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Minyan Mailbag: Index Traction

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Yeah - what's the deal with that?

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Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next column with that very intent.

Prof. Succo,

Why is it that indices sometime have a feeling that they just won't go down (like the SOX today)?

I realize that legitimate demand could be one reason. Options activity could be another (although that doesn't really come into play until expiration is within spitting distance [hey, I'm from the South]).

What other reasons could there be? Do institutions really "defend" their positions that way? I have heard that terminology before, but it seems to me as though that is throwing good money after bad and they should know better than to do something like that.

This is something that I have often wondered.

Thanks,


Minyan Ryan

Ryan,

Whose money is being thrown to bad? This has become a major cultural phenomenon of mutual funds.

A ponzi scheme works in the same way. Once you are in such a scheme, it pays for you to "get the next guy in" because it reduces your risk at the expense of increasing the risk to another. Once in, you become very familiar with the mechanics of such a scheme. You know it will eventually collapse, for there is no value (just like when paying a 20 P/E for a stock) underlying the "purchase". The next guy's money reduces your risk and gives you upside. So you don't effectively care if that person loses their money.

Mutual funds attract investors for their relative performance first, absolute performance second. They know this, so to keep the money coming in they buy the same stocks over and over no matter what the price to keep relative performance going. At one point, a major mutual fund company had some twenty different funds with 90% of the stocks overlapping. So it is your money that is being thrown to bad to support their relative performance.

There are certainly good mutual fund managers, especially value managers. One of the smartest men I know has been in this business for almost fourty years and has basically had no returns for the last two because he can't find any stocks to buy. His fund has had large redemptions because no one wants to wait for the right opportunity. Good men are being penalized for risk control and opportunistic investing.

Regards,
Prof. Succo

No positions in stocks mentioned.

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