Jim Cramer brought out a great point last week during his TV Program, Mad Money, when he attributed much of the market volatility to “hedge funds gone wild”. He knows an awful lot about hedge funds since he managed one himself in the 1990s.
For my readers unfamiliar with the term “hedge fund”, let me define:
A private, aggressively managed portfolio of investments, having a largely unregulated pool of capital, whose managers can buy and sell any assets, make speculative trades on rising as well as falling assets, and participate substantially in profits from money invested. It is open only to very wealthy, qualified investors. These investors are required to keep their (illiquid) money in the fund for at least one year. Since they are not open to the public, hedge funds do not have to make the same public disclosures as do mutual funds or brokerage firms.
Historically, the term “hedging” implies reducing risk. This was done predominently via short-selling (the selling of a security that the seller does not own). Short sellers make money if the price of the stock goes down. More recently, hedge funds use dozens of different strategies, so it isn’t accurate to to say that hedge funds just “hedge risk”. In fact, because hedge fund managers make speculative investments, these funds can carry more risk than the overall market.
In my book, DVDs, and CDs I often allude to the hedge funds as one of the “big boys”, a group that also includes banks, mutual funds, and insurance companies. These groups collectively are responsible for more than 80% of the trading done in the market each day and therefore are the market movers. As Blue Collar Investors, it is our responsibilty to predict what these folks are up to and we do so via technical analysis and checking lists like “Stocks on the Move” on the IBD Homepage. Volume Surges or Spikes (see pages 78-79 in my book, Cashing in on Covered Calls) are the result of “big boy” activity.
When hedge funds start short-selling, the glut of sales bring down share price. Label this simple supply and demand economics. This can now become contagious among other such funds and even average investors. Cramer’s point was related to the 370-point swing in the market on Thursday which he alluded to as “insanity”. This is a great word that can apply also to the market in general lately which has been challenging at best. In his view, hedge funds were betting on a market collapse as worries about Lehman and Washington Mutual peaked. What do you do when you think the market will tank? You sell short and that’s what these “big boys” did.
Later in the day, it became apparent that this theory was failing to materialize. Frantically, these funds started to cover (buy back shares before they went too high) and the market turned around dramatically.
Cramer named 2 companies that “fought back” against these hedge funds. JOYG announced that it was buying back 2/5 of its capitalization (# shares x share price), or 2 billion dollars worth of stock between now and 2011. Cramer said the company had enough of the short selling and could almost take itself completely private if its stock keeps falling.
The other equity he mentioned was our old friend CSX, whose embattled CEO Michael Ward won a proxy (vote of confidence by shareholders) battle with hedge funds to keep his job. That day, CSX reported a great earnings report and was up more than 10% in price.
Cramer’s point regarding hedge funds accentuates our Blue Collar position that it is critical to do technical analysis as well as fundamental analysis in our investment decisions. We must anticipate the moves of these gazillionnaires. They have the ability to take down great companies and there is no one looking over their shoulders to warn us.
How I found CSH:
I took a look at The Stocks on the Move List on Friday’s IBD Homepage. I ran only those stocks that traded 50% above their normal daily trading volume (the “big boys” are taking positions). Suffice it to say that there weren’t many.The only one that made it through our system criteria was FISV.
Next I scrolled down the Stock Check-up page to the list of the top-rated stocks in the same industry (Financial Services-Misc. Group):
Top 5 Companies in the Financial Services-Misc Group Stocks Above $10 – Sorted By Best
Cash America Intl Inc
Ezcorp Inc Cl A
M & F Worldwide Corp
Lender Processing Svcs
Then I evaluated the 4 equities ranked ahead of FISV. MFW was eliminated because it was not optionable and had low volume. LPS was removed from consideration because it became public in July and thus has a limited history.
Finally, I checked the calculations and liked CSH the best of the 2 remaining stocks (CSH and EZPW). Let’s look at the chart and sell the option:
– Buy 100 x CSH @ $43.23
– Sell (1) CSH-JH @ $4.50 This is the Oct. 40 call.
– 5-week ROO is 3.2% (4.50 – 3.23/ 4000)or 32% annualized.
– Our downside protection is a whopping 7.5% (323/4323).
Bottom Line: We have a great return, with great downside protection on a great performing stock in a great performing industry that the “big boys” may be taking a position on.
Last Weeks Economic News:
I’m sorry to report that there is little positive news in this arena. Retail sales came in much weaker than anticipated, business inventories increased, and the U.S. trade gap widened significantly. The fact that credit card debt rose less than expected appears to be a positive but also may reflect decreasing consumer spending. I saved my last comment for an economic positive: Producer Price Index (PPI) fell significantly in August due to rapidly declining energy prices. For the week, The S&P 500 ROSE .9% to 1252 for a year-to-date return of -13.5%.
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Note: I will be lecturing on behalf of Norwegian Cruise Lines during the last 2 weeks of September so I will not be responding to all your emails. I’ll do my best to get to as many as possible.
My best to all,