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Friday, September 7, 2012

That Stock Market Rally of September 6....Don't Believe the Explanations in The Media

As the business news and today’s press will report it…today’s 2% rise in the S+P 500 and  rise in European stocks  (based on ETF VGK) of3% was attributable to actions (or pledges of  )
·         Further action to  support the European  bond market
·         A stronger than expected employment report from  private payroll  firm ADP (which doesn’t   always match the government figures which this month are released on Friday).

I have another explanation: the calendar and money managers trying to catch up.

The calendar: We are in the first week after Labor Day. The summer was a quiet one in the markets giving money managers a chance to get away…as described in a recent WSJ article. The deadly low volume and volatility  of the last  weeks in August indicate a lack of managers taking on new positions.
Paradoxically large moves are not uncommon in the summer—whether they are panic selloff or “melt ups in rallies
Some may attribute this to breaking news. Having worked on trading desks I can suggest another reason.
The reason: trading desks are lightly manned with junior staff in the summer. That staff is either instructed to cut back positions if the market moves against the portfolio in sharp moves, but not to undertake new strategies….or  the senior portfolio manager watching the markets intermittently from  his iphone on the East Hampton  beach calls up the junior staff and tells them to liquidate some positions pending a  portfolio review after Labor Day.
Well, the summer house is closed down, the trip to the mountains  or lake cabin with poor cellphone reception and no wifi is over and everyone is back to work.
And what are many mangers looking: at a missed summer rally in the stock market

In fact  I would not at all be surprised if much of the summer rally was fuelled by hedge managers short the market…anxiously calling their junior traders and instructing them to cover those short positions.
Stocks jumped nearly 10% over the summer, defying the expectations of many hedge- and mutual-fund managers who had bet on a decline. They saw a multitude of headwinds from Europe's woes to the slowing U.S. economy and sluggish corporate earnings.
Now, those defensive fund managers are facing what's known in Wall Street lingo as the "pain trade": having to buy stocks just to avoid being left in the dust.
Here’s the picture and it’s not pretty. Jeremy Grantham recently wrote a great paper on career risk in money management.  Underperformance gets punished with fickle investors chasing performance and fleeing from underperforming managers….this may be particularly the case with the increasing preference for index instruments among individual investors. Many will give up on active mangers and index…others will move funds to a hot manager
 Whether it’s a hedge fund manager or mutual fund manager their compensation is tied to assets under management and assets under management tied to performance. With a little less than 4months in 2012, those mangers are forced to catch up and buy stocks.
This whole pattern leads to short term fund management, the managers are not totally to blame….the investors respond to short term performance and movetheir money accordingly.
Academics callthis concern of managers of exceeding a benchmark “information risk”. The risk of underperforming the index is greater…the more the manager strays from the index….even if he thinks the move may make sense.  Of course this is ironic beause investors think they are paying active manager to find investing opportunism….Short termism and concern about the information ratio leave some opportunities unexplored. There seems evidence of potential for outperformance…on a risk /return basis but often not on an outright basis….more of that in a future article.
Other cyclical dates to watch:
The period towards the end of the quarter when managers will window dress, increase  their stock allocation particularly in top performing stocks
The period right after the end of the quarter when individual  investors review their 401ks and inevitably chase hot asset classes. With the heavy move of investors away from stocks and into bonds in the last couple years…they may rethink that positioning. With the S+P 500 total return over 13%for the year and the aggregate bond index +3.5%....I wouldn’t  be surprised by some asset shifting(missing much of the move) from individuals around the end of September/beginning of October.

A major survey of individual investors AAII shows a great deal of caution despite the stock markets strong 2012 performance....A look at those September 30 401k statements may lead to moving some more money into stocks....chasing performance.


Bullish sentiment among investors was down during the week ended this Wednesday, according to the most recent weekly online survey of members of the American Association of Individual Investors.
Bullish sentiment fell to 33.06% from 34.72%, while bearish sentiment rose to 33.06% from 32.64% during the previous week.
The percentage of investors who described themselves as neutral on the stock market rose to 33.88% from 32.64%, according to the poll. 

I wrote this blog entry (honest) before I saw this from Barry Ritholtz on his Informed Consent blog

Stock oriented hedge funds are charging 2% + 20% of the profits for their YTD returns of under 3%. Mutual funds that focus on large cap stocks are up YTD less than 7%. Oh, and those of you who index are up YTD 13%.
If you want an explanation as to what is driving stock prices, that is as good as any . . .

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