Navarro's Broad Market Outlook: CPI to the Rescue
Score one for the Rally Monkeys as the markets got a big lift last week.  If you want a reason for the rhyme, look to the PPI-CPI news. 

While the PPI provided hints of inflation, the CPI flat out found nary a clue.  The bullish view is that low inflation means a restrained Fed.  But really, if the PPI is inching up and the CPI isn't, doesn't that suggest some type of squeeze on corporate profits that over the long run can't be bullish.  And speaking of squeezes, consumers are certainly grumpy, squeezed as they are by high oil and gas prices.

Still, it's pretty clear that Mr. Market frankly doesn't give a damm about longer run issues - at least for now.

Market Movers of the Week:  GDP Me...

New and existing home sales come out - always a source of volatility for the sector.  But the biggie is going to come on Thursday when Q1 GDP will be revised.

The betting is on a strong upward revision from 3.1 to as high as 3.8.  Why?  New trade numbers have come in showing more exports and fewer imports which adds to GDP growth.   So…..if we get 3.8 or higher, the bulls should get a nice buck up.

Portfolio Musing: Short WYNN

I conventioneered last week in Vegas and parked myself at the new Wynn Resort.   A la the stock picking method of Peter Lynch, I hereby speculate based on a rather sour personal experience that WYNN will be an excellent short.

This is a mediocre hotel marketed as the crème de la crème and, after the euphoria of its open fades, its room rates are going to plunge back to earth - somewhere below the Venetian, Bellagio, and Mandalay Bay which it can't hold a candle to and above Treasure Island and New York, New York.  Here's just a short list of some of its flaws:

A car entry that can't accommodate even half of the traffic flow, a claustrophobic rather than grand entrance, big lines at the check-in because of slow computers and inadequate staffing, a casino that looks no better than what the Indians provide in California, relatively small and surprisingly noise rooms, a total inadequate gym with a very expensive price, a pool with too few seats for the number of guests, mediocre cuisine, a Dragone show that isn't as good as several other of the Dragone shows in town, a golf course that charges $500 to play and doesn't have a driving range, a TV that malfunctions, and last but hardly least for this poor stock market junkie, no copies of Barron's for sale in the news stand (as of Sunday a.m.).

Hedging Your Bets With Matt Davio: The Latest Boogeyman
FIRST IN TWO-PART SERIES:

Like water is the most universal solvent and type ‘O' blood the universal donor, hedge funds have become the financial industry's universal causal factor. If you can't figure out why something happened in the worldwide financial markets, you are safe saying it was those ‘mysterious', ‘secretive', ‘largely unregulated', ‘powerful' hedge funds. 

For example, when the semiconductor names go up hard, it's hedge funds that have been ‘caught short' and are covering their positions. When oil tumbles, it's those hedge funds that have been ‘too' long oil futures. When bond yields tumble, it is hedge funds that have been pressing their short bets. 

Before we tackle this convenient but ultimately false nostrum, let's get some facts straight first. The worldwide mutual fund industry 5 years ago, excluding money market funds, was $9.3 trillion dollars in size and represented 46,000 different funds (ICI data). At the end of 2004, those numbers were $12.75 trillion and 51,363 funds, growing at 6.4% CAGR per year and 2.2% per year respectively.

As for the hedge fund industry, in 1995 the worldwide hedge fund industry was $480 billion in 6,200 funds (Van Hedge Fund Advisors data). At the end of 2004 those numbers had grown to $950 billion and 8,700 funds for a compound annual growth rate of 14.6% and 7% respectively.   In other words, hedge funds as a whole are less than 1/10th the size of mutual funds. 

But wait, can't hedge funds use leverage? And wouldn't such leverage cause them to have a bigger ‘footprint' in the market?

Well, Reg T does allow 2 to 1 leverage. And of course other derivative strategies could yield 10 to 1. So let's say, for argument's sake that something like 3 or 4 to 1 leverage is the average industry-wide (and this is a very aggressive assumption, it is likely to be much lower). That means that the $975b in hedge fund assets could represent a notional amount of $2.8 to $3.8 trillion. Still, hedge funds would be less than 25% of assets even under this most aggressive assumption.

So what's my point?  That hedge funds remain a relatively small portion of the overall assets under management in the world. Yes, they are more active and turn their portfolios over more frequently. But making the case that such active styles causes more volatility is an untenable conclusion.

Now here the most damming fact: During the time when hedge funds have proliferated in the last 5 years, the VXO measure of volatility has declined to 8-year lows. One could hardly make the case that the more active investment strategies of hedge funds has caused increased volatility over the last few years.

So if hedge funds, via higher portfolio turnover, the use of leverage, and total assets under management, are not to blame for whatever the latest unexplained move in bonds/currencies/stocks/commodities, why do they get a bad rap?  

For starters, the hedge fund industry doesn't have a lobbying group.  That makes them an easy target for legislators - and if you don't think that the hedge fund industry won't be a massive target for regulation in any serious bear market, you haven't read your history books.

Perhaps more importantly, there appears to be a psychological basis for hedge fund bashing.  Psychologists call it “projection bias.”  This happens when a person projects their own undesirable thoughts, motivations, fears, etc. onto someone or something else.

In this case, traders, investors, and media pundits are projecting their generalized fear of financial markets onto hedge funds. It's not the financial markets that we fear, it's really the hedge funds who “make" the markets do strange and distasteful things.  And of course, all those mutual fund managers that get outperformed by hedge funds have more than a little bit of fear and hate too.

My last take on this subject relates to a specific comment made by a sell-side strategist on PBS's Nightly Business Report. The strategist stated that hedge funds have made the stock market much more volatile in the last few years and that, as long as patient long term investors can live through that volatility, stocks will reward that patience.

Apparently this particular strategist is either (1) unaware that volatilities in March of this year made 8-year lows or (2) does not in fact know the definition of volatility. But that didn't stop a sophisticated show like NBR from blaming hedge funds for a non-existent volatility.  Note to the media: Please do a better job of doing your homework!

NEXT WEEK Matt will discuss the various kinds of hedge funds that exist and why you really can't generalize about this industry.

Peter Navarro is a business professor at the University of California-Irvine (www.peternavarro.com).  Matt Davio is a managing partner at the hedge fund, Infinium Partners, and be contacted for hedge fund services at infinium@peternavarro.com.

DISCLAIMER: This newsletter is written for educational purposes only.  By no means do any of its contents recommend, advocate or urge the buying, selling, or holding of any financial instrument whatsoever.  Trading and investing involves high levels of risk.  The authors express personal opinions and will not assume any responsibility whatsoever for the actions of the reader.  The authors may or may not have positions in the financial instruments discussed in this newsletter.  Future results can be dramatically different from the opinions expressed herein.  Past performance does not guarantee future performance.