Hedge Funds Accumulate Stocks As Individuals Cash In

Hedge funds have been accumulating shares as retail investors are cashing their shares, a contra signal for professional investors that the Standard and Poor’s 500 index is poised to extend its gains.

Investors have redeemed $37.3 billion worth of mutual funds since August 2009, according to the Investment Company Institute. On the other hand data compiled by Bloomberg, Goldman Sachs (NYSE: GS) and industry consultants reveals that Hedge funds have been buying aggressively to the highest level since 2007. After October 2007, when S&P 500 stocks peaked, Hedge funds lost on an average half of their value owing to recession.

Mutual funds witnessed a similar redemption prior to credit freeze in August 2007, during the nine months up to February 2003, just as S&P 500 started a five-year rally. The sell off by individuals is offering hedge funds an opportunity to bet on over $11 trillion spent, lent or guaranteed by the U.S. government to end the recession, and this will fuel the stocks.

Individuals Turn Risk Averse, Move to Bonds

According to Washington based ICI, individual investors, who account for 82 percent of mutual fund owners, have turned risk averse as they were net sellers of equity at $21.4 billion and put $312.8 billion into bonds this year through the end of October.

Hedge Funds Turn Net Buyers

Harry Rady, who oversees $250 million as CEO of Rady Asset Management LLC says “It makes sense that hedge funds are getting long given that the market’s up so much in a six-month period. The Fed has said they’re not going to let the market go down and they’ve done it by pumping liquidity into a variety of markets and that’s spilled into the equity market. People have the confidence to take equity risk.”

2008 was one of the worst years for Hedge Funds as 900 went out of business, as S&P 500 declined by 38 per cent, the steepest drop in seven decades.

The Rally Since March

The S&P 500 has rallied 61 percent since reaching a low on March 9, for a 2009 return of 24 percent including reinvested dividends. In the backdrop of the debt standstill by Dubai World, most U.S. stocks fell last week as speculation that the recovery in the global financial system will reverse and it overshadowed fewer American jobless claims and increasing home sales. The Dow Jones Industrial Average slipped 0.1 percent to 10,309.92, while 273 companies in the S&P 500 declined compared with 224 that rose.

Stock Speculation On The Rise

Stock speculation is on the rise, thanks to the Federal Reserve, which has held its target rate for overnight loans between banks near zero since December. The benchmark three-month dollar LIBOR fell to a record low of 0.254 percent this month. Chicago Board Options Exchange Volatility Index, a benchmark based on prices paid to insure against S&P 500 losses, dropped to 20.05 last week, the lowest level in 15 months, before jumping to 24.74.

In the NYSE, Short interest increased in March and remains above historic levels. As of end October, stock sold short equaled 3.51 percent of shares outstanding, or 40 percent above decade’s average. According to an expert “Yes, hedge funds are buying stocks, but they’re also shorting stocks in record numbers and buying put options in record levels.”

At 21.9, S&P 500 P/E At 7 Year High

In the last week, S&P 500 was trading at 21.9 times the past year earnings of its companies, the highest since 2002. Also, survey done among economists by Bloomberg revealed that the numbers from the economy may not turn out on the comfortable side: US unemployment rate could stand at 10.2 per cent this month and there could be a spending decline in the manufacturing and construction sector.

Favorite Picks Of Hedge Funds

A Goldman Sachs survey of 13F filings revealed that Bank of America (NYSE: BAC), Pfizer Inc. (NYSE: PFE) and Apple Inc (NASDAQ: AAPL) were the popular picks of hedge funds. Since March 2009, Pfizer, the world’s largest drug maker, added 45 percent and Apple, maker of the iPhone, rallied 141 percent.

John Burbank III, the CIO of Passport Capital, a $2.1 billion hedge fund firm began adding shares halfway in to the rally and says “This is a phenomenon that should continue into next year and perhaps far into next year,”. Individuals “may never believe in equities again, we don’t know. But hedge funds are generally increasing, partly because they’ve been conservative, and partly because they see opportunities to make money.”