An answer to the hedge fund question. I think they are impacting Compaq also.
NW
Should you worry about hedge funds?
Their problems are not over, but how much impact do they really
have? Here's what the experts say
By Andrew Marks
moneydaily.com
Ever since the near-collapse of Long-Term Capital Management and
the Federal Reserve's subsequent orchestration of a rescue of the
tottering hedge fund, the small investor has been bombarded with
conflicting information about these funds and their role in the
world's financial crises. On the one hand, hedge funds are
portrayed as the exclusive domain of large institutions and a
relative handful of very wealthy individuals, whose losses have
little impact on most investors. On the other, we hear everyone
from Wall Street traders to Fed chairman Alan Greenspan warning
that hedge funds are powerful enough to single-handedly
destabilize the world's financial systems, to say nothing of
sending stock prices tumbling. Which is true? That depends on how
broad the hedge fund problem turns out to be.
While there is no doubt that hedge fund jitters have adversely
affected some large bank stocks and have helped tighten credit,
they are not the dominant force moving the market. In the last
several days, investors seem to have shrugged off their fears of
really bad news. On Tuesday, the buoyant mood that has sent the
stock market to big gains since the Fed announced its surprise
rate cut last Thursday continued. The Dow Jones Industrials
rallied throughout the afternoon, settling up by 39.40. Two
reasons the Dow slowed a bit by the close of trading: a rumor in
the markets that another big hedge fund might be on the brink, and
word of some disappointing corporate earnings. But there were
countervailing forces at work as well. For one thing, many were
encouraged to see Washington finally get back to business and rush
to pass the Federal omnibus budget.
"Clearly, investors have decided to look on the bright side of the
situation, for now," said Merrill Lynch analyst Richard Bernstein.
"The Fed seems primed to help our economy avoid a recession, and
third quarter earnings aren't offering any bad surprises. Some
people are starting to think we might have hit bottom." Still, the
fears that so recently gripped the market are far from vanquished.
Indeed, as Money Daily discussed in The Fed's cut may cut both
ways," many Wall Street pros believe that concerns over new
market-shaking troubles at hedge funds like the tremors that hit
Long-Term Capital, Ellington Management, and D.E. Shaw, pushed the
Fed to take its impromptu action.
So does the average investor need to worry about hedge funds?
Money Daily asked the experts. Here's what we came up with:
* The hedge fund troubles are a symptom of the market's ills, not
the cause. "Every time we have a major market correction, there's
a scapegoat," says Merrill Lynch analyst Richard Bernstein. "In
1987, everyone blamed the program traders. This time, it's the
hedge funds that get stuck with the blame." The problem the hedge
funds illustrate is greed. "There was just way too much capital
and credit being made available for high risk investments," says
J.P. Morgan's investment strategist Doug Cliggot. "Banks,
brokerages, big and small simply forgot that risk exists. Russia
was a prime example of that." Just as investors kept dumping money
because they started assuming that every year will bring the 25
percent-plus returns of the past few years, banks got careless
too, and lost sight of the fundamentals.
* The hedge funds helped create fear and uncertainty in the
market. While they are not to blame for the underlying
fundamentals that ultimately pulled down the market, they bear a
great deal of responsibility for the extreme volatility of stock
prices during the past several weeks, our experts say. News of
Long-Term Capital Management's collapse, coupled with subsequent
problems at other hedge funds, marked a new low point in months of
global financial pessimism, and raised doubts about the ability of
regulators to police markets. "I don't know how much blame to lay
on them, but there's no doubt that the sense that more hedge funds
are poised to blow up has contributed to the violence of the
market's downturn and the length of this correction," says
Cliggot.
* Hedge funds can drive prices of individual stocks far below
their fair value, since they take large positions in individual
stocks or bonds. While most hedge funds are not facing troubles of
the kind Long-Term Capital experienced, many are being forced to
come up with cash to pay creditor banks and for investor
redemptions. "They then have to liquidate their holdings of
healthy, liquid investments in a big hurry and that can cause the
stocks they're selling to take big hits," says Jeff Benjamin of
Cerulli Associates, the author of a report titled "The State of
the Hedge Fund Industry." Traders point, for example, to such
highly-liquid technology stocks as Dell (NASDAQ: DELL), Cisco
(NASDAQ: CSCO), Microsoft (NASDAQ: MSFT) and Intel (NASDAQ: INTC)
as examples of companies hit by recent hedge fund fire sales. And
it gets worse: "Many hedge funds expect to be experiencing heavy
redemptions at the end of the year," says Lois Peltz of MAR/Hedge,
a firm that tracks and analyzes hedge funds.
* Do blame the hedge funds for softness in bank stocks. As any
holder of financial sector stocks knows all too well, news of
Long-Term Capital's woes sent money center bank and brokerage
stocks reeling during the past three weeks, though they are now
rebounding. Shares of Chase Manhattan (NYSE: CMB), which concedes
$3.2 billion in exposure to hedge funds, fell from 50 on September
23 as low as 40.125 on October 7, or nearly 20 percent, before
Chase recovered all of its losses and then some in the last two
weeks. Merrill Lynch (NYSE: MER), which has $2 billion in such
exposure, fell from 57.75 on September 23 to 37.75 on October 7,
then bounced back, closing Tuesday at 54.8125.
* You can also blame the funds for helping bring on the credit
crunch. Analysts believe that the Fed cut rates another 25 basis
points last week because it feared a big pullback in lending.
While taking big losses, both on the loan and investment side,
won't necessarily ruin the banks, it does have the affect of
drying up credit, from global markets, to the local mortgage
market. "The banks slow their lending both because they are losing
so much money -- and because they are afraid of losing more, they
become overly risk averse. That curtails economic activity, and
that leads to recession," says Ethan Harris, a senior economist at
Lehman Brothers. Interest rates on the 30- year fixed mortgage,
for example, rose from 6.7 percent just before the Fed's September
29 rate cut to 6.9 percent on October 16, an increase of 20 basis
points.
All in all, the hedge fund jitters may present some opportunities
for the careful investor, especially given the rapid recovery of
many stocks hit hard a few weeks ago. But be cautious. "I'd
hesitate to recommend a buy on the dip strategy at this point,"
says Jamie Atwell, who heads NASDAQ trading at Nicholas Applegate.
After all, "there's no telling how far down the next hedge fund
failure could take the market." And with those heavy redemptions
due at the end of the year, don't look once when you think you
hear opportunity knocking: look twice.
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