15 December 2003
Like generals, investors always risk fighting the last war instead of the current one. The increasing popularity of hedge funds after three years of stock market declines is a manifestation of this tendency, coming just as equities begin their bull run.
According to a report in The Business Times today, more than 100 Asia-Pacific focused hedge funds have been launched this year. It cited industry sources in stating that the Asian hedge fund universe, including Japan, will have expanded to US$25 billion to US$30 billion by the end of the year and will continue to grow at a rapid rate in 2004.
It has taken a full-fledged bear market to awaken many investors to the fact that equities are not one-way bets; they go down as well as up. Ironically, after the decline of the past three years, Asian equities have rebounded quite nicely this year. Hedging or hedging techniques like shorting is hardly the right strategy for such a market. But such is the nature of investing -- strategies come and go, and often at the wrong moments. Unwary investors often hop onto a strategy just as its effectiveness is coming to an end.
However, stocks cannot keep going up. Indeed, many analysts think a correction is likely over the near term. The main questions are over how deep the correction would be and how long it would last.
Another article in The Business Times "Will the Dow party last till New Year's?" provides reasons for optimism, suggesting that the US stock market is poised to remain strong in the coming months, even though there is some uncertainty in the coming weeks.
"While there is a growing consensus among market experts that the Dow and Nasdaq will easily move above 10,000 and 2000 respectively in the coming months, there is much more doubt when it comes to the market's direction in the weeks to come.
"‘The economy is going to be better than expected, therefore earnings will be better than expected,’ said Paul McManus, a fund manager at Independence Investment.
"‘The Dow and the Nasdaq should have no trouble building off, or topping, those levels eventually, but we've come a long way in a short time. I wouldn't be surprised to see a minor sell-off before the end of the year,’ he said."
With the Dow Jones Industrial Average and the Nasdaq closing at 10,042.16 and 1,949 respectively last Friday, McManus' prediction is hardly a challenging one. The bigger question is what happens beyond those levels.
The stock market usually anticipates the economy by about six to nine months. Its performance in the next few months depends on the economy's expected performance in the second half of 2004. For the market to do well in the next few months, the economy needs to do well in the second half of 2004.
Is such a good economic performance on the cards? After the boost given to the economy in the second half of 2003 and the first half of 2004 from the US government's tax cuts, most economists actually think that the US economy is likely to decelerate thereafter. Such a deceleration is usually associated with a weak stock market.
Of course, McManus did suggest that the economy is going to perform better than expected. That remains to be seen. With the US budget deficit, corporate and household debts all at or near record levels and no other economy looking likely to take over as the world's engine of growth, the source of such a positive surprise is not very apparent to me. And considering the fact that the US stock market is already trading at a forward price-earnings ratio of 17, it appears that the market may have already discounted a positive "surprise".
Indeed, not all fund managers are as sanguine as McManus. The same article quoted Ron Banner, president of Banner Asset Management, as saying: "Stocks are certainly not compellingly cheap at this point and after such unexpectedly big gains this year, the market, looking six months ahead, might start to wonder if the best has already occurred."
In which case one might be better off buying hedge funds after all.
Disclaimer: The commentaries posted here represent the opinions of the author at the time of posting and should not be taken as investment advice. Readers who wish to take any investment action based on information obtained from this site should seek appropriate advice from a qualified financial adviser.