Hedge fund buyers are on strike
One perspective on what has happened with NASDAQ over the past couple of months and past year as well is that a lot of the bullish action over the past year was driven primarily by hedge funds capitalizing on momentum. Hedge funds have billions to throw around and they can certainly move the market. Traditionally, short-term speculation, which is what the hedge funds do best, could only move the markets for short periods such as a couple of months at a maximum, but since the end of the dot-com bubble retail investor interest in stocks has cooled enough that hedge fund activity can easily move the market a lot more and for a lot longer than mutual fund money flows driven by retail and institutional investors, such as retirement accounts and pension funds. I figure that hedge funds can now "move" the markets for periods of six months or more in any direction, before they run out of steam and reverse their course.
Not all hedge funds are created equal or have equal strategies or equal trading parameters. Many can be bullish even as others are bearish.
And they have no loyalty nor interest in the interests of everyday retail investors. They have no compunction to refrain from attacking companies and trying to drive their stock into the ground – for short periods of time. It is not uncommon to see a stock rise dramatically, then take a 10%, 25%, 30%, or even larger hit, and then bounce right back to a new high in fairly short order. This is volatility that profits the hedge funds at the expense of retail investors – unless the retail investor is smart enough to keep enough cash on hand to buy on these dips and pocket the profit of the rebound as well.
I think what we are seeing right now for NASDAQ, in particular the hotter momentum stocks of the past year is that the hedge funds are diligently engineering another one of these attacks, based not on company business fundamentals, but just because the hedge funds have the available capital to do so.
The current scenario has a number of stages:
- Bullish hedge funds run up stocks (last year.)
- Bearish hedge funds go into attack mode.
- Bullish hedge funds dump their stocks simply because the short-term momentum has evaporated.
- Formerly bullish hedge funds pile on on the short side to attempt to profit from the downward momentum.
- Retail investors and mutual funds dump momentum stocks as the downdraft becomes too painful.
- The process repeats, sometimes with recovery rallies which turn out to be temporary "dead-cat bounces."
- Eventually we hit "seller exhaustion" where everybody who is willing to sell has done so. At this stage the downwards momentum trend is gone and hedge funds gradually or quickly lose interest and begin closing out short positions, which kicks off a new bullish trend. This process is not clear cut, with lot of extended confusion, leading to false starts and trading ranges, with stocks moving both up and down on almost a daily basis, with no clear trend.
- Finally, enough of the bearish hedge funds bail out that the new bullish trend becomes more clear and sustained.
- Rinse and repeat.
So, where we are now is in stage 7, I think, with even formerly bullish hedge funds sitting tight and waiting for for stage 8 to play out.
Anxiety over the "sell in May and go away" seasonal trading pattern is in turn layering on top of all of that, possibly being the reason that stage 8 has not occurred yet.
The net result is that we are experiencing a so-called "buyer's strike" by the hedge funds as they wait for the new momentum to firmly take root and start growing.
From my perspective and looking at the NASDAQ chart, not to mention the state of the economy on a slow grind upwards, it looks like NASDAQ hit its near-term bottom back on April 11, 2014, and bearish hedge funds haven't been able to breach that level for over a month. But it is the lack of action by more bullish hedge funds ("on strike") that is now holding us back, even as even some of the bearish hedge funds may be beginning to sense the potential for a reversal for another leg upwards for NASDAQ – at some point.
NASDAQ is in a trading range, but that range seems to be narrowing, on both the high and low sides, suggesting that both bullish and bearish hedge funds are going on strike. Eventually enough of them will have gone on strike that collectively they will say "enough is enough" (not enough profitable momentum for each the bullish or bearish side) and then next bullish run will take off. Whether that happens within days or weeks remains to be seen.
-- Jack Krupansky