Why Things Will Get Worse First - November 30

Let me say that we are about 75% through the correction phase. Is it too early to go long on equities again, I would think so. There appears to be a few more shoes waiting to drop. We have the auto sector. There could a few more big corporate failures which could dent sentiment, e.g. GE Capital and a few big hedge funds, and some private equity companies as well. AIG is still in ICU and the bloody wound is not clotting properly, its still bleeding and the doctors are very tired.

The biggest shoe among the many shoes to drop will be the hedge funds. Yes, many hedge funds have sold down their positions as early as 2Q 2008. In fact, for Malaysia hedge funds and normal institutional investors have sold down Malaysia earlier than the rest of Asia due to our big political uncertainty, and the flip-flop policies on IPPs and CPO. The entire process of selling has seen its fury over the last two months in particular when funds of all kind had to de-leverage. Good stocks and almost all asset classes were sold down mercilessly. Stocks and bonds as well, even bonds of companies which are in no real danger of going bankrupt are now selling at distressed levels (e.g. 70-75 cents to the dollar).

Naturally there has been an oversold situation, but nobody is willing to come in to bat for these oversold situations yet. Thats largely because fund redemptions are still high and many are still expecting more redemptions. While up to 15%-20% of all hedge funds might have closed shop or is in the process of winding down, the actual number needing to close down by middle of next year could reach double that figure.

While many hedge funds and mutual funds have been selling down everything, there are still a huge number of hedge funds who have frozen redemptions temporarily. You can only freeze redemptions for so long. Unlike mutual funds which are traded daily, hedge funds clients can only request their money back on certain dates, usually once a month or quarter. Many have suspended the monthly dates, but they are unlikely to be able to hold out on the quarterly dates for redemptions requests. Guess the FINAL DATE for this year for most hedge funds investors to file to redeem their stakes. Yes, its November 30th.

Many traders are already shorting some stocks that are likely to to be affected. If you are close to Goldman Sachs, they have a list/index that tracks the top stocks held by hedge funds. Request the index stocks there from them. To get some insight on how hedge funds have been de-leveraging, the 3 weeks ending October 10th saw that GS index falling by a massive 34%, while over the same period S&P 500 fell only 28%. The lock up period is only a temporary haven, it might make for another round of selling. Only, this time it could be a lot worse as volume and bargain hunters may have used up some of their cash already over the last few weeks bargain hunting. 7,600 for the Dow looks more likely than 9,000 for now.

But like I said on the first line, its about 75% over, best to do nothing, best to give up the first 10%-20% in a bottoming rally rather than trading into a volatile market with a strong downside bias. Keep at least 70% cash.

p/s photos: Tracey Ip Chui Chui