It's happening all over again. Daily index put/call ratios of 150-200%. Weak dollar. S&P forward P/E of 25. CNBC bubbleheads saying the S&P is "reasonably valued". Ned Riley recommending QQQ. James Cramer ranting and raving. Place your bets ladies and gents.
It's a bubble on top of a bubble. As I mentioned in a prior thread, an equal weight index of the S&P 500 is at all-time highs, as are the S&P SmallCap 600 and S&P MidCap 400. The recent bear market was insignificant. But I'm not ready to try to short this market -- yet. Let the market tell you when.
There is a new type of portfolio insurance that is creating a sort of systemic instability. It is that of hedge fund insurance. Various funds of funds offer the ability to insure that you preserve your principle. The fear is that if enough hedge funds are holding the same losing position and they are forced to liquidate at the same time because of these client calls it could trigger a cascade effect. While this isn't yet a big force, it is becoming an increasingly popular choice amongst institutional investors. I have an article documenting this somewhere. If it is of extreme interest to anyone I will track it down if you PM me.
I was happily surprised to get a few PM's wanting to see that article. Below is the excerpt I mentioned: "In their rush to cater to hedge funds, investment banks are also aiding and abetting the creation of new types of fundraising vehicles that make even hedge fund managers nervous. So-called guaranteed hedge-funds-of-funds notes - a structured product that is meant to ensure that investors get back their initial outlay even if their hedge fund blows up - have been marketed extensively to Japanese and European investors. Commercial banks provide the requisite credit guarantees to protect investors' principal, although they generally don't sell guaranteed products themselves. Many hedge fund and structured-product specialists say that the products are often a bad deal for investors and a potential menace to the whole hedge fund market. Some trading experts warn that because these products virtually compel banks to be big sellers of hedge funds during moments of market stress, they could conceivably set off a landslide of sales that would spread panic in the wider market." - By Hal Lux June 2002 Institutional Investor Magazine I've attached the entire article which is an excellent article on a great number of topics related to the hedge fund industry. It is worth the read.
The relationship between hedge-funds and prime brokers is nothing new, nor are the "structured-products" and derivatives that they use as vehicles to perform with. Of course large international banks are at the forefront of Prime Brokerage~! . . . their cost of capital is very low, and perfect for helping a hedge-fund leverage their positions!
More excellent information from waggie945. That's no surprise. You are correct about the use of "structured products". The difference here is the lack of diversity amongst the products. If this "always-get-your-money-back-on-hedge-funds" note takes off it could be a potentially further destabilizing factor during times of market instability. Of course this would imply that most hedge funds would be holding the same directional positions, which of course would be a big assumption. But if just enough of them were holding the same position ... In any case the world of structured products really blew my mind when I first learned of it. They are often preferred vehicles for tax avoidance as well. 60 minutes had a piece a few months back on a rich business owner who was approached by one of the reputable IB's to purchase a structured note whereby he would reduce his taxes through currency sales to and from himself in various offshore shells he would own. Of course the complexity was mind boggling. In the end I believe he saved 5 million in taxes and paid the IB 1 million. Now both the rich man and the IB have found themselves in trouble with the government. If you'd like to read more about the insides of these types of deals visit the following links: http://www.derivativesstrategy.com/magazine/archive/1997/1197fea5.asp http://www.derivativesstrategy.com/magazine/archive/1997/1197fea6.asp