One of my favorite lines is “I’m not the kind of guy to say I told you so – but if I was, I’d sure be saying it now.”
As far as saying “I told you so,” back in the summer of 2008, in my “Friday Night Illumination” emails to my banker and trader friends, I screamed, “SELL EVERYTHING!”
People thought I was nuts. Literally, that I’d lost my mind. Sell everything – no one ever says that, ever.
But I said it, over and over. SELL EVERYTHING! It was an insanely bold call. At least that’s what everyone said to me after the fact.
It wasn’t a bold call. It was telegraphed. And I wasn’t the only one who read it right.
Now for the really bad news. It’s going to happen again. The time to sell everything is approaching. It’s not here yet.
And we’re not inching forward. Nor are we dashing.
Today I’m going to show you how it will not only be different – but also a lot worse…
That’s because the rescuing armies this time – the U.S. Federal Reserve and the globe’s other central banks – are the ones going under. If that happens, we’re going to have a global depression of biblical proportions.
There is time to stop it. However, those central banks are stoking the locomotive’s furnace to the tune of “Old Charlie stole the handle, and the train, it won’t slow down.”
The crash is coming because central banks’ engineered low-to-no interest-rate policies grossly distort free markets. That makes true price discovery impossible, and front-running, financed by flimsy carry trades, has become a perpetual-motion trade.
If you don’t get that, don’t worry – you’re not alone. The central banks don’t get it, but they’re starting to. It’s not complicated at all. It is what it is. It’s about casino capitalism.
Here’s the game that’s being played, plain and simple. And here’s how it’s going to end.
Central banks artificially lowered interest rates, which causes market distortions, which leads banks and households to leverage themselves up, up and away. When the housing market and mortgage securities imploded, the pain spread around the world.
But the pain wasn’t all about mortgages.
It was all about “credit” in the system and how easy credit, courtesy of low interest rates, facilitated cheap financing of real estate and heavily margined and leveraged securities positions. Easy credit also aided and abetted counterparties wagering trillions of dollars on bilateral derivatives contracts that they folded up and tossed about like paper airplanes.
Confidence in the system collapsed when credit evaporated and players crapped out.
The credit crisis was a global phenomenon. That’s because credit stems from banks. Banks everywhere were in trouble. By trouble, I mean insolvent. Central banks had to rescue them.
That’s where “stimulus” came in. Zero interest rates don’t matter if you’re a bank with zero money to lend. So what if you can borrow from the Fed at zero interest? If there’s no one borrowing from you and you can’t make money by lending, you’re toast.
That’s where quantitative easing came in. QE was a desperate measure. Plain and simple, if you’re a central bank and your banks don’t have any money and you work for them, you find a way to give them money so they don’t have to close down for good.
The Fed and other central banks (using different names, though the European CentralBank just went ahead and called its latest $1 trillion giveaway QE) printed money and steered it directly onto banks’ balance sheets so they wouldn’t be insolvent.
Stay with me here, because this is the part that will blow your mind if you don’t know it.
This Year’s Front-Runners
The Fed and the world’s other central policymakers manage this balance-sheet bloating trick by buying bonds from banks. But there’s no difference inside the bank if they have bonds (which are worth something) on their balance sheets that they sell for cash. It’s just a switch. There’s no addition to the balance sheet.
What really happens is that banks (I’m talking about big banks, the too-big-to-fail banks that all failed in the credit crisis) buy government bonds from governments that always have to roll over their debts. Sure, they pay full price for the bonds, but they don’t put up the full amount. They buy them on margin.
It’s done with clicks on electronic ledgers, so don’t sweat the mechanics. Anyway, central banks then buy those bonds from the banks and pay in full (credit them in full on another electronic ledger). And presto!
The Fed stuffed its big banks with more than $4 trillion. That’s enough to make them not only solvent but very profitable again. And the folks in the government? They love it because they don’t have to worry about selling their debt. They’ve got a readymade syndicate to take all they have to offer – at very low rates mind you!
Bank balance-sheet bloating has been going on around the world.
And, as if not a single lesson was learned from the last credit crisis, speculators have leveraged up their “risk-on” positions because they can finance them for next to nothing.
Almost all of the big bets being made, in the tens of trillions of dollars, are front-running bets. Front-running central banks, that is.
Take any example you like, the front-running trade works the same everywhere.
Let’s take Europe, because it’s the latest example of massive front-running.
Hedge funds, institutional traders, mutual funds and banks all bought the sovereign debts of beleaguered European Union member countries back in 2012. They were all paying big interest-rate spreads over better quality bonds, like U.S. Treasuries.
But when ECB President Mario Draghi famously said, “Whatever it takes,” (to support the euro, the EU and its banks), the front-running began.
Buyers paid higher and higher prices for government bonds, driving their yields down. As of this morning, the 10-year yield on German Bunds is 0.34%; 0.57% for French bonds; 1.46% for Spanish ones; and 1.62% in Italy. And the Swiss 10-year yield is negative 0.08%.
Why so low? Because, just like in the United States, bond buyers (speculators) knew the central bank would have to come and buy their inventory from them. The ECB just announced a 1 trillion euro QE program. So, the speculators who drove up bond prices and drove down yields to insanely low levels will make a fortune selling their stockpiled government bonds to the ECB at the bloated prices they drove them up to.
But, Houston, we have a problem.
Ghosts in the System
Somewhere, probably in Europe, maybe in Japan, maybe in Russia, banks are going to fail, probably because they loaned too much money to beleaguered oil and gas companies. Or worse, a European crisis could erupt from a Greek implosion and contagion – and then what?
After everything central banks have done to save the credit system, in the end they leveraged it up even higher with even lower interest rates.
A break anywhere in the credit system could cause contagion. If the central banks have done all they could do and are themselves leveraged well beyond being insolvent (none of them have real capital – they’re all ghost lenders), confidence in the system will evaporate.
That’s when it will be time to sell everything.
It could happen. It’s going to happen.
Only by immediately addressing the structural problems facing indebted countries and still shaky banks can we veer off in another direction. But the likelihood of that happening is precisely between slim and none.
Pssst! Do you want to make some money trading some initials? Real easy money?
For real. I just made my subscribers 382% trading these initials. And we’re not done. After closing out our 382% gain, we’re in the same trade again, and we’re up 180% in just a few weeks – and still going.
We’re also in a conservative trade, trading the same initials mind you, and we’re up 41% there.
The initials are EUO. EUO is an ETF (exchange-traded fund).
As soon as you read this “ECB and EU LTRO and QE for Dummies” explanation, which would take even a dummy about two minutes to read and understand, I’ll share both of these trades.
Then, you’ll be making some real money…
The World’s Biggest Economic Experiment
The ECB is the European Central Bank. It’s Europe’s central bank, just like the U.S. Federal Reserve is the central bank of the United States.
The EU is the European Union. The EU is a confederation of 28 European countries, a sort of wannabe United States of Europe. Of the 28 countries in the EU, 19 of them exchanged their sovereign currencies for the euro, the EU’s single currency. The other nine EU member countries, though they gladly accept euros, kept their old currencies.
After the credit crisis of 2008 and the Great Recession, which devastated Europe as much as the United States, the EU and the ECB followed the U.S. government and Fed’s “stimulus” plan and worked to drive interest rates down.
The ECB embarked on an LTRO program, longer-term refinancing operations. But its “stimulus” program wasn’t nearly as big as what the Fed did in the United States.
While the Fed spent about $4 trillion buying U.S. Treasuries and agency mortgage-backed securities (“agency” means that those mortgage-backed securities are guaranteed by some federal agency, like Fannie Mae or Freddie Mac), the ECB spent less than half that amount on asset-backed securities and covered bonds from European banks.
The Fed’s stimulus programs, which happened in three stages – the first in November 2008, the second in 2010 and the third in 2012 – became known as QE1, QE2 and QE3. QE stands for quantitative easing.
When the Fed drove down interest rates to essentially zero in 2008, and growth in the economy wasn’t stimulated, it began the experiment we now know as QE.
Quantitative easing simply means the central bank has driven interest rates as low as it can and the central bank is out of old-fashioned ammo. So, to try and get banks to lend more to stimulate consumption and production, the central bank buys assets from banks. By buying assets that banks are sitting on – meaning U.S Treasuries the banks stockpile and mortgage-backed securities the banks invested in (to earn interest) – the trillions of dollars the Fed pays banks to buy their inventoried bonds is supposed to make the banks flush with cash that they supposedly will lend out, stimulating consumption and growth.
At least that’s the idea.
The jury is still out here in the United States as to whether QE was just a boon to the big banks who benefited by it, whether or not it artificially pumped up “risk assets” like stocks, or whether or not it exacerbated income inequality and wealth disparity by enriching those who benefited by owning stocks and real estate “risk assets” while middle-income incomes stagnated and the ranks of the poor grew.
Nonetheless, the U.S. economy is growing while Europe faces its third recession since 2008. U.S. banks are in better shape than their European counterparts. And in spite of everyone’s deficits and government debts increasing, the United States is managing to slow the rate of its debt growth while European nations are piling on more and more debt.
Viewing all that, the ECB, in consultation with its oversight body, the European Commission, decided today to embark on its own version of quantitative easing.
Quantitative easing in Europe is vastly different from the ECB’s former LTRO programs. QE means for the first time the ECB isn’t just going to buy asset-backed securities and covered bonds (essentially those are packaged corporate loans and bank loans) – the ECB is going to buy government debt obligations from member nations in the EU.
Make These Trades
Okay, here’s how to make money on Europe’s new QE experiment.
To grow its way out of recession, Europe has to export more goods and services. To make its exports cheaper to buy, Europe has to devalue its currency. The ECB is printing money to buy member nations’ government bonds, and asset-backed securities (ABS) create more money in the system. More money in the system is supposed to devalue the euro.
In other words, the ECB is doing QE to devalue the euro.
On the other side of it all, whether or not this experiment creates growth, remains the fact that if it doesn’t work, if the ECB can’t create inflation (which it won’t be able to do) and growth, and faith in the European Union experiment itself comes into question, the euro could be doomed.
In my trading services, Capital Wave Forecast and Short-Side Fortunes (shameless plug, YES!), we’ve been betting, correctly, that the euro will fall against the U.S. dollar.
We’ve been doing that by betting on EUO. EUO is the ProShares UltraShort Euro (NYSE ARCA: EUO), a leveraged ETF that goes up in price if the euro falls in value relative to the U.S. dollar. And it has been falling.
We bought EUO some time ago at an average price of $17.165. It’s now up to $24.25 (it might be higher or lower by the time you read this), so we’re up 41.275% on that trade.
We also bought May $26 call options on EUO. We paid 25 cents for them. They’re now trading at about 70 cents, so we’re up about 180% and counting.
We previously bought January 2015 $21 calls on EUO last year for 28 cents and sold them before expiration for $1.35. So we made a tidy 382% there.
I’m betting that the ECB’s QE will be a bust one way or another for the euro.
I hope you make these trades – and I hope you also make a HALOM…a helluva a lot of money.
Editor’s Note: Shah’s subscribers have a lot more gains like this coming their way. In fact, he’s just uncovered one of the biggest capital waves in history – and it’s hitting soon. Shah has put together a full breakdown for you on how to take advantage of it, and he’ll be sending that report out next week. Watch for it.
Netflix Inc. (Nasdaq: NFLX) shares soared nearly 18% yesterday on an earnings boost. The streaming media service handily beat Wall Street‘s per-share earnings estimate of 44 cents, posting an EPS of 72 cents.
But investors tempted to buy Netflix stock need to be cautious. On Fox Businessyesterday, Shah warned viewers to watch Netflix’s volatility.
To see whether Shah likes Netflix right now, check out his TV appearance below.
No one wants a broken toy. Shah talked with Stuart Varney on Fox Business about just how low some major market darlings are about to plummet – Tesla Motors Inc. (Nasdaq: TSLA), Amazon.com, Inc. (Nasdaq: AMZN), Google Inc. (Nasdaq: GOOG) and Netflix Inc. (Nasdaq: NFLX) among them.
And that’s not all. We should expect a rocky first quarter ahead, Shah says, no matter what stocks we may hold.
In a brand-new conversation with Money Map Press Executive Editor Bill Patalon, Shah made the case for a New Year rally in stocks – and a rebound in crude that could turn Big Oil into a true “Black Gold.”
Remember when banks used to make it worth your while to deposit cash with them?
Heck, if you’re old enough you probably even remember such inducements as free toasters.
But in a reprehensible turn of events, now you – the depositor – are about to get toasted.
Thanks to U.S. Federal Reserve policies that are holding market rates down near zero, you’re getting just a few basis points in interest (a basis point is one one-hundredth of a percentage point) on your cash deposits – and haven’t been for several years.
It’s bad enough that you’re getting practically no yield on your savings. But now the big banks – those greedy fellows that we taxpayers bailed out from a crisis that they actually caused – are about to start charging you to deposit money with them.
I’m not kidding.
There’s so much money floating around that the biggest banks that are sitting on the most of it and can’t – or refuse to – lend it out for any number of selfish reasons, now don’t want it stuffing their vaults.
So big depositors – who already weren’t earning anything on the savings they’ve asked big banks to hold and safeguard for them – will soon have to pay a fee for that questionable privilege.
There’s a litany of disturbing elements to this tale. But the most galling is this: It won’t be long before you and I are receiving notices of this unseemly new Big Bank tariff.
Welcome to the Brave New World ofCentral Bank Tyranny!
Sycophant central bankers here in the U.S. and over in Europe (and everywhere else, for that matter) have artificially manipulated interest rates down to nothing. That makes it possible for their masters – the big banks – to rack up record profits: They borrow from each other at one basis point and then go out and buy massive quantities of higher-yielding government bonds, cashing in on the “spread.” The United States, European countries, Japan, China and everyone else is happy, since they can keep running huge deficits.
In that equation, the banks don’t need to make loans to us.
Still, we need a place to park our money.
But now the big banks are saying that they have too much cash and can’t lend it fast enough. Of course, what they’re not saying is that they don’t want to lend it out to us at current low rates because, when rates rise, those loans will be “under water.”
The banks are fat and happy making so much on their risk-free government loans (that’s what them buying government bonds is all about; those bonds are nothing but cheap loans to profligate governments) that the extra money they have on deposit is starting to cost them profitability.
Yeah, you heard that right.
Here’s where it gets a tad technical.
Deposits are “liabilities” for banks. That’s because that depositor cash can be withdrawn at any moment. Loans are “assets” because banks are getting paid interest on them. When big banks’ deposit liabilities get too big they become a problem because they have to keep “reserves” against those deposits. Banks, especially with new banking laws and regulations, have to hold certain “assets” (usually U.S. Treasury bills, notes and bonds) in reserve against all those deposits that could leave in a flash if there is any kind of banking panic.
Big banks don’t have enough U.S. Treasuries to hold against deposits as reserves and at the same time use their stash of Treasuries to lend out overnight to other banks as collateral for overnight loans of more cash, so they can use that cash to buy – you guessed it – more risk-free Treasuries.
And why are there not enough Treasuries in the almost-$14 trillion world of U.S. Treasury securities? That would be because the Federal Reserve has been buying trillions of dollars’ worth of them from the big banks that have been buying them up to sell to the Fed, for a nice profit, thank you. And other central banks around the world have been buying Treasuries, too, for different reasons, but all good ones for them.
So the big banks got what they needed, to get bailed out. And they got what they wanted, to make record profits – yet again. And we all get hosed because the big banks aren’t lending to little people.
And soon enough now, we’ll have to pay them out of our own pockets to hold our money so we can write checks against our deposits and conduct normal banking transactions.
It’s Central Bank Tyranny. It’s the tail wagging the dog. The whole world has become one giant banana republic – with central bankers acting as militant officers enforcing the profitability schemes of the oligarchy of bankers that are the real dictators of our future.
If yours wasn’t happy, just think – it could have been a lot worse. You could have been the turkey and gotten slaughtered, like the turkey in this tale I’m about to tell you.
It’s a tale of two birds of a feather, one a greedy, fat butterball stuffed with gibberish and ripped-off profits.
And then there’s the other bird. It’s not just easy pickins for the butterball investment banker that stuffed it royally, but itself a turkey of international renown.
Keep reading, and find out why we may soon get to see the insides of one of the crookedest birds around…
The two turkeys are Goldman Sachs Group Inc. (NYSE: GS) and the Libyan Investment Authority (LIA), the nation of Libya‘s sovereign wealth fund.
Back in Big Mo‘s day, in early 2008, the Libyan Investment Authority (“Big” Muammar Gaddafi‘s piggybank) put on some complex derivatives trades that Goldman Sachs allegedly talked it into.
Not that Goldman is known for its honesty. After all, it helped Greece lie and cheat its way into the European Union by masking that Mediterranean nation’s budget deficit with currency swaps and dubious derivatives dealings.
Nonetheless, Big Mo’s money machine trusted the golden fleecers.
Folks say, “It takes one to know one,” so we should be able to assume these two knew whom they were dealing with.
But apparently not.
Here’s what happened, according to statements, filings, documents and evidence being bandied about in the U.K. High Court of Justice, where the Libyan Investment Authority is suing Goldman Sachs.
Goldman took advantage of the LIA’s “inexperience” and “naiveté” and slam-dunked them like LeBron James taking it to Danny Devito.
Big Mo’s men say that between January and April 2008, Goldman’s boys sold them nine derivatives trades worth $1.2 billion. After the credit crisis crash, the trades were worth all of nothing.
Goldman, on the other hand, for its handiwork, pocketed $350 million.
The LIA’s suit alleges that the trades were unsuitable, that Goldman’s profits were “unusually high for financial derivative transactions involving a substantial international bank,” and that the premiums the LIA paid were “substantially overvalued.”
The trial gets underway in 2015. Right now, the two sides are jockeying in the High Court.
Now we’re going to get to find out what Goldman’s 13-man Libyan banking team and another nine Goldman executives, including Michael Sherwood, co-chief executive of Goldman Sachs International, said in e-mails. We’ll learn what advantages Goldman had over the LIA in talking the authority into trades and how Goldman planned on harvesting flowers from the Libyan desert.
What’s going to be even more interesting is learning to what extent Goldman overcharges and tees-up customers on opaque derivatives trades.
In your post-Thanksgiving hangover, you may grumble as your tummy rumbles, “Who cares?” After all Goldman and Libya are two giant turkeys who deserve to slaughter each other.
I care, and you should, too. If for no other reason, it’s good theater.
One of them got plucked, for sure. I’m hoping the other one – the bigger, fatter, more crooked critter – gets its wings clipped, too.
Talk about putting your foot in your mouth. This would be funny if it wasn’t sickening.
During congressional questioning on Friday, Sen. Elizabeth Warren (D. Mass.) commented that the U.S. Federal Reserve‘s job is like that of “a cop on the beat.”
And that’s when New York Fed President William Dudley inserted a foot in his big mouth.
He responded, “I don’t think our primary purpose as supervisors is a cop on the beat, it’s more like a fire warden; make sure that the institution is well run so that, you know, it’s not going to catch on fire and burn down. And managed in a way that if the institution is stressed that it doesn’t collapse and threaten the rest of the financial system.”
In other words, there’s no “policing” going on.
Dudley said it – not me.
But today I’ll share with you what I do have to say – and I’ll show how the close relations between Wall Street and Washington could lead to yet another financial conflagration…
Too Close for Comfort
According to Dudley, then, the Fed’s job – its reason for existence – is to protect banks from burning themselves down when their greedy schemes ignite depositors’ ample piles of kindling.
The New York Fed president was testifying before the Senate Banking Committee’s Subcommittee on Financial Institutionsand Consumer Protection on the subject of the Fed being too close to the banks it’s supposed to police.
Now we know why banks and the Fed are so close. When the banks’ crack pipes break from excessive heat, the Fed is there with liquidity beer bongs to dampen their highs so they don’t OD and send the whole economy on a bad trip.
And here’s even more evidence that lawmakers failed to jam the revolving door between the big banks and their so-called regulatory agencies following the 2007-’08 financial crisis: Dudley is the former chief economist of Goldman Sachs Group Inc. (NYSE: GS).
And after that statement, he wasn’t done.
Dudley stuck another foot in his mouth by explaining why the Fed is not the cops.
“Our main goal is to ensure the safety and soundness of the institutions that we supervise,” he told Sen. Warren. “If in the process of doing that we see behavior that we think is illegal, then our job is to refer it to the enforcement agencies.”
A stunned and angry Sen. Warren replied, “But you don’t think you should be doing any investigation? You should wait to see if it jumps in front of you?”
Yep, that’s what the Fed’s job is. It’s not an arson investigator or fire inspector, just a fire department putting out pesky conflagrations by pumping more flammable liquids into their basements.
How else are banks going to survive and thrive?
When it comes to foot and mouth disease, the Fed is Patient 1.
There’s a lot of action over in the subprime auto sector, and it’s not pretty
The saying is “Where there’s smoke, there’s fire.” So, it’s probably just a matter of time before the mainstream media and the general public catch on and see the flames being vigorously fanned by greedy lenders.
It’s the same old story – and one I’ve recounted here before.
Lenders are making subprime auto loans to low-income (and no-income) borrowers, most of whom are down on their luck. And the lenders are teeing those folks up to hit them out of the park again.
The name of the game is yield. That’s what it’s been since the U.S. Federal Reserve started manipulating interest rates further and further down.
Yield-hungry investors want more income. Fee-hungry bankers want to deliver it to them. And car-hungry buyers are getting suckered.
A lot of the country’s current economic “optimism” is predicated on surging auto sales. So, maybe the state of the economy isn’t as rosy as the president, Congress and the media would like us to believe.
And today I’ll show you why…
Bottom Feeding for Borrowers
Auto lenders fan out to dealers, especially to used-car dealers, where low-income borrowers are more likely to shop. The lenders tell the dealers to sell cars, and they’ll make loans so borrowers can drive off in that shiny used clunker.
However, the lenders don’t want customers with good credit to borrow to buy. They want to lend to struggling people whose credit is so bad that they know they’re going to get hit with a lot of interest.
And these borrowers, no matter how “subprime” their situation, can get loans.
You see, the worse their credit, the higher the interest rate. Because the car might be older, they’re going to want a warranty and some other must-have services and “upgrades” to make sure the car is going to get them where they want to go. And for too many of those folks, that’s the unemployment office.
But what if the borrowers don’t pay? No matter – lenders “protect” these cars as collateral and can pick them up wherever they are turned off and left on the side of the road because of the neat shut-off devices dealers are installing.
That, however, is another story.
What am I worried about? I’m looking at the smoke and figure the flames are coming.
If you haven’t seen the smoke, here’s where it’s coming from:
The U.S. Justice Department has subpoenaed GM Financial (NYSE: GM) and Santander Consumer USA Holdings Inc. (NYSE: SC) over their subprime auto underwriting and securitization practices.
The U.S. Securities and Exchange Commission (SEC) is looking into Ally Financial Inc.’s subprime auto lending practices.
The New York State Department of Financial Services is suing Condor CapitalManagement, a subprime auto lender accused of stealing from its customers.
The New York County District Attorney’s Office recently subpoenaed Capital One Financial Corp. (NYSE: COF) regarding its subprime auto-lending business.
The New York City Department of Consumer Affairs said on Friday it’s investigating used-car dealers’ tactics for getting low-income borrowers to take out more expensive loans with hidden fees.
The federal Office of the Comptroller of the Currency’s deputy comptroller for supervision risk management said in a speech on Oct. 28 that he’s concerned about borrowers’ equity in their cars relative to the amount borrowed and the actual resale value of the cars.
And the federal Consumer Financial Protection Bureau is on the case, too. It’s opening more investigations after extracting $98 million from Ally Financial last year, having charged the lender with jacking up interest rates and fees to African American subprime auto borrowers.
That’s a lot of smoke.
What’s sad in all this is that sophisticated lenders and auto dealers are using these poor folks in order to soak them and then repossess their cars. And then they’re doing it again and again to as many down-on-their-luck borrowers as they can wave into their showrooms and onto their lots.
Do you still think auto loans are just the minor leagues compared to the mortgage game that home lenders played not long ago?
U.S. stocks have been making new highs in recent days. And I believe we’re looking at strong odds for a market rally that lasts to the end of the year.
There are lots of reasons why stocks are headed higher, but one in particular is both surprising and telling.
It’s also a difference maker.
You see, if you understand what that “catalyst” is, you can pick some winners yourself.
And today we’re going to look at it together…
The Bonus Round
The financial markets – stocks, bonds, derivatives and currencies, for instance – can be quite complex.
But the catalyst that’s likely to drive U.S. stocks higher between now and New Year’s Day is surprisingly simple.
You see, if the players on Wall Street are going to earn their fat year-end bonuses – and, in some cases, actually keep their jobs – the Dow, the S&P 500 and the Nasdaq need a good rally during the final weeks of 2014.
Here’s why the institutional players are feeling such urgency.
In spite of markets making new highs repeatedly this year, it hasn’t been a smooth ride.
The bumps throughout the year, especially the mid-October swoon, kept money managers on edge and too often took them to the sidelines and out of the action. Worse, a lot of hedge funds were betting against the rising tide of stocks and shorting U.S. government bonds.
2014 started out well enough, but an ugly 5% dip in late January scared stock players into believing that the long-in-the-tooth rally was nearing a possible end.
That didn’t happen.
Stocks rallied back and higher, though not without a few minor bumps here and there.
Then at the end of July, after the S&P 500 poked its head above 2,000, we got another quick 5% pullback. Once again, there was talk of the rally getting tired and petering out.
That didn’t happen.
By late September, stocks made new highs, closing nicely above 2000. Then, seemingly out of nowhere in mid-October, stocks tanked about 8.75% in what seemed like the blink of an eye.
That’s when a lot of managers threw in the towel.
Most mutual fund managers sold winners and raised cash, while at the same time aggressive hedge funds shorted momentum stocks and tried to push the market lower.
Unfortunately, hedge funds got a double whammy in the mid-October selloff.
The mini U.S. stock market panic caused the usual “flight-to-quality” run into U.S. government bonds. The U.S. 10-year yield dropped from about 2.25% down to 1.85% with stunning speed.
The mini-panic had resulted from a sell-off in European stocks when weak European sovereign peripheral countries saw interest rates unexpectedly rise on their government bonds,
The problem for hedge funds was that they were short U.S. government bonds, believing that the coming end of quantitative easing would cause rates to rise. Bond prices fall when yields rise.
However, the flight-to-quality run into U.S. bonds caused bond prices to rise to near record highs – not fall. Hedge funds that were short government bonds got killed when prices went through the roof.
Then, even more quickly than it fell, the stock market bounced to new highs yet again. And just as quickly as bond prices rallied, they fell back to where they were before the stock-market sell-off.
Net, net, mutual fund managers and long-only money managers (“long-only” means they don’t short stocks) sold stocks, raised cash and went to the sidelines. Hedge funds had little choice but to lick their wounds and scratch their heads.
When the picture in Europe all of a sudden looked brighter, thanks to calming pronouncements from the European Central Bank, U.S. stocks rallied back with a vengeance.
However, because they feared the October sell-off was the end of the rally, long-only money managers missed the quick run-up to new highs.
Now, those managers are lagging the S&P 500′s positive 2014 performance, and hedge funds sitting on losses all have to figure out how to make money by New Year’s. Their bonuses and jobs depend on it.
So, the easiest path for them all is the path of least resistance, which is up, up and away. That’s what they’re betting on. They all got into stocks as the bounce was creating new highs, and now they have to push stocks higher so they don’t lose out.
That’s how Wall Street wants to play through year’s end. It doesn’t mean the market is guaranteed to go higher. There will be some big players who will short stocks up here and try and create a panic.
And the market is facing the usual macro-global headwinds. Russia is entering Ukraine again, and there’s the possibility of a full-blown conflict there.
Still, when it comes to Wall Street paychecks, they’re going to do whatever they can to get markets higher through the end of their December performance and bonus calculation period ends.
How can you play along?
The best opportunities will be getting into big-cap stocks that have lagged in the recent rally to new highs.
Players will look to push those stocks higher. Stocks having made new highs will be looked at as fully valued for the moment, and big-caps with good earnings that haven’t moved up as much will be seen as undervalued and ripe for a bounce.
Here’s why big-caps are the way to go.
After saving their jobs and earning their bonuses, managers may want to pull out after their year-end accounting periods have passed. And it’s easier to get out of more liquid big-caps than mid-caps and small-caps.
They look ripe to bounce, too, but are less liquid than big household names – so now’s the time to go large.