Jul. 14–There are two dynamics at work in the stock market. Hedge fund managers, who think the market is overvalued, keep selling, while individuals, earning less than 1 percent on their moneyfunds, keep buying.
One of these groups will be wrong. Short-term, my bet is with the individuals and against my fellow hedgies.
Here’s why: Individuals still have large parts of their assets in money funds and bonds. With interest rates this low, many are shifting more into stocks. This means there are trillions of dollars on the sidelines that could propel the market upwards.
The new tax bill should also give stocks a boost, because dividends are taxed at the capital gains rate, while money funds are taxed at the full income rate. People looking for yield may choose solid, slow-growth stocks rather than cash.
The move away from options and towards stock grants, as Microsoft did last week, should also ironically push stocks up.
As more employees own stock, companies with strong balance sheets and solid profits could significantly increase their dividends, especially when those dividends are taxed at the capital gains rate.
With high yields in a low interest rate environment, some stocks could move higher than they would have under the older based earnings models. Just look at how well real estate investment trusts (REITs) have performed. In many cases, investors don’t know what they’re worth. They only care about the dividends they pay.
A third bullish factor is the hedge funds themselves. In the past two years, huge sums have flowed into these funds, as they proved they could outperform a bear market. But now, many of these hedge funds are massively underinvested and losing ground to the market. If they don’t perform, they’ll lose assets. So the pressure is intense.
There are many brilliant hedge fund managers. But there are also average investors, who were in the right place at the right time. Many of these hedge funds are betting against the same overpriced stocks. That’s why the high profile stocks that the hedge funds love to hate, have performed the best.
The problem is there may be too much money in negatively oriented hedge funds, just as there was too much money in tech funds three years ago.
The difference between tech funds three years ago and the hedge funds now is, when money left the techs, it left the market. And the techs crashed.
If money leaves hedge funds, it may ironically flow into more bullish investments, like mutual funds. So hedge funds may have to buy the same stocks the mutual funds are buying, creating a double whammy on the upside.
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