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The Forces That Move the Market

Posted at 2:23 p.m. EST on Friday. Oct. 3, 2014

»Hedge funds made me do it. I just didn’t know that was the reason.»

You would often hear me say that something happened because some hedge fund was flailing. I might exclaim, as I did yesterday, about how the market rallied at 11:43 a.m. on Wednesday for no reason. I would say, »that’s hedge fund capitulation.»

Critics came flying in, »explaining» that I couldn’t be more wrong, and that there were real reasons the market did what it did. Maybe some of the critics were sensitive because they were hedge fund managers themselves and didn’t want the scrutiny. Maybe others just refused to believe that the actual customers of stocks, the buyers and sellers of merchandise, could have that level of impact. They would like to believe that everything happens according to fundamentals.

Maybe they don’t understand that supply and demand don’t just play out in the real world but also in the stock world. Sometimes there’s as much supply from a busted hedge fund as there is from any commodity producer run amok. The demand side, the buyers, just can’t handle the merchandise all at once.

These critics, by and large, are wrong, dissembling, or clueless.

In my autobiography, Confessions of a Street Addict. I have already explained how hedge funds can distort the market to an extraordinary extent. I wrote about how the stock market almost fell apart in 1998 because a huge overly-leveraged hedge fund, Long Term Capital Management, blew up. LTCM’s collapse caused colossal collateral damage in many parts of the stock market, including my own portfolio.

There are always precipitating events that cause the collapse or near-collapse of a hedge fund. In 1998, we had the so-called Asian contagion, where some Asian economies living on borrowed money lost their lifelines. Their growth hit a wall and then imploded. It was hard to figure out how downturns in those countries could affect the earnings of our country’s corporations. I ignored it in the beginning.

As our stocks started plummeting day after day, when the only major event was the downturn in Asia, I became as flummoxed as others. I began to presume that many companies which I owned shares in were being hurt in a way I couldn’t understand. I was aghast at how many of my regional bank holdings were being crushed. I was also appalled at how some major money-center banks and brokers with little exposure to these countries were taking out to the woodshed relentlessly.

In 1998, I didn’t figure out that Long Term Capital’s unwiding was the link to our market. I ended up giving away shares in some of my best companies to stave off my own margin calls. Only after the Fed intervened, to cut rates and stop the decline that Long Term Capital had inflicted on the markets, had I finally realized what was going on.

I never forgot that lesson.