguna Beach, California…

“The 1930s” is the new black…as terms like “economic depression,” “bank failure,” “government bailout” and “unprecedented financial crisis” accent the nation’s headlines like fashion accessories on a supermodel.

Do you like the new look?

No?…Me neither…but I’m trying to warm up to it. I’m afraid this edgy, new, brother-can-you-spare-a-dime look might be with us for a long while. Just last week, for example, the Dow Jones Industrial Average produced its best 5-day performance since 1932.

Oooo…VERY hip!

Then yesterday, this same financial fashionista plummeted 7.7% – the worst start to any month since 1932.

Très Chic!

But for those of us who care more about our cash than our caché, this new financial fashion holds very little appeal.

We are still fond of those out-dated bull market fashions that brought us Dow 14,000. We are still fond of those Greenspan-era terms like “savings glut,” “home equity wealth extraction,” “financial innovation” and “buy the dips.” We miss the asinine terms and Nobel Prize winning idiocy that inspired so many asinine and idiotic financial endeavors. Without this inspiration, we might not have ever enjoyed the long, delightful stroll toward Dow 14,000.

If only, we could turn back the clock – and then freeze the clock, and then spend all the money we made without ever unfreezing the clock again – we would long for a return that era of excess leverage.

But since the clock will neither turn back nor freeze, we must now face the nasty consequences of the new financial fashion, in which leverage is déclassé and de-leveraging is de rigeur.

Chris Mayer explains the newest financial “dos” and “don’ts” in today’s edition of the Rude Awakening

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De-Leveraging and You
By Chris Mayer

The stock market is certifiable. It is crazy. Extraordinarily large one-day moves have become utterly ordinary. Why has the stock market become so manic-depressive? The market’s fleeting episodes of manic behavior are not easy to explain, but its depressive behavior results from one very powerful influence: de-leveraging.

“De-leveraging,” which is just another way of saying, “forced selling,” is occurring in nearly every corner of the investor universe. Every type of leveraged investor – from banks to insurance companies to mutual funds to individuals to hedge funds – is attempting to sell assets they have purchased with borrowed funds and to repay their loans. This process shifts into panic mode when the prices of the assets they are attempting to sell are tumbling, as has been the case during the last few months.

As long as leveraged investors are under the gun to reduce their leverage by selling stocks, the stock market will have a very hard time rebounding. So that’s why I’m keeping a close eye on the activities of some of the largest leveraged players on Wall Street – the hedge funds.

The latest regulatory filings of some of the biggest hedge funds around show that many of these guys have been de-leveraging…big time!

These funds are unloading positions, not only to re-pay some of their borrowings, but also to return capital to investors who are asking for their money back – i.e., “redeeming.” When an investor in a hedge fund wants his money back, and the hedge fund manager doesn’t have the cash on hand to meet the redemption, the manager must go out and sell stock to raise the money. It doesn’t matter if the manager loves the stocks he owns or if he thinks he’s holding a bunch of 50-cent dollars, he must get rid of something.

This holds true for mutual funds, too. I’ve been reading the letters of various fund managers, and most face heavy redemptions. Quite simply, investors are yanking their money out of all funds – both mutual funds and hedge funds.

The financial press is already onto this story. But most papers report on this phenomenon very casually, without ever touching on the magnitude of the forced selling. The details might shock you!

Money managers who manage over $100 million must file a quarterly 13-F with the SEC. (I talk about this in my book, Invest Like a Dealmaker, because trolling through these filings can provide a good source of ideas. You can see what some of the best investors are putting in their portfolios and build a nice watch list of your own to research further). Importantly, the 13-F shows only invested assets. So, if the fund manager made the decision to go to all cash, then his 13-F would show zero assets. Also, managers don’t have to disclose some positions, such as stocks they are short.

In any event, the numbers coming in so far are just mind-blowing. Some of the big hedge funds have dramatically reduced their invested assets. Consider these examples from 1440 Wall St.:

• Tudor Investment Group had $5.7 billion invested at June 30 as disclosed in its 13-F. Its September 30 filing shows only $453 million.
• Atticus Capital, another much-celebrated hedge fund, went from $8.1 billion to $510 million.
• SAC Capital, run by the Steven Cohen, went from $14.4 billion to $7.7 billion.
• Vinik Asset Management, led by Jeffrey Vinik, who once ran Fidelity Magellan, went from $11.8 billion to $1.8 billion!

Remember, these numbers are as of September 30. So they do not include the awful months of October or November. We can assume, therefore, that the current assets at these funds would be even lower now. The reduction is a combination of selling positions and a decline in market value of existing positions.

It’s still breathtaking to see those kinds of declines in big pools of money. Now multiply that out over hundreds of funds and you can see what’s happening here. There is just a giant liquidation going on. In my own rummaging around the 13-Fs of my favorite investors, I’m also shocked by how their funds have all shrunk. Those examples above are not atypical.

I suppose that should make us feel better. In other words, the prices that we are seeing on many of the stocks we own do not reflect calm, rational reasoning about their value. Instead, the prices reflect the panicky, irrational forced selling of funds that must repay either their lenders or their investors…or both at the same time.

Still, the intraday swings on stocks are incredible – and painful – to behold. I watched Seaboard (SEB:amex), a rather staid business of old-world business like pork processing and shipping, move as high as $1,125 per share and as low as $875 per share in a single day. That’s a 250-point move, or 28% from the bottom. That kind of movement is not unusual of late. But it reinforces the idea that such moves don’t reflect business values. Nothing happened on that one day to warrant such sweeping hourly reassessments. There was no earnings report, no announcement from the company, nothing.

As I write, the markets are down big again today. Getting through this year could be rough on the stocks I’ve been recommending to the subscribers of my investment letter, Capital & Crisis. But as the massive wave of forced selling ends, a trickle of opportunistic buying is sure to begin.

I don’t like to guess about the market, but what the heck: My guess is we don’t see much relief until some of the money comes back into the markets after the New Year. (We’ve got tax-loss selling in the mix, too, don’t forget.) I don’t think investors are going to be happy holding cash or T-bills for long, especially when some of the valuations and yields in the market look so compelling. The markets swing between greed and fear. The pendulum is still on the fear side, but it won’t be there forever.

Joel’s Note: The legendary investors did not amass their fortunes by following the crowd. They did not buy when everyone was optimistic or sell when everyone else was jumping out the window. They were greedy when the pendulum was on the fear side, and cautious when others were overdoing it. They carefully passed a fine-toothed comb of due diligence through the carnage of post-apocalyptic markets and loaded up on bargain companies.

Now, as stocks become cheaper and cheaper (by the day, in many cases) Chris Mayer recommends for pennies on the dollar the best ones he finds. As fear strikes the hearts of investors everywhere, it might be a good time to start nibbling on a few well-researched companies yourself. As a value investor, Chris has plenty such names in his Mayer’s Special Situations portfolio, which you can access here.

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[Rude Endnote: Asian indexes mirrored yesterday’s U.S. market decline overnight with Hong Kong’s hang Seng and Japan’s Nikkei 225 dipping 5% and 6.35% respectively. The Aussie markets too continued their relentless selloff, finishing down the session another 4%.

Thus far, European markets are faring somewhat better with London’s FTSE holding up just under 1.5%. France’s CAC is up 1.4% and Germany’s DAX surged 2.4% as we write to you this morning.

Much to the chagrin of our Middle East neighbors, oil dipped back under $50 per barrel, despite OPEC’s meeting of the minds last week to try establish a floor under the $75 mark. Gold too was hit hard yesterday, down almost $50 for the day before rebounding about $10 this morning.

And that’s it from us today. See you again tomorrow.

Until then…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com