January 20, 2019

Is the Market Slide Over?

“The key to investing success in 2019 is remembering that “V” is for victory.

December was wretched for stocks, but it’s over. As I detailed last week , stocks always bounce after extreme nasty stretches. And they do so in a near-perfect V-shaped pattern, it’s merely a question of when. You’ve survived the left side of a V: the terrifying slide. Soon stocks will rocket up the V’s right side, if they haven’t already started.

So let’s talk about the V’s left side. Last week, I said December’s market action seemed like “mass forced institutional liquidations” – shuttering hedge funds scrambling for cash by year end. There isn’t good data on this, but hundreds of hedge funds closed Dec. 31 after botching three straight years. Most were bearish in 2016 and 2017, fearing Trumpageddon. They lagged terribly as U.S. stocks rose 36.4 percent. Then they reversed in 2018, swinging uber-bullish, and getting hammered as stocks fell after September.

The hedge fund business model makes these long, lagging stretches challenging to recover from. The funds are paid largely through a 20 percent fee on any gains above some contractually detailed “high-water mark” in the value of the investments. That mark doesn’t ever reset when asset values fall. If they get too far underwater and can’t get back above it before long, continuing isn’t worthwhile. Their self-interest becomes closing shop and starting fresh later. Hence this year’s unusual stampede for liquidating cash by year end.

Then, too, most hedge funds let their investors leave only at contractually specified periods. So many surviving funds likely felt forced to raise cash, anticipating disappointed investors fleeing right about now, when redemption windows open. The result: Mass December selling, which prioritized speed over price. Imagine hundreds of folks in a one-door room. One yells “FIRE!” They all start stampeding together. That was most of December.”

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