Market Speculation -- Bubbles and Manipulation

[chinaco]

A little setup first.

The Hedge Fund Industry stood at $2.68 T in 3Q 2007. That is a lot of wealth. The customers of the hedge funds are the extremely wealthy... the price of entry is usually high and people are warned of the risk that they could have substantial losses due to the employment of maximum leverage, derivatives, etc.

They can be self fulfilling in that they ruin the normal markets and people are driven to them to try to get some sort of return if the normal markets become less viable.

A few considerations

1. That amount of money move the markets by itself
2. They are less about going long on investments, but instead speculate and employ short-term techniques that magnify the money they use (massive leverage and derivatives).

It seems to me that they have grown to a size that they do harm to the market. To state it differently, they employ techniques that drive up volatility and are a force that feeds bubbles... or perhaps is the current day force that causes them.

A large part of the stock and bond market is owned by middle class people saving for retirement.

We are down stream consumers in other markets (consumer markets/comm) like fuel. Futures were created to help the producer of commodities and the buyer (businesses that produce something) to set prices so they were not ruined by speculative price swings.

http://en.wikipedia.org/wiki/Futures_market

Gluts and shortages of these products caused chaotic fluctuations in price, and this led to the development of a market enabling grain merchants, processors, and agriculture companies to trade in "to arrive" or "cash forward" contracts to insulate them from the risk of adverse price change and enable them to hedge.

Of course when bubbles begin to form on the way up... financial companies find ways to feed into it. An example would be the run up in commodities and financial companies creating new consumer mutual funds to get in on the action. IT seems to me that even pension funds were getting in on the action of the commodities bubble.

The futures market for corn was setup to enable a stable market between corn producer and corn product manufacturers. How does a financial entity that is engaged in neither throwing money into the market with no abandon help that market?

Stock markets - This was created to allow capital to be raised by business to form enterprise. In other words go long. Bond markets similar.

Here are questions.

1. Commodities Markets (specifically non-financial products). Are hedge funds and certain other financial entities destabilizing those market... ultimately leading to business failure and economic instability.
2. Securities Markets - Are hedge funds and certain other financial entities destabilizing the stock and bonds markets and causing problems for actual long investors that create the capital markets so business can thrive.

If so, how should it be dealt with? I am not for banning it. Although on the commodities side it could be banned.

• For example. If you are in the business that produces or consume crude oil... buy away. If hedge funds (and other non-oil producing entities) speulate, they will be fined and lose your fund will be closed if caught trading in instruments related to oil.
• Another approach is to take the profit out of speculation. Cap gains for companies not involved in producing or selling oil (any commodities) will pay a cap gains tax of 75 or 80% (something large).

It seems that these entities have figured out a way to manipulate and consequently disrupt the market mechanisms (established for reasons other than short-term manipulation and speculation).

Can we the normal retirement investors (long investors) and can businesses be stable with this going on... especially if it increases?

What do you think? Are we being scr3wed by these entities? Is it time to shut them down or contain them?

Will we be able to [effectively] save for retirement if something is not done. And we could have huge inflationary price hikes (consumer goods) that are not due to supply demand of the actual products but the speculative demand for the derivatives that were created to allow business to flourish.


I am sure the hedge fund industry would have us believe that they are bottom feeders that clean up things... but like anything in nature, if they grow big enough they can begin doing harm.

 

[al_bundy]

the higher commodity prices gave more money to producers of the commodities and enabled them to invest in new infrastructure to build their businesses. have you looked at Caterpillar's earnings the last few years? the energy industry sucked up a lot of the IT people who were out of work from the dot com bubble

 

[Gone4Good]

1. Speculators keep markets efficient. Without them, the buy and hold index strategy wouldn't work. A long-term indexer is actually getting a free ride on all of the analytical work, cost, and speculative risk taking of active managers . . . whether they are hedge funds, pension funds, mutual funds, or mom and pop.
2. I'm not sure why we would single out hedge funds specifically and not all active managers or individual investors. If size is an issue, Fidelity has many times the assets under management of even the largest hedge funds.
3. Hedge funds often put a lot of capital to work on the short side, betting against the bubbles you suggest they cause. Paulson & Co, for example made something like $15B betting against subprime mortgage securities. Had more people taken his side of the bet, the problem might not have happened in the first place, or could have been substantially less.
4. Retail, long-only, investors are often the ones who propel the speculative binges . . . think the Dot Com's and residential real estate. Maybe it is the retail investor who needs to be banned.
5. As of yet, the federal government has not needed to bail out any hedge funds in this recent crisis. It is the highly regulated banks and investment banks that are the problem.

 

[al_bundy]

usually one of the best indicators of a market top is the size of trades. large block trades are institutional investors

large block buys at market bottoms are signs of a turnaround
small block buys outnumbering large block buys are signs of a market top as retail investors buy up stocks at peak valuations

another indication is the quality of stocks going up. at a market bottom the best quality stocks are the ones to go up first. at market tops all the crappy stocks with no earnings are bid up by retail investors based on hope and dreams

 

[chinaco]

the higher commodity prices gave more money to producers of the commodities and enabled them to invest in new infrastructure to build their businesses. have you looked at Caterpillar's earnings the last few years? the energy industry sucked up a lot of the IT people who were out of work from the dot com bubble

My point was about the health of the markets, business (in general), and consumers.

Markets are a cornerstone of capitalism. They are meant to raise capital from investors.

Of course someone makes out in a speculative bubble on the way up. But many lose on the way up and the way down.

1. Speculators keep markets efficient. Without them, the buy and hold index strategy wouldn't work. A long-term indexer is actually getting a free ride on all of the analytical work, cost, and speculative risk taking of active managers . . . whether they are hedge funds, pension funds, mutual funds, or mom and pop.
2. I'm not sure why we would single out hedge funds specifically and not all active managers or individual investors. If size is an issue, Fidelity has many times the assets under management of even the largest hedge funds.
3. Hedge funds often put a lot of capital to work on the short side, betting against the bubbles you suggest they cause. Paulson & Co, for example made something like $15B betting against subprime mortgage securities. Had more people taken his side of the bet, the problem might not have happened in the first place, or could have been substantially less.
4. Retail, long-only, investors are often the ones who propel the speculative binges . . . think the Dot Com's and residential real estate. Maybe it is the retail investor who needs to be banned.
5. As of yet, the federal government has not needed to bail out any hedge funds in this recent crisis. It is the highly regulated banks and investment banks that are the problem.

IMO - there is some validity to a couple of your points. But I am not convinced that HF are not destabilizing the markets and driving certain consumer prices up (in terms of commodities recently).

Do you really think they are a net positive force in the markets and on consumers? I don't see it.

usually one of the best indicators of a market top is the size of trades. large block trades are institutional investors

large block buys at market bottoms are signs of a turnaround
small block buys outnumbering large block buys are signs of a market top as retail investors buy up stocks at peak valuations

another indication is the quality of stocks going up. at a market bottom the best quality stocks are the ones to go up first. at market tops all the crappy stocks with no earnings are bid up by retail investors based on hope and dreams

Yes when the bubble forms people tend to chase the rise.


------------

There seem to be a number of people that believe that speculation from certain large institutions is causing market instability and many losers.... including some hedge fund investors.

I do not care if the hedge fund investors lose their shirts from a philosophical perspective (they are taking a large risk and they may lose). But it seems that they may be causing more harm than good. And that harm is to markets, consumers, businesses and investors... and ultimately our interlinked economy (which is based on capitalism).

I am reading some material from people in the industry and people that study it. There seems to be a case (a legitimate one) that they are doing harm.

[Historically] it is pretty widely accepted that rampant speculation is not a good situation for markets (capital, commondities, etc), investors, consumers, or businesses.


The Problem with Hedge Funds — HBS Working Knowledge

 

[al_bundy]

in most bear markets stocks usually go below fair value whatever it is before they start going back up. First all the margin players sell out to meet margin calls and the last part is retail investors cash out of mutual funds or sell their stock shares because they think the world is ending. 2002 the big spectacular down day on big volume and a high VIX was in July. The October low was on low volume, lower VIX, etc. all the retail investors got scared and probably pulled out because after a 3 year bear they were worn out.

hedge funds have been around for a while, but now it seems everyone had a hedge fund a few years ago. Art Laffer, Ron Insana few other people that 10 years ago you would never think they would be a hedge fund manager. Even one of the surviving members of Black-Scholes just had another hedge fund go down on him.

in the past a hedge fund looked for values where a security was above or below it's mean price and went long or short until it reverted to the mean. last few years a bunch of companies were selling program trading quant software and anyone was opening hedge funds just to trade on margin.

it was almost like the stories from 10 years ago when it seemed everyone was opening dot coms or was associated with one

 

[Gone4Good]

But I am not convinced that HF are not destabilizing the markets and driving certain consumer prices up (in terms of commodities recently).

Do you really think they are a net positive force in the markets and on consumers? I don't see it.

I'm sympathetic to the argument that speculative demand pushed commodity prices up. But why should we single out hedge funds when both retail investors and pension funds were throwing money at commodities and commodity linked funds? You might as well blame some of the members of this forum who a couple of months ago were touting PCRDX pretty hard as a portfolio diversifier.

Hedge funds help make markets efficient and, in ordinary markets, provide a lot of liquidity. I do think we should find a way to potentially limit the use of leverage and monitor the systematic risk these funds may create. I'd also be in favor of broadening the oversight of the over the counter markets to prevent manipulation. But having said that, none of those things are in response to any evident failures in the hedge fund community. No fund has been found to be manipulating markets, despite several investigations. And while many funds have gone out of business, none has created systemic risks.

So to answer your question, yes I do believe hedge funds are a net positive force in the market. But I would agree that some added regulation may be wise to keep them that way.

 

[chinaco]

We are in a time where people are thinking up new ways to game the markets instead of invest faster than anyone can know the results on the entire system... the net result is destabilization of those very markets. And the amount $ they are pushing around in that endeavor is not healthy... it undermines the entire capitalism ecosystem.

Unfortunately, the regulators let it fly and try to fix it later if it is a problem. This is all under the philosophy of "don't throw the baby out with the bath water". I agree with that idea up to the point that they have some reasonable idea of how it will affect the overall system.

Now middle-class America has been placed in a position where we have to invest to try to accumulate money to retire. This is not about getting rich... it is about heating the house and putting bread on the table in old age.

Right now we are looking at about 15 years of no gain with 15 years of inflation stacked on it.

A fairly small group of financial entities crafted something very large that has ruined our financial ecosystem... or at the very least seriously impaired it for years. There is also a form of collusion that goes on between the businesses and the systems watch dogs (analysts and rating agencies).... because they sell each other services (payoff).

The govt is now engaged in trying to prop up the underlying mechanisms of capitalism that have been pillaged along with the economy in general. This will probably work to a degree (but leave the US in sever debt with large inflation).

The system is stacked against the small investor.

Without fundamental changes... we are looking at serious boom/bust/bubble cycles that create instability for most everyone from consumer to business. It is just a matter of time before we are ruined or impaired permanently. There is no way to insulate yourself in a practical way. You are in a position to have to participate to try to accumulate retirement savings. The entities that manipulate and game (hedge funds and other financial companies) are doing this to the degree that they are killing the entire system.

Something must be done! If it is not... we are in trouble.

IMO - sweeping regulation that has wide ranging wording and power... kinda like RICO to combat this type of behavior is needed. Not exactly sure how to do it... but it would work like this. If you are involved in activity that causes great harm... [fill in the RICO type wording] you go to jail for a minimum of 25 years to a hard core federal penitentiary.

The complication is that many of the activities that lead to ruin are not per se illegal because they are ahead of regulations. Regulations are almost always instituted after the fact.

Putting laws in place that make these people responsible for their actions after the fact is what it will take for them to respect the overall system. I think it can be done and it will stabilize the markets.

Most investors do not what ridiculous instability... they work to try to reduce those risks.

 

[lazygood4nothinbum]

Soros says deep recession inevitable, depression possible: Financial News - Yahoo! Finance

* Said hedge funds were an integral part of the financial market bubble which now has burst.
* Said hedge funds will be "decimated" by the current financial crisis and forced to shrink their portfolios by 50-75 percent.

fortunately, i am comforted that firecalc ciphered in a depression.

 

[chinaco]

Congress is investigating.

Hedge Funds do not really want transparency. They do not want others to know how they are investing. No one really knows.

Speculation and the use of derivatives (not used as a hedge)... not owning the underlying asset, shorting, and other speculative moves should probably have 2x or 3x the normal short-term and long-term cap gain rate.

The allowed amount of leverage used should also be lowered.

 

[al_bundy]

and ironically Soros runs a hedge fund that took on the BOE back in the 1980's

 

[chinaco]

and ironically Soros runs a hedge fund that took on the BOE back in the 1980's

Then he had better be ready to be regulated heavily and taxed at a much higher rate.

 

[FinanceDude]

1. As of yet, the federal government has not needed to bail out any hedge funds in this recent crisis. It is the highly regulated banks and investment banks that are the problem.

They are imploding on their own without his help. I think most "average Joe" Americans care more about their 401K balance than if some multimillionaire lost 80% in a hedge fund.........

 

[chinaco]

[/list]
They are imploding on their own without his help. I think most "average Joe" Americans care more about their 401K balance than if some multimillionaire lost 80% in a hedge fund.........

True enough... but average joe is worried about the hedge funds speculation in the markets.


Stock markets and bond markets to a mechanism for business to raise capital. Investors invest and make a return.

Commodities markets are intended to stabilize prices and make them a bit more predictable for both parties the producer of the commodity and the company that uses the commodity to produce the product.


Hedge Funds seem to be nothing more than a pool of money for short-term speculation that destabilizes these markets. Yes they are losing money right now. But they cause the markets normal participant to lose money and disrupt the basic mechanism.


IMO - The practice should be banned or heavily curtailed.

 

[al_bundy]

Then he had better be ready to be regulated heavily and taxed at a much higher rate.

i'm sure with the obama administration this is a certainty. Soros is one of the largest DNC donors in history. anyone remember moveon.org?