The bear market has moved into a new phase. What started as a reasonable reaction to a potentially slowing economy accelerated into a full-blown crash triggered by the credit crisis and near collapse of the banking and financial systems.
The speed and extent of the market’s move down caught many by surprise. Interestingly, those on Main Street have done significantly better than those on Wall Street. This time around it was the big-wig hedge fund managers left holding the bag. Because of the amount of leverage used by the hedge funds, many managers had no choice but to sell positions into the tsunami. Margin calls require funds to raise cash.
Any guesses as to what they chose to sell?
You got it. They sold their biggest winners before the bull market came to a screeching halt, and those biggest winners were some of the hottest momentum stocks.
Because of the selling, these stocks are now the biggest losers during this bear market.
Typically, the bottom of a bear market is marked by a wave of forced selling. We have seen that happen here in spades. So is now the time to jump in?
If you have been following my Rational Investor approach, you managed to avoid this big mess by moving a large portion of your portfolio to cash. Now with that cash in hand, the time has come to take advantage of the misfortune of others.
What I’m proposing here is that by identifying some of the largest positions of hedge funds prior to the decline profits will follow. In theory, the stocks sold due to forced selling do not reflect true value.
Instead, these stocks are now inefficiently priced in a very disjointed market. Buying and holding them for the long term should result in significant out-performance.
According to my research, these six stocks had the highest dollar amounts invested by hedge funds. I suspect many were sold recently due to margin calls. They are as follows…
>
Stock #1: Microsoft Corporation (MSFT)
If you have to raise cash, and raise cash quickly, you will most likely sell assets that are fairly liquid, heavily traded and will best hold their value after you sell. Keep in mind that you are not selling because of some underlying flaw in future prospects. Instead, you’re selling because you have to.
Microsoft (MSFT) is a huge company that is heavily traded and generates a very dependable and large cash flow. The stock is owned by hedge funds, and they are selling shares in large increments. Shares traded lower during the month of October as hedge funds raised cash by selling shares. This stock rarely moves with such volatility. Use the selling as an opportunity to buy a very solid and stable technology leader.
Stock #2: Google, Inc. (GOOG)
Google (GOOG) fits in the same category as Microsoft. The company is a leader in its field and shares are heavily traded. It’s an easy call for hedge funds needing to sell shares.
Since the end of September, shares of GOOG have dropped by nearly $100. That makes little sense, especially in light of its most recent earning report. The company is doing quite well irrespective of the credit crisis. In fact, one could argue that the company will benefit during an economic slowdown as companies look to the Internet to maximize advertising dollars. This good news is not reflected in the stock. That tells me the decline in price was a direct result of hedge fund selling. I’d be a buyer of GOOG.
Stock #3: Yahoo!, Inc. (YHOO)
Hedge funds were huge buyers of Yahoo (YHOO) during the drama that involved a potential sale of the company to Microsoft. Given that MSFT’s bid put a huge premium on the stock, hedge funds acquired shares in what was some kind of arbitrage play. When the deal fell through, those on betting on YHOO being sold were caught holding the bag. Not wanting to sell when shares fell on the collapse of a deal, hedge funds held for the long term. Unfortunately, redemptions and margin calls forced their hand. (See also: "Yahoo: Short of the Year.")
YHOO has dropped some $8 per share since the end of September. Though a case can be made to avoid the stock as management has clearly dropped the ball, there is still the potential for YHOO to be sold for a higher price.
Stock #4: Hess Corporation (HESS)
The biggest beneficiary of hedge fund activity is the oil markets. Trading on an exchange that allowed for huge amounts of leverage, crude prices tore through the roof on rampant speculation. We know now that much of that speculation was hedge fund driven. Once oil moved to the $150 mark, prices reversed course. You can only push a commodity so far before consumers push back with lower consumption. That was the case with oil, and the move lower sent shockwaves throughout the hedge fund community. In fact, some funds closed up shop due to the huge price swings in crude and other commodities.
What about oil stocks like Hess Corporation (HESS)?
>
They benefited on the way up, but they are now paying the price. That price gets much steeper as hedge funds flee in droves of forced selling. Since late September, HESS has lost nearly half its value.
That makes little sense. I get that lower demand impacts pricing, but most of what we are seeing is deleveraging that has gone too far. I’d buy HESS at these discounts and count on an oil rally in the near future.
Stock #5: Potash Corp. of Saskatchewan (POT)
Like oil, anything tied to the agriculture sector experienced similar momentum buying from hedge fund managers. The push for ethanol in a market with high crude prices, combined with global demand for food stocks, provided a near failsafe investment thesis for big dollar managers. Given that there is no such thing as a risk-free trade and the fact that prices do not go up forever, it was easy to predict the end of the agriculture trade. (See also: "Potash: Is There Potential for Growth?")
One of the hottest stocks in the space was fertilizer maker Potash (POT). One of the biggest winners in 2007, the company hit a brick wall when oil prices began declining. Shares fell further in October with forced sales of hedge fund managers. Dump it, and dump it they did. At its low shares fell to $70 per share. That’s a bargain in my book. Ironically the food trade is usually considered a defensive position during a declining economy. That makes POT a safe haven.
Stock #6: Target (TGT)
Giant retailer Target (TGT) has been a favorite of hedge funds led by Pershing Square’s large stake in the company. Well before the credit crunch TGT shares lost value due to weakness in the consumer and an interest in lower prices. It was stumbling and hedge funds like Pershing believed that intrinsic value was much higher than where TGT was trading. (See also: "Is Target Strong Enough to Survive?")
It has not been a good trade, and it has only gotten worse with the credit crisis. Shares of TGT dropped more than $20 since September as many of hedge funds raised cash. If a fund has a redemption of $1 million, $10 million in stock needs to be sold due to the use of leverage.
Because TGT was a large holding, it was one of the stocks sold during the tsunami. Now would be a great time to buy shares. Even Pershing Square is working on a pitch to help management release the value in the stock. I would take advantage of the discount.
This article was written by Jamie Dlugosch, contributor to InvestorPlace.com. For more actionable insight like this, go to: www.InvestorPlace.com and check out:
