Alaric Securities celebrates at Nasdaq MarketSite
May 13, 2016

Why markets have gone insane this year

Alaric Securities

There is something unprecedented going on with the markets, not with just the yen right now, but with all assets, as discussed by John Thomas, one of the founding fathers of the modern hedge fund industry.

A market where both fundamental research and technical analysis are utterly useless and everything goes the opposite of where it should is no place for me. Despite having negative interest rates and the world’s worst fundamentals, the Japanese yen has been skyrocketing since the beginning of February.

The last time the yen (NYSEARCA:FXY), (NYSEARCA:YCS) moved this sharply was when President Richard Nixon took the US off the gold standard in 1972, and currencies floated for the first time. The yen immediately shot up 10%.

I remember it like it was yesterday. There is something unprecedented going on, not with just the yen right now, but with all assets. So I am getting out of the way. If I don’t understand what is happening with a position, I drop it like a hot potato.

This could be occurring because Japan’s oil bill has been cut in half over the past year, shaving some $125 billion off its annual imports. That means less dollar buying and yen selling to settle the trade. However, in looking for reasons to explain the madness about us I could be too logical and analytical here.

In my travels around the US two weeks ago, I discovered what might be a more pressing reason to cause all asset classes to go haywire. I heard on the grapevine that there are at least a half-dozen large hedge funds with tens of billions of dollars in assets each that are going out of business.

Poor performance has led investors to demand redemptions en masse. That means unwinding possibly $100 billion worth of positions. And every one of these positions was financed by short sales in the Japanese yen. The only way for them to get out of these positions and raise cash is to buy yen, a lot of them, to close those shorts.

 If this is the case, it would explain a lot of what is going on in the markets this year. The worst performing asset classes of 2016 have been those where hedge funds were major owners. Those would include US banks, short positions in ten-year Treasury bonds (NYSEARCA:TLT), shorts in the Euro (NYSEARCA:FXE), and special situations like Variant Pharmaceutical (NYSE:VRX).

It provides the logic behind the atrocious performance by the big tech FANG stocks in recent weeks. And yes, it gives the backdrop for the enormous overreaction in Apple (NASDAQ:AAPL) shares after the Q1 earnings report.

It gets worse. When markets sniff out that big positions have to be shifted, they suddenly go illiquid. That leads to small amounts of capital triggering exaggerated moves in the underlying prices. That has given us the enormous volatility in all asset classes we have seen this year. Look at oil, stocks, gold, gold miners, silver, and the yen and they are all delivering the most extreme moves in a half century.

This all makes markets impossible to trade. Markets aren’t breathing. We are seeing one straight line move after another. Prices aren’t trading within defined channels that traders make their living from. Instead, they are going ballistic. In other words, the price action of 2016 can be described as liquidity events.

And this is the good news. All liquidity events burn out. Eventually, the positions get liquidated, the investors get their money back, and markets return to normal. You could blame all this on negative interest rates, which have never occurred before in history. I have never seen the strategist community so clueless before.

You might also ascribe it to the demise of the hedge fund. It seems that whenever industry assets approach $3 trillion in assets, it implodes. The market can accommodate only so much “smart” money. Almost all hedge funds accumulated their stellar track records when they were small. Get above $20 billion and they can only generate slightly better than utility-type returns. Only a select few friends of mine have been able to keep the numbers coming.

 My strategy has always been to break even when it is tough, and coin it when it is easy. This is one of those break-even times.

This is why my performance has been flat-lining just short of an all-time high for months. This too shall pass. When it does, it will be back to racking up double-digit returns, as I have done with this service for the past eight years.

Personally, I have great hopes for the second half of the year, when the presidential election gets out of the way. (Original article at Seeking Alpha with some charts by the author)

Disclosure by author: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.  I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Originally published by John Thomas at Wealth Management through Seeking Alpha.