Is subprime the tip of the iceberg that sinks the market?

Is subprime the tip of the iceberg that sinks the market?

The market has known for months about the sub-prime problem and just like an ostrich it has buried its head in the sand. Traders have been blindly pointing to the positives earnings and global growth while ignoring the storm clouds ahead.

Here's what concerns me the most ...

The growth of hedge fund has been nothing short of phenomenal. Look at this chart, did the rich people get it wrong?

Did all the smart people from Harvard climb on the bandwagon a little too late, while at the same time chasing too few deals that made sense?

Has Harvard who has 18% of its money in hedge funds become addicted to double digit returns?

According to the Wall Street Journal (8/1/07) edition, one hedge fund manager who graduated from Harvard lost 350 million dollars this past month for the Harvard Endowment Fund! Ouch, I guess tuition will be going up next year for Harvard.

All this leads me back to the subprime mess. Here we have a bunch of bright guys coming out of Harvard and Stanford and all the top business colleges coming up with exotic ways to create securities on bundled mortgages. On paper this idea looked great and worked out perfectly, but that is not how the real world of trading works. Theory and reality often collide in the marketplace. What looks good on paper can actually turn into a disaster in the market.

That bring us back to the Hedge Funds ... just how many esoteric and exotic deals have these guys cooked up that we don't know about ... yet??

The Fed has no clue on tracking what the hedge funds are doing. Why should they. If government can't keep track of 1.1 billion dollars paid to dead farmers how on earth are is the Fed going to track a hedge fund gunslinger.

My guess, and I'll use my friend Dennis Gartmans who writes the Gartman Letter, cockroach theory to illustrate this point: "if you see one cockroach you know there are more of them around".

In the coming weeks and months I expect we will see a lot more stuff hit the fan.

Is it time to run for the hills?

Read on and then decide on a course of action that works for you.

In the last twenty years we have had two major bear markets that have moved over 20% from peak to valley.

The first was in 1987 when the DOW dropped 36.1% in 40 days!

The next came in 2000 with the dotcom peak when the market dropped 23.9% in 436 days. The latter was more of a classic bear market.

There's really very little difference between a hedge fund manager and a regular investor. Both are driven by fear and greed. As human are genetical programed with these traits.

Now I think it is safe to say that hedge funds managers along with mutual fund managers are going to look after there own self interest in the markets. Which means they will be bolting thru the same barn door before the next guy. That is just how the market works.

Here's an amazing fact that just took place in June 14th, 2007. I still am in shock on this one. The SEC decided to repeal a rule that has been in place since 1938 that allows you to short a stock without having an uptick in the stock. What this means to me is that you can have a stock literally pummeled by massive amount of selling both from shorts and investors just wanting to get out thru the same barn door.

The question I have for the SEC is why now, and for what reason. What are these guy thinking?????

This one rule change alone from the SEC completes the scenario for a perfect storm in my opinion.

I did not talk about crude oil/ inflation/ interest rates you can see that here and in other parts of our blog using the search tool above.

Stay vigilant, listen and believe what the market it telling you. Remember, actions speak louder than words, and they slide faster than they glide.

Stay safe,

Adam Hewison

P.S. Last poll gave the bears a slight edge over the bulls after 180 votes cast.

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