Will The Real Smart Money Please Stand Up?
Peter Cohan of DailyFinance asks, Hedge Funds Bet on Inflation, Institutions Bet on Deflation. Who's Right?:
smart money -- by which I mean hedge funds and institutional investors
-- is placing its bets outside of the stock market. But the smart
money isn't by any means in agreement about the direction of those
bets: Hedge funds are doubling down on big inflation down the road by
buying gold. But institutions are buying corporate bonds -- a wager on
deflation, since bonds grow in value as prices and interest rates fall.
only thing they do agree on is that neither group wants to invest in
stocks. But should you follow them? And if so, which way?
fund honchos such as George Soros, Leon Cooperman, John Paulson and
Erich Mindich are making big bets on gold because they see the specter
of inflation ahead. Bloomberg reports that Mindich's $13 billion Eton Park Capital Management bought 6.58 million shares of SPDR Gold Shares (GLD)
-- an exchange-traded fund that tracks the price of bullion. In that
gold trade he joins Paulson -- operator of a $31 billion fund -- who
personally made $3.7 billion in 2007 betting on the subprime mortgage meltdown.
institutional investors who are tired of getting beaten up by their
clients -- who are themselves tired of paying big fees for weak
performance -- are starting to creep out a little further on the
risk-return frontier from buying U.S. Treasury bonds to scarfing down
blue-chip corporate bonds. According to Fortune, 10-year notes for Johnson & Johnson (JNJ) yield 2.95%, a mere 0.43 percentage points more than comparable Treasurys.
institutions are clamoring to buy them, and companies are happy to
lock in the cheap capital. What strikes me as interesting is that
institutions are willing to pour capital into those low-yielding bonds
when J&J's stock sports a much higher 3.69% dividend yield
(dividend/stock price). This suggests that institutions are still too
scared to buy stocks.
Common Stocks: The Bottom of the Liquidation Hierarchy
times are heaven on earth for those in the bond trade. As PIMCO honcho
William Gross told me in February 2009 -- a few weeks before the
S&P began its 49% rise from around 735 to its current 1,098 -- we're
in an era where owning stocks is pointless.
He made an interesting argument: With slow economic growth, it makes
no sense to take the risk of being at the bottom of the so-called
When a company files for bankruptcy, its
bank lenders get first dibs on the proceeds from selling the company's
assets. If there's any cash left over, it goes to bondholders, then
preferred stockholders, and last of all to the people who hold the
company's common stock. Gross argued that investors are better off
buying bonds because with a reasonable risk of bankruptcy, such
investors will be better off than stockholders.
This is a great
argument -- except for the fact that it has proven to be wrong
recently. And the odds of companies going bankrupt seem to be
diminishing. Corporate America is in a cash-hoarding mood, holding $1.84
trillion according to the Federal Reserve. And since these companies
can now lock in extremely low long-term borrowing rates, their balance
sheets have been buffed up even as their common equity is out of favor
Can They Both Be Right?
thing seems to clear to me: The gold bugs and hedge funds betting on
inflation and the institutions betting on deflation can't both be right
at the same time. It's conceivable that the institutions could be
correct in the short and medium term, while the gold bugs end up being
right in the long term.
Let's face it -- those hedge fund guys
are the smartest and richest in the investment universe. But all the
statistical evidence I've seen says inflation is dead and is staying
buried despite the 140% increase in the U.S. national debt since 2000
from $5 trillion to $12 trillion.
Maybe the hedge funds buying
gold are momentum traders -- in that case they're buying because
everyone else is buying, and they're betting that they'll be smart
enough to get out before that buying turns to selling.
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