This note was originally published at 8am on May 12, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“I’ve worked with dogs before and they’ll sit and they’ll roll over. With kangaroos, you say sit and they start boxing with you, they’re nuts.”
Keith is out on some family business today, but I think he would, after the last 24+ hours of global market trading, agree with the titled of this note: Kangaroo Markets. As creative as I can be at times, I have to give credit for the origin of the title to its rightful owners, the Aussies.
In another capital markets sign of the topping of the global economic cycle, it seems Kangaroo Bond sales surged to a record A$37.3 billion last year and are on track to nearly match that total this year. As a prominent Australian fixed income manager recently said to the financial press, “I expect more financial kangaroo sales.” Indeed, and we expect more kangaroo markets, which is to say markets that are “nuts”. Now, of course, markets can’t really be nuts, but Centrally Planned Price Volatility can certainly make those of us who trade them nuts.
Yesterday’s market action likely didn’t reward many. The dollar index rallied hard, so commodities were taken out to the woodshed and U.S. equities were down -1% or so with the small cap Russell 2000 leading the way to the downside at -1.8%. The pundits are calling this the “risk off” trade. I’m not sure risk is really ever off, but it is a convenient way of explaining that many investors got caught leaning way too hard into consensus. Or, perhaps, all the Hedgies at the SALT conference just aren’t trading this week…
The other important event yesterday related to the investment management industry was that Raj Rajaratnam, head of Galleon Management, was found guilty on all 14 counts of fraud and conspiracy. Personally, I don’t have a lot of knowledge about the case, but I can tell you this, Raj’s lawyer certainly thought he was in a Kangaroo Court as he announced immediately after the verdict that they intended to appeal to the Second Circuit.
To the extent that this was actually a catalyst for the market yesterday, there is another catalyst in the pipeline on this front, which is the trial of Zvi Goffer, more commonly known in technology insider trading circles as Octopussy, who according to the accusations and this chart from the WSJ (http://online.wsj.com/article/SB10001424052748703386704576186592268116056.html) was purportedly in the middle of a web of inside information. Personally, I just think he had a terrible nickname.
The bigger question, of course, is what does this all mean for the investment management industry? Luckily, despite the headlines, most actors in the investment management industry are ethical and have legal processes, so the prevalence of cheating is likely much less than the headlines would currently suggest.
In an unusual move, before we even had paying clients at Hedgeye we brought on board our compliance officer, Rabbi Moshe Silver, a Wall Street veteran of over 25 years. Prior to joining Hedgeye, Moshe worked with Keith at the Carlyle-Blue Wave hedge fund, where he was director of compliance. When Moshe came on board he recommended we introduce ourselves and our unique business model to our regulators – another unusual move, but in this day and age of increased scrutiny, we thought it was appropriate.
Moshe’s contributions have expanded to sharing his unique – and occasionally hilarious – insights into the world of regulation, un-regulation, and the shadowy places where Wall Street and the Real World meet. His thoughts appear in a weekly column that is a must-read for many of our clients. Needless to say, Moshe hasn’t been effective at limiting our use of hockey references, but we’re glad he’s got our back as he oversees our research and communications to ensure that compliance always comes first.
If there is any potential market impact of more insider trading trials and investigations, it is perhaps to accelerate Centrally Planned Price Volatility. We've highlighted this last point in the chart below. Over the course of the past decade when interests rates have been taken to abnormally low levels, such as in the 2002 – 2003 period and in the 2008 – current period, price volatility increases, as emphasized by the VIX stepping up to a new level.
In theory, this makes sense. Aside from attempting to artificial co-opt the natural business cycle, the other impact of our Central Planners taking interest rates to abnormal levels for extended periods is to force investors to speculatively chase return. Practically, what does that mean? As an example, it means bidding oil up into the $100+ level when global growth is slowing and global oil inventory is building. This works, of course, until it doesn’t and then the trade gets unwound, as we are seeing again this morning with the commodity complex down across the board and silver leading the way, down a cool -8.5%. (But wait, silver’s an industrial metal! Or is it?)
Underscoring the heightened commodity and equity market volatility we are seeing is currency volatility. This is a function of both the Central Planners at the Federal Reserve, but also the Fiat Fools in Washington, who are currently playing politics with the fiscal future of the United States on the debt ceiling debate. For a comprehensive review of our thoughts on the debt ceiling debate, please see the note written by my colleague Darius Dale yesterday, titled “Fear Mongering Meets Brinksmanship: A Comprehensive Guide to Navigating the Debt Ceiling Debate.”
Be it the moniker Octupussy, or the Fiat Fools in Washington, some days all of this just seems a little childish, so with that we’ll end with a nursery rhyme:
“Jump, jump, jump goes the big Kangaroo,
I thought there was one, but I see there are two.”
Keep your head up and stick on the ice,
Daryl G. Jones