This morning on The Big Picture blog, Barry Ritholtz stated that the explanations for yesterday’s rally were just too convenient.  “Draghi” or positive “ADP data” or the “market getting comfortable with the prospects of an Obama win” are “narratives [that] tend to try to tell a story that give us comfort, rather than determine what actually happened and why.”

Barry continues, “There simply is nothing new in any one of those items that wasn’t a) well known and/or b) expected or c) easily deduced by simply looking at history.”

I don’t agree.  I think that the market reacted positively to Draghi’s furthering the ball down field in what will be a massive money printing effort by the ECB.  I’ve commented many times about the reasons why they will eventually do this and the impact that stimulus has on equity markets (see here for just one post). 

Furthermore, unlike Barry who says, “What did cause the rally? I don’t know, and mostly, I don’t care,” I do care.  Because if I’m right (and there’s obviously no guaranty that I am), then the market will have the Bernake put to limit potential downside over the short to intermediate term.  This affects portfolio positioning as it provides reasons for healthy–but not full–equity market exposure.

Finally, Barry thinks that “underperformance” by hedge funds and mutual funds “is an explanation as to what is driving stock prices that is as good as any.”  Maybe, but these funds still need a reason to chase…and that reason, in my view, is the additional stimulus.

Regardless, Barry references the Wall Street Journal article that speaks to the fund’s underperformance.  It’s excellent information that most of you will not be able to read through a link (due to those pesky firewalls), so I’ve copied the full article here:



It was the rally that left many fund managers behind.

Stocks jumped nearly 10% over the summer, defying the expectations of many hedge- and mutual-fund managers who had bet on a decline. They saw a multitude of headwinds from Europe’s woes to the slowing U.S. economy and sluggish corporate earnings.

Now, those defensive fund managers are facing what’s known in Wall Street lingo as the “pain trade”: having to buy stocks just to avoid being left in the dust.


The longer stocks hold the summer’s gains, the more deeply the pain could be felt, forcing fund managers to start buying. That, in turn, could give stock prices another leg up and potentially generate a virtuous circle for the stock market and even more pain for those on the defensive.

“A lot of people were waiting for the next big selloff and it never materialized,” said Dan Greenhaus, chief global strategist at brokerage firm BTIG. “There’s going to be that pressure to try and play catch-up and not just merely play along but to gain some outperformance.”

While stocks pulled back in late August, they still are well up from lows hit in early June. The Standard & Poor’s 500-stock index is up 12% this year, with most of those gains coming from a 9.8% rally since June 1.

The performance gap is particularly stark among hedge funds. As of the end of August, the HFRX Equity Hedge Index is up 2.6% since the start of the year.

“The gap we are looking at is going to be very hard…for hedge funds to make up,” said Anurag Bhardwaj, head of hedge-fund consulting at Barclays PLC. “At this late stage in the year, when the rally has been around for a bit, do you decide to get into the game now?”


Among mutual funds, there is evidence of caution as well. In June and July, the most recent data available, stock mutual funds held 3.8% of their assets in cash and other liquid investments. While this metric doesn’t move around much, that’s a stockpile that was matched only once in the past three years, during last September’s financial-market turmoil. In March, mutual funds held 3.3% in cash.

The average mutual fund focusing on U.S. large-company stocks was up 6.9% through Tuesday, according to Morningstar Inc., roughly half the S&P 500’s total return, which includes the reinvestment of dividends.

Much of the skepticism about the summer rally has been rooted in concerns about events that will dominate the news for the remainder of the year.

September is seen as a month that is particularly ripe for a stock-market pullback. For starters, historically it tends to be a bad month for stocks.

On the news front, Europe is seen as a potential flash point. Many see Spain as still in need of a bailout, and Greece must persuade European authorities to hand over its next round of aid. While European Central Bank President Mario Draghi has been hinting at a program to boost European bond markets, many in the markets are skeptical it will work, especially with German officials not fully on board. The ECB meets Thursday, and some expect it to disclose details for a new bond-purchase program. Moreover, on Sept. 12, Germany’s Constitutional Court is expected to rule on whether Germany can participate in a rescue fund to aid some European governments.

Some also see risk for a pullback in stocks should the Federal Reserve not fulfill expectations for additional easing of monetary policy at its next policy meeting on Sept. 12-13.

Against this uncertain backdrop, many managers appear content to keep their powder dry. Some have bought to reserve bearish bets in stocks and other risky investments, such as commodities, analysts said. That likely has been providing some of the lift for the market recently. But there hasn’t been a race to make big bullish bets.

“Equity hedge funds have moved from having their toe in the water to putting a foot in the water,” said Philip Vasan, head of prime brokerage at Credit Suisse.

Colin Symons, chief investment officer at mutual-fund company Symons Capital Management in Pittsburgh, said he is sticking to a defensive posture even though it has meant lagging behind the broad market. The firm’s $93 million Symons Value fund has roughly 20% in cash and is up 8.7% this year. That has placed the fund behind 90% of funds in Morningstar’s large value category in 2012.

Mr. Symons points to long-term price/earnings ratios, which smooth out cyclical swings in margins, as suggesting stocks are expensive. He said current price-to-sales ratios also are high. Then there is risk from Europe, as well as the “fiscal cliff” in the U.S., where expiring stimulus measures threaten to send the U.S. economy back into recession.

In the current environment, “it is possible to lose money very quickly,” said Mr. Symons.

That continued defensive posture can be seen in the performance among hedge funds in August. The S&P 500 rose nearly 2% but the HFRX Equity Hedge Index gained just 0.8%.

Mary Ann Bartels, head of technical analysis at Bank of America Merrill Lynch, said Merrill’s measure of “net” position among long-short stock hedge funds, which make bets both on stocks rising and falling, also shows caution. Net positioning is calculated by subtracting the percentage of portfolio positions that are short from the percentage that are long. Net long positioning tends to fall when managers are more defensive.

Historically, net positioning for long-short funds has tended to be 35% to 40%, Ms. Bartels said. Recently, however, it is 19%. That makes hedge funds a likely source of demand for stocks. “That’s where the potential buyer is,” she said.