Friday, 24 October 2008

Capitulation trades? – not yet

Quite a number of commentators have (particularly on Fridays during the last trading hours) used the term “capitulation”, intended to mean that sellers in the stock markets are now exhausted of selling and need a well-deserved rest after having “capitulated”. Thus tired of some day’s hard work, there are no more left to sell and presumably it should lead to a stabilisation of the markets.

I am afraid that this may be too early. Obviously I hope to be wrong on this one, but there are some market elements missing from this all too human explanation.

Over the past years, hedge funds have represented some 60% of the turnover in the stock market. Despite the allure of the name, hedge funds are not necessarily hedged, and the best indicator for hedge fund performance remains a simple stock market index, leveraged between two and three times. The truly market neutral or even market contrary funds are thin on the ground among the estimated 11,000 hedge funds worldwide.

Obviously, the best hedge fund managers have already long time ago unwound positions. But it is my guess that they are still only a minority. With the credit markets drying up, banks have increasingly put pressure on all leveraged investors to unwind positions or to put in more collateral. Given that most hedge funds are so-called long-short funds, but for the past two years for all practical purposes long funds, it is highly likely that there are still many hedge funds out there who are caught in exactly the same situation as a lot of amateur investors. They have seen huge losses, they did not get out in time, and now they feel it is “too late”. But they will increasingly be squeezed into action by banks tightening up on the credit.

I agree that there are many, many companies out there who are already trading at very attractive prices. We are rapidly approaching a classical value situation where companies are selling below their asset value or even below the value of their cash holdings. It may indeed be the buying opportunity of the decade.

Unfortunately that is no guarantee that the ongoing credit freeze compounded with galloping recession fears cannot force further falls in the stock markets. Beware before you step out to catch the falling piano.

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