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Precipitous Drop Off in Demand for Money May Signal Repricing of Risk Assets

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Connecting the dots between the decline in the need to hedge to a decline in the demand for credit, and looking at early harbingers of the oil and scrap industries.

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MINYANVILLE ORIGINAL Last week Bloomberg reported its hedge fund index returns for the month of September, and Long Biased Equity HFs were the clear winners by multiple percentage points, posting an incredible 5% gain for the month. Despite this remarkable performance Long Biased HFs are still down 1% YTD, dramatically underperforming the S&P 500 (INDEXSP:.INX) which closed out last month +14.5% on the year.

I have been suspecting that the post Labor Day trade would be a performance grab by underexposed managers and that appears to be exactly what is happening. Back on August 13 in The VIX According to a 20-Year-Old 'Seinfeld' Episode I suggested investors were positioned for a repeat of August 2011, and if the rally held, the pressure would be on to get long:

But after two weeks into August risk assets haven't crashed and now the market is at the post crisis highs, looking like it wants to break out despite decelerating economic and earnings growth. Investors are hearing it from both Costanza and Kramer and the uncertainty with whether they will get suckered yet again gets more intense the longer the market rally lasts. It is a dangerous time for all investors, retail and professional alike, but if this market remains bid into the Labor Day weekend, there will be tremendous pressure to get exposed to risk into year end.

With a 5% gain on the month while remaining down on the year it's pretty clear to me that this performance grab has been largely responsible for the push to new highs. No doubt the underexposed speculative community has been pushing prices higher as they cover and get long. Also the consensus belief that QE3 will see a risk-on rally is an obvious display of confirmation bias and points to the fact that the market is long.

Friday the S&P closed out one of the worst weeks since the June lows, down 2.2%, with the equity market losing much of the momentum that has been behind the recent rally as further evidence the market was full coming into the week. There might be one last push into year end, but I believe we are in the late innings of this leg of the rally.

Everyone knows the known risks. BlackRock's (NYSE:BLK) Bob Doll writing in Bloomberg's Economics Brief Friday lays out the long list of concerns, but despite these risks, he argues that equities are still a buy because they are attractive compared to the alternatives:

Headlines through much of 2012 have been dominated by risks ranging from the fragile nature of Europe's financial system, to fears of a slowdown in China, sluggish growth in the US and the looming 'fiscal cliff.' Meanwhile US stocks have gained close to 20% this year and some other markets have seen even stronger gains. Why the disparity? And, more importantly, is the bull market nearing an end? While the risks are certainly evident, and markets may be overdue for a consolidation or corrective action, the bull market should continue and we expect stocks to outperform Treasuries and cash over the next year.

This short squeeze that has stock prices near the highs of the year is providing investors with a false sense of security, masking risks that are lurking under the surface. As an analyst, my job is not to guess about market risks that everyone already knows are the most systemically important, but rather to try to identify rising tail risks which are not yet in the general perception. It's an equation. I take various indicators that could be saying different things and try to align them to see if there is a common theme.
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