Aug 29, 2010

Big Money Managers Turn Away From Stocks: The Real Disturbing Trend

By Andrew Mickey, Q1 Publishing

Last week the New York Times released a feature article on how mutual fund investors were “cashing out” of their mutual funds.

Specifically, it talked about how “small investors” investors are cashing out of stock funds and moving into bond funds.

In Striking Shift, Small Investors Flee Stock Market the paper reports:

Investors pulled $19.1 billion from domestic equity funds in May, the largest outflow since the height of the financial crisis in October 2008…

As investors pulled billions out of stocks, they plowed $185.31 billion into bond mutual funds in the first seven months of this year, and total bond fund investments for the year are on track to approach the record set in 2009.

The trend of mutual fund investors selling stocks and buying bonds has been going on for a long time. It’s usually a good sign too because mutual fund investors tend to buy and sell at the worst possible times.

But the “big news” picked up the financial media, and which was only added to by the ongoing strong of disappointing economic reports, only seemed to hide a much more disturbing trend.

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The most disturbing trend in the markets today is that some of the great money managers getting conservative or simply throwing in the towel altogether.

It’s no secret the markets are tough and will continue to be for a long time. The economy continues to worsen, higher taxes loom, and the entire business world is in standstill.

So the financial markets rally, fall, and repeat. And there’s no foreseeable end to this trend.

All of that undoubtedly played a role in some recent key decisions made by some top-performing money managers.

And successful investors should be watching why John Paulson, Stanley Druckenmiller, and Paulo Pellegrini made big moves recently. Because if we look at the likely reasons why they made them, we can get a much better of idea of how we can be more successful in the weeks and months ahead.

John Paulson: A Speculator Gets Less Speculative

It’s no secret the most important underpinning behind the 2008 credit crunch was leverage.

Homebuyers borrowed so much, they made the speculators of the late 1920s who put up 10% cash and borrowed 90% to buys stocks look conservative. Businesses used too much financial leverage (a.k.a. debt) to boost profit margins. Investors and traders took on too much leverage to buy stocks, bonds, timberland, and all sorts of assets.

The leverage was so high that when the gears of credit seized, well…2008 happened.

So when John Paulson, the man who profited the most from the credit crunch, reduces his own funds’ leverage, we should be paying attention.

A few weeks ago Paulson revealed his firm’s Recovery Fund, which was set up to capitalize on the rebound from the 2008 lows, was reducing its leverage. The fund cut leverage from 140% to 107% (that means it was fully invested and borrowed 40 cents on every dollar and is now fully invested but borrows only seven cents). This is a clear signal that Paulson sees some, but limited, upside potential here.

Paolo Pellegrini: When Nothing Makes Sense

Another big move was made by Paulo Pellegrini who helped Paulson set up the big bets against the subprime mortgage market.

Pellegrini has been an outspoken bear on the economy. After hitting it big in the 2009 rebound as his fund gained 61% for the year, Pellegrini has reestablished his bearish bets. As a result his fund is down 11% so far this year.

That’s why it was a notable surprise to see Pellegrini declare his firm will be returning all of its investors’ money. The firm will continue to manage Pellegrini’s own money.

This signals that all the easy money has been made. Pellegrini has made his mark capitalizing on the truly big opportunities – the credit crunch and the 2009 rally. But now, he’s not seeing any big opportunities. The combination of a range-bound market for stocks and few high-reward opportunities a multi-billion fund can take advantage of are surely a part of this decision.

Stanley Druckenmiller: The End of a Consistently Profitable Era

Finally, we got news this week one of the truly great investors has decided to hang it all up.

Stanley Druckenmiller has had an incredible run. After getting his start working for Soros and managing his own fund focused on growth oriented value stocks, he went on to average a 30% annual return for 30 years without posting a single losing year.

As the 30-year credit boom winds down, Druckenmiller’s fund is down 5% for the year and he has decided to leave it all.

Undoubtedly, there are a lot of factors involved here. He runs a large foundation and has worked very hard for a long time, so they’re part of it. But also the simple fact we’ve entered a long-run bear market has to be a factor too.

Investing Successfully in a Free Money World

The big takeaways from this trend come from looking at how these guys were so successful.

They foresaw the truly great opportunities. They spotted the low risk/huge reward opportunities and took advantage of them. Now, they’re all signaling opportunities are getting fewer.

Also, it shouldn’t be surprising all of this coincides with the end of the long-term credit bubble. The credit bubble drove up prices of everything and made a lot of money managers look great. Although these managers have the credentials and have consistently outperformed the markets, their moves signal investing successfully isn’t going to be as easy in the years ahead.

This week, however, we’ll be looking at where some of the fewer and fewer opportunities still remain.

Good investing,

Andrew Mickey
Chief Investing Strategist, Q1 Publishing

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