According to a recent WSJ article, in the wake of the recent Madoff and Stanford scandals, hedge fund investors have been requesting their money back at an increased pace over the last few months. Morgan Stanley analysts are forecasting that assets under management could fall by another 30 percent before the year is over. This follows an already 20 percent decrease at the end of 2008, reducing total hedge fund AUM to below $1 trillion. The withdraws are getting large enough that some funds are now left with only illiquid assets, most of which have to be sold at depressed prices. Increased selling has certainly help pressure the market recently, and will likely continue to do so if the hedge fund redemption forecasts from Morgan Stanley are correct. Having the DJIA fall to 6,000 and the S&P 500 fall to 700 would certainly seem more likely under such intense and systematic selling.
Although the DJIA and S&P 500 were each down over 10 percent in January, the Credit Suisse / Tremont Hedge Fund Index was up 1.09 percent (also see Investment News article). The January returns were the first time the index was up since May 2008. Top strategies for the month were convertible arbitrage (returning 5.72 percent), dedicated short bias - no surprise (up 3.69 percent), multi-strategy (up 3.35 percent), and global macro (up 2.33 percent). Managed futures took the biggest hit for the month, falling 0.56 percent.
There is an old market rule of thumb that states as "January goes, so goes the year." Often the January Indicator pertains to the first five days of January, other times to the entire month. This year it may not really matter. As it turns out, this is the worst January on record for all of the major indexes, except the Nasdaq - and even the Nasdaq is nothing to write home about. The DJIA was down 8.8 percent, the S&P 500 was down 8.5 percent, the Nasdaq was down 6.2 percent, and the Russell 2000 was down 11.0 percent. The Dow Transports, which are used by some as a barometer and forecast for movement in the industrials and the broader market, was down a whopping 16.0 percent. Certainly, not an encouraging start to the new year.
On the lighter side, at least this weekend we have the Super Bowl to enjoy, along with the Super Bowl Indicator to watch - which states that "a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in the stock market for the coming year, and that a win for a team from the old NFL (NFC division) means the stock market will be up for the year." Given the market action over the last six months, even those market participants that think technical analysis is irrelevant, and indicators are just plain silly, may be saying "Go Cardinals." Yes. I know. I am grabbing for straws.
Note (update): Not that it matters, but apparently the Steelers and Cardinals are legacy teams from before the NFL’s merger with the AFL. Therefore, according to the SB indicator it should be a good year for stocks regardless of who wins the game. Of course, if you are investing based on this indicator, then maybe you should move your money to Treasuries (well, then again .....).
Some leading technical analysts are continuing to be worried about the major indexes potentially falling another 30 percent. Ralph Acampora believes that if the DJIA falls below the low of 7,552.29 it reached on November 20, that it could fall further to 6,000 (see Bloomberg article). John Murphy also believes that the November lows represent "a very, very significant area," since this is near the point where the market began to recover when the bear market ended in 2003. If we are to break these levels, the trend is expected to become very negative. Recent market action has not been encouraging. Louise Yamada expressed similar concern during an appearance on Fast Money late last year, where she also expressed concern that the DJIA could fall to 6,000. She had successfully predicted before the recent sell-off that the Dow could fall to the 8,000 range. Just last month, her website posted the following:"The overall market picture still looks troubled. Both the S&P 500 and the DJIA have seen each recent rally (and potential bottom evidence) fail at a slightly lower peak. This progression of lower highs is evidence of supply -- price cannot rise to a slightly higher level because supply is being sold into the rally. ...... The recent pattern of sellers entering into each rally is characteristic of a downtrend, i.e., the failure of the rallies to get above the prior peak. In the study of supply and demand, which is the basis of technical analysis, this pattern represents aggressive supply. Contrarily, in a bottoming process or in an uptrend, higher lows are followed by higher highs, representing aggressive demand. .... Now, however, there is a confluence of sectors rolling over together, which is problematic. The majority of stocks are showing topping patterns."
Technicals are never the whole story, but they certainly help you to know where you have been, and how much trouble you may have getting to where you want to go. The data is certainly not encouraging for the bulls.
As we begin looking at our year-end investment portfolios, and feeling a sense of dread as we see our retirement savings down a third or more, it is useful to compare the US markets with the rest of the world. As it turns out, over the last year US investors would have been better off investing more in the US, and less overseas in the "hot" markets, such as China and Brazil (see WSJ article). Just as many investors this year realized that their global exposure was a little lite, the bottom fell out in some of the very same markets they began increasing their exposure in (not to mention drops in the US market - see graphic below from the WSJ).
After rallying nearly 10% over the last week, the DJIA is down "only" 33 percent for the year. In comparison, the Shanghai Composite (China) is down over 64 percent, while the the Bovespa (Brazil) the DAX (Germany) are down over 42 percent. The FTSE 100 (UK) is down about the same as the US DJIA. The Dow Jones World Index, which excludes the US markets, is down 49 percent in dollar terms YTD. Of course, massive sales of foreign stocks by US investors has also not helped international markets. Between July and September, US investors sold $92 billion more of foreign stocks and bonds than they bought during the same time. Therefore, if you recently failed to jump on the international diversification train this year, either because you had foresight, or were simply too confused or too lazy and never got around to it, smile - you could be even worse off this year. If you jumped on board back in 2003, you have experienced a nearly lost half-decade for many markets, but you can also smile - at least you are nearly flat. If you jumped on board in late 2007, or earlier this year, well ........, at least you have your health (and a lot of company to commiserate with).
The Inside Scoop feature at Barron's (see article) is reporting on how Warren Buffett has increased his position in Burlington Northern Santa Fe (BNI). Earlier this week, Buffett bought another 825,000 shares, bring his total position to about 19% of the company. Not only does this recent transaction put approximately one-fifth of the company in strong hands, but Buffett has also recently sold 5.5 million puts in October, with strike prices ranging from $75-$80. The put position effectively places a floor on the stock, since if the past is any indication, the position implies that Buffett is comfortable being a buyer at these strike price levels.
As with the rest of the market, Burlington has fallen over the last month, but not as much as some of its biggest competitors. Since Burlington hauls a higher percentage of coal and fertilizer, as well as other domestic goods, analysts believe they will most likely not be hit as hard by a global recession. Furthermore, any return to higher fuel costs, which will impact global growth, could also help Burlington weather any further downturn as companies continue to shift from trucking to the rails for transporting their goods. As the chart below shows (from BigCharts.com), BNI, the DJIA, and the Dow Transports (DJTA) have diverged somewhat since the beginning of the year.
Source: BigCharts.comOften the DJIA will follow the transports, but in this case the market sell-off in October has caused the transports to catch-up on the downside with the general market. BNI fared a little better during this time. Each has gained over the last week. Of interest is how the transports are bumping up against resistance levels in place since January, whereas BNI has actually found some support at these levels. If the market can break these levels and continue to build a bottom in November (or even begin to rally), and the six months from November to April do turn out to be bullish after the heuristic-based "sell in May and go away - until November" trades are unwound, than BNI may not only be a potential recession play, but it may also help to lead the market over the next year. Nothing is fool proof, but with the winds of Buffett, energy (coal), and ethanol (fertilizer) at your back, the profit trains could start rolling again for BNI stock holders.
Banks are continuing to ask for more collateral to back past hedge fund lending, causing more funds to liquidate their positions (see WSJ article). When added with investor redemption, bank-induced liquidation is forcing hedge funds to step-up their deleveraging. Such selling is continuing to put pressure on the market, generating more requests for bank collateral and investor redemption, in what amounts to a catch-22 that continues to spiral the market downward. Such selling has been occurring for a while, as funds have been unwinding exposure to financial and energy stocks, both of which continue to suffer as crude oil continues to drop, and the credit crisis continues to unfold. While Hedge Fund Research recently reported that the level of hedge fund market exposure has decreased by one-third over the last year, I suspect that this still may not be enough. As mentioned by Antonio Munoz-Sune, head of the U.S. for fund of funds EIM: "The combination can take anyone down." Unfortunately, it is difficult to tell where we are in the hedge fund closing and deleveraging process, with many hedge funds still appearing to use every rally as an opportunity to sell. I suspect that until we see the VIX approach more normal sub-30 levels, stop seeing the DJIA and S&P 500 Index post intra-day percent swings in the high single digits, and see crude oil stop falling in price, it is unlikely that the market will stop feeling the effects of hedge fund selling, allowing for a long-term and lasting rally. Like most bottoms, we won't know for sure that it has occurred until we see it in the rear-view mirror, but I will be watching the VIX, the price of crude oil, and the Dow Jones and S&P 500 index percent swings for clues.
FedEx warned Friday afternoon, cutting its fiscal Q4 earnings forecast for a second time this year (it warned earlier in March), citing increases in fuel prices, which had increased by 7% ($100 million) since giving its last estimate. The company now expects earnings for the quarter ending in May to be in the range of $1.45 to $1.50 a share, compared with previous forecast of $1.60 to $1.80 per share. Not surprisingly, the shares are down in Friday after-hours trading.
A few observations. First, for those that follow FedEx, this was somewhat to be expected given their earlier warning, but troublesome nonetheless. Furthermore, anytime a company warns on Friday afternoon, when they expect that everyone will be home with family or in The Hamptons, this is also sometimes a tell that the company is in trouble. This again is certainly not encouraging.
So what does this mean for the overall economy? Just recently we discussed how the Dow Transports were making a small rally earlier in the year, even as the Dow Industrials were relatively flat. While not a perfect indicator, the transports have at times been a leading indicator for the industrials. From a previous post we discussed why:
The logic behind the indicator being that if product is being shipped from supplier to retailer, than retailers are experiencing lower inventory and increased demand, eventually resulting in both the supplier and retailer booking revenues and earnings. The leading transportation indicator occurs since the transports are the first to signal demand, with the transportation companies also being the first to actually get paid for their services, resulting in higher valuations and stock prices. Both the suppliers and retailers have to wait a few months before seeing increased revenues at the retail level, or increases in accounts payable at the supplier level. As a result, increases in the transports can at times signal future revenues and stock prices for the industrial companies.A current comparison of the charts for the DJIA and DJTA gives us no real conclusion:
As expected, there was a nice breakaway in transports in late January, followed a few months later in March by the industrials. The recent moves this week in the transports, while down, are still above the current uptrend line. Nonetheless, the industrials have appeared to roll over slightly. Certainly higher oil prices and recent new developments (i.e., problems) with some financial companies are most likely having some impact on the broader market.
Of course, FedEx, and even the over the road shipping companies, such as YRC Worldwide, may no longer tell the whole story. Given the strength and demand of the once maligned rails, it will be important to see results from companies such as Union Pacific, Burlington Northern Santa Fe, Canadian National Railway Company, and Norfork Southern before we can declare that shipping and transportation are weakening, and that lower demand will result in lower profits for the production-driven industrials. With the rails it is also important to see what is being shipped, given that recent agricultural and energy demands have seen an increase in business for moving coal and crude oil, along with wheat, corn, soybeans, and fertilizers. The energy commodities in particular, along with higher levels of corn production, will provide an increase in freight levels, while at the same time signaling pressure on the energy consuming industrials, thereby weakening the significants of the DJTA indicator.
Tickers: FDX, BNI, UNP, NSC, CNI
The Dow Jones Transportation Average has been rising since the end of January, moving nearly 25%, even as increased fuel costs take their toll on the transportation sector. During the same time, the Dow Jones Industrial Average has been relatively flat. 
While not a perfect indicator, the transports have at times been a leading indicator for the industrials. The logic behind the indicator is as follows. If product is being shipped from supplier to retailer, than retailers are experiencing lower inventory and increased demand, eventually resulting in both the supplier and retailer booking revenues and earnings. The leading transportation indicator occurs since the transports are the first to signal demand, with the transportation companies also being the first to actually get paid for their services, resulting in higher valuations and stock prices. Both the suppliers and retailers have to wait a few months before seeing increased revenues at the retail level, or increases in accounts payable at the supplier level. As a result, increases in the transports can at times signal future revenues and stock prices for the industrial companies.
Of course, one important caveat is in order. Given the recent agricultural and energy demands, both the trucking and rail industries have seen increased business moving coal and crude, along with wheat, corn, soybeans, and fertilizers across that states. Given that they have pricing power to ship these high priced, and high demand cargo, they are also able to recoup most of their increased fuel costs. This business in particular is certainly contributing to some, if not most of the recent moves in the transports. Only time will tell if this trend transfers over to the entire economy, but at least for now the signal looks positive.
