The “hope” trade
I heard a disturbing bit of market intelligence from an investment banker friend. Apparently, several large hedge funds (e.g., $8bn+ under management) put on the “hope” trade in December. In the hope trade, these large hedge funds that were down a lot in the first 11 months of 2008 decided to go “all in” in December and try to bid up equity prices before the end of the calendar year. By boosting prices–which were up about 20% for the month of December–they were able to report higher returns for the entire year in the hopes of staving off distributions. A large asset manager who used to manage almost all my money seemed to be engaged in something similar, so this story seems highly plausible to me. (I have managed to extract myself from my manager after sustaining major but not critical injuries to my personal account.)
So far, the strategy has been OK. But has added even more risk to the US economy. If prices go down (as they have so far in 2009) and the limited partners decide to withdraw their money in March, it could put a lot of additional downward pressure on the stock market. Especially with the baby boomers at or near retirement age, stock declines and net capital outflows could become a vicious cycle. Translation: a run on the stock market!
This scenario isn’t set in stone. If you think that economic conditions will materially improve by March, then perhaps the ‘hope’ trade will pay off. Does that seem likely to you? Soon, the day of reckoning may be upon us!