BUSTING HEDGE FUNDS (December 17, 2023): I had worked at Thomson Reuters for 16-1/2 years; the person sitting next to me had the responsibility of tracking hedge funds and reporting on their behavior. After doing this job for a couple of decades, he pointed out to me how the vast majority of hedge funds which had shown little correlation in their investing behavior through the early 1990s had become increasingly alike by the second decade of this century. The proliferation of hedge-fund conferences where they discussed their "best ideas," combined with nearly identical computer algorithms and momentum strategies becoming increasingly much more popular, almost totally displaced former tendencies toward value investing and identifying compelling bargains.
Although there remain key exceptions including money managed by Seth Klarman, Marc Faber, Jim Rogers, Howard Marks, Ray Dalio, and some others where it is unlikely that you will be able to have them handle your accounts, more than 90% of hedge funds are crowding into identical concepts at any given time. This herd following is especially prevalent at key extremes and has almost certainly caused many of those extremes to become much more exaggerated than they would have been if they hadn't existed. It is also increasingly the case that hedge funds as a group are doing almost exactly the opposite of top corporate insiders and commercials. Thus, tracking insider behavior and the traders' commitments has demonstrated repeated multi-decade extremes where the insiders and commercials are heavily on one side while hedge funds have been piling even more aggressively the other way.
Doing the same as insiders and commercials and the opposite of hedge funds has become an increasingly available and profitable investing strategy which I have been doing more consistently as the 21st century has progressed.
As a result, the most consistently successful strategy in the 21st century has been to do whatever the insiders and commercials are doing at any rare extreme, while going against the hedge funds. During the past year we have already seen several examples of this behavior with hedge funds establishing an all-time record short position in U.S. Treasuries in October 2023. This was followed by the biggest Treasury rally in four decades which intensified during the past week as hedge funds rushed to close out their shorts ahead of all the other hedge funds, and were not particularly successful in doing so. TLT had traded at 81.92 in the pre-market session on October 23, 2022, and less than two months later was trading above 99.
Hedge funds piling into the AI bubble is their latest extremely overcrowded trade, while the top corporate insiders of these companies have done all-time record selling of their shares.
The latest overcrowding by hedge funds has been in being long AI stocks. While most U.S. and global stocks and their funds including IWM have been in bear markets since they had topped out in November 2021, funds which are concentrated in the biggest and most popular megacaps which have generated the most investor excitement in this year's AI bubble have dramatically outperformed in spite of their unimpressive profit growth. QQQ has almost regained its all-time top, while XLK and SMH are among those funds which have experienced the greatest percentage gains during the past year and have achieved new record highs. The top insiders of these companies have never sold more aggressively than they have done during the past few years, while the only time hedge funds had been more committed to any concept was when they had been massively short U.S. Treasuries in October 2023.
This chart, just updated, highlights the amazing recent overcrowding by hedge funds into QQQ and Nasdaq 100 futures which has achieved an overwhelmingly lopsided extreme by a large factor even when compared with 2021 or 2022:
Less historically extreme but still massive overcrowding has created other 2023 situations ripe for busting.
Hedge funds, as is evidenced by the official exchange data at cftc.gov, had never demonstrated a higher ratio of shorts to longs for palladium, thereby leading to PALL plummeting to 85.25 at 12:06 p.m. on December 5, 2023. Since then it has rebounded above 100. Hedge funds piled massively into gold on Sunday evening, December 3, 2023 to reach a spot price of 2137.50 U.S. dollars per troy ounce for the first time in history. Given how hedge fund crowding leads to huge reversals, gold bullion is likely to drop to around 1750 during the next several months before enjoying its next strong rally. The traders' commitments for gold as of December 5, 2023 showed commercials (who are those that own physical gold, such as miners, jewelers, and fabricators) long 103,193 contracts and short 330,138 which is more than 3:1 short to long. Not surprisingly, almost all of those on the other side of this trade were hedge funds and related managed money organizations which the commodity exchange calls "large speculators."
Silver's commitments the same week showed commercials long 40,974 and short 92,988 which was clearly also bearish for silver. Hedge funds were thus aggressively long gold and silver and even more aggressively short palladium. Palladium commercials that week were long 12,814 and short 1,537 which is more than 8:1 long to short.
Hedge funds had done all-time record crowding into shorting the Japanese yen, enabling the yen to fall to its lowest point since July-August 1990. Since then the yen, which trades as an exchange-traded fund via FXY, has experienced its strongest short-term rebound since the Bretton Woods agreement was terminated over a half century ago.
Hedge funds formed a lesser bubble by massively overcrowding into energy commodities and their shares two months ago.
Several times since November 2022 including around the middle of September 2023, hedge funds massively crowded into anything relating to energy while energy insiders sold shares at their most intense pace ever recorded. This was an especially notable reversal for top energy executives who in 2020 were their most aggressive in buying their own shares in their entire history. Starting on September 14, 2023, when XLE reached an all-time dividend-adjusted zenith of 93.685, energy shares and their funds including XLE have been among the biggest losers of all unleveraged exchange-traded funds in any sector.
The media often encourage ordinary investors to do as the hedge funds are doing, which is not surprising since they get a lot of their information from hedge funds which are naturally trying to get others to follow whatever will benefit their own portfolios.
Why have the media suddenly been talking about a "Fed pivot?" It's not because financial journalists have suddenly discovered how to interpret whatever the Fed has been doing. It is because they receive a lot of their data and even more of their interpretation of that data from hedge funds which naturally want to get retail investors to pile into their largest positions. In addition, whenever any asset is especially popular or depressed, the media will seek out stories which will allegedly explain "why" U.S. Treasury yields will keep climbing even when they are at their highest levels since 2000 (as in October 2023) or why AI stocks will keep rising regardless of how overpriced they are (as in December 2023). If you follow the media then you will repeatedly buy near each top and sell near each bottom.
The current U.S. equity bear market is following its usual sequence of sector bottoms.
The Russell 2000 and nearly all related funds such as IWM, along with most stocks worldwide which are unrelated to the AI bubble, have been in notable bear markets since their November 2021 tops, on average losing about 20% of their value during the past 25 months. Before any U.S. equity bear market intensifies, as the current one will almost certainly do soon, we have a sequence of historic sector bottoms which are completed in the following order: 1) U.S. Treasuries which probably completed their nadirs in October 2023 and are in major uptrends; 2) gold mining and silver mining shares which I expect will bottom around the spring of 2024 before initiating powerful rebounds; 3) emerging-market stocks and bonds which will perhaps bottom around the summer of 2024 with Chinese shares notably underpriced and which could thereby become compelling bargains at that time; 4) non-precious commodity producers which might also gain by substantial percentages after they bottom later in 2024; 5) special situations which vary from one bear market to another. In this case, the sectors which could approach multi-year lows in 2024 and thereafter rally strongly might include currently unpopular biotech shares and their funds like XBI along with airline shares and their funds including JETS.
I also plan to be open-minded about other sectors becoming worthwhile for purchase sometime during 2024.
The ultimate bottoms for most AI shares won't occur until 2025 or 2026.
As a general rule, those shares which achieve historic bubbles tend to lose over 80% of their value and to take two to three years to complete their total downtrends. After QQQ had topped out on March 10, 2000, it lost 83.6% of its value by the time it bottomed exactly 31 months later on October 10, 2002 (see stockcharts.com which includes all reinvested dividends by default). If QQQ loses 83.6% of its recent high of 406.5, which could potentially go even higher in the short run, then this would mean an eventual QQQ bottom of 66.666 which looks to me like a very lucky number indeed.
The bottom line: An increasingly profitable strategy during the 21st century capitalizes on the tendency of the vast majority of hedge funds to use momentum methods and to thereby overcrowd massively into various positions. Top corporate insiders and commercials throughout various points in 2023 have been doing almost exactly the opposite of those hedge funds near all key extremes for a wide variety of assets including AI stocks in December (QQQ,SLK,SMH), U.S. Treasuries in October (TLT), the Japanese yen in November (FXY), large-cap energy shares in September (XLE), and all precious metals in early December including palladium (PALL), gold (GLD), and silver (SLV). You can therefore consistently make money, although not always immediately, by following the insiders and commercials and doing the exact opposite of the most overcrowded hedge-fund concentrations during the next several years.
Disclosure of current holdings:
Below is my current asset allocation as of 4:00 p.m. on Friday, December 22, 2023. Each position is listed as its percentage of my total liquid net worth.
I computed the exact totals for each position and grouped these according to sector.
The order is as follows: 1) U.S. government bonds; 2) shorts; 3) bear funds; 4) gold/silver mining; 5) coins; 6) miscellaneous securities.
VMFXX/TIAA(Traditional)bank CDs/FZDXX/FZFXX/SPRXX/SPAXX/Savings/Checking long: 36.32%;
26-Week/17-Week/52-Week/13-Week/2-Year/8-Week/3-Year/5,10-Year TIPS/4-Week/42-Day long: 21.66%;
TLT long: 11.67%;
I Bonds long: 10.54%;
PMM long: 0.01%;
XLK short (all shorts once again unhedged): 28.39%;
QQQ short: 17.23%;
XLE short: 5.15%;
XLI short: 2.77%;
XLV short: 1.69%;
SMH short: 1.01%;
AAPL short: 0.02%;
SARK long: 0.90%;
PSQ long: 0.03%;
PALL long: 0.20%;
GDXJ long: 0.14% (fully hedged with out-of-the-money covered calls);
Gold/silver/platinum coins: 6.28%;
FXY long: 0.17%;
PAK long: 0.03%.
