Dr.Marc Faber: A Modern History of Investment Booms

Posted by Dr. Marc Faber on The Daily Reckoning Australia: Modern History of Investment Booms

Some news articles: Faber Likes Asian Property, Says Stocks `Vulnerable' and Market jumpy? Blame privateers

• THE recent volatility and pull-back in Asian markets have prompted some investors to sound a familiar refrain: It's all the fault of the hedge funds.
  
  In the past two years, dozens of these funds have set up shop in Asia hoping to find relatively hidden lucrative opportunities, as markets in Europe and the US become more crowded and competitive. Their trading in equity markets has grown sharply: they were responsible for 22 per cent of the brokerage commissions paid on Asian cash equity trades in 2006, up from 5 per cent in 2004, Greenwich Associates says.
  
  Many small traders and brokers in the region argue that the growing influence of hedge funds in Asia has exaggerated market movements, particularly the declines that rocked global markets recently. They also say the funds contribute to higher volatility in Asian equity markets.
  
  Hedge funds are going to create even more unpredictable gyrations in the future, making things still more difficult for other investors, they say.
  
  On Wednesday, markets across Asia fell again on worries about the Western markets and the outlook for the US economy, with the Nikkei average in Tokyo falling 2.92 per cent.
  
  Regulators are keeping a close eye on these funds. Market regulators from Britain and Hong Kong are meeting Indian regulators in Mumbai in April to discuss hedge fund participation in markets. It is the first time India has hosted such a roundtable.
  
  A 15-fold increase in market capitalisation on Vietnam's stockmarket recently ignited fears among regional market analysts that Vietnamese regulators would impose capital controls to start shutting out foreign investors.
  
  Aggressive hedge fund managers normally take positions intended to profit from a market decline if they anticipate one. Many say the correction in late February was widely expected. In December, fund managers in Asia say they had begun warning of an imminent slide in markets.
  
  What is surprising about the February drop, though, analysts said, was how few hedge fund managers appeared to have profited from the market declines. Instead, they seemed to have been trying to take advantage of the bull market for Asian stocks and bonds by buying aggressively.
  
  Short selling - bets that certain stocks will fall - is not allowed in some Asian equity markets. But fund managers can mimic that strategy by using complicated financial derivatives and options to achieve the same effect. When stocks started to move down, though, investors jumped out, making drops even steeper.
  
  Referring to the sell-off that began in late February, Henry To, an investment adviser at MarketThoughts, said, "At the height of the selling, money managers in Asia were remarking that they have not experienced this kind of selling intensity since the height of the Asia crisis" in 1997 and 1998.
  
  A focus on hedge funds does not tell the whole story, though, emerging market veterans say.
  
  "The ferocity to which the market decline in China spilled over to the global markets is to some extent attributable to hedge funds," said Marc Faber, an investment adviser nicknamed Dr Doom for his bearish sentiments. "But today, it is not just the hedge funds that act like hedge funds - it is also the proprietary desks of banks like Goldman Sachs and Morgan Stanley."
  
  Because the compensation of traders at these banks is based on short-term trading profits, "when the market goes down they all sell," Mr Faber said.
  
  Wall Street investment banks have poured money and talent into proprietary trading desks in recent years, helping to earn record profits for their banks. Assets under management at these proprietary desks are difficult to quantify, but analysts at Keefe Bruyette & Woods estimate that these banks have more than doubled the amount of money in those businesses since 2001.
  
  Other factors are influencing the Asian equity markets. Hedge funds are "a growing player, and arguably a shorter-term player," said Hugh Young, managing director at Aberdeen Asset Management Asia. "But there is a lot of human emotion involved across the board," from hedge funds, traditional funds and other investors.
  
  A wide array of established hedge funds and the firms that serve them are setting up shop or expanding operations in Asia, including K2 Advisors and Bisys Alternative Investment Services.
  
  In some thinly traded Asian markets, the influx of new capital can be felt keenly.
  
  Trading volume of Asian interest rate derivatives tripled, to $US414 billion, in 2006 from the year before, Greenwich said, and the amount of credit derivatives doubled to $US67 billion. Greenwich Associates estimates hedge funds account for 30 per cent of the total trading in one of these assets, structured credit derivatives.