Momentum is a double-edged sword. When things are flying up, those who own stocks are cleaning up. When momentum is going down, the shorts are crushing it.
Given that hedge funds have to make money in good and bad times, they have to develop styles that can make money in good and bad times. Some are sleuths; they are looking for chicanery, legerdemain. Alchemy.
Others are making big, macro bets, wagering against rates or indexes, typically the S&P 500.
But the most common style is to bet for or against sectors, buying the hottest on the way up and shorting the coldest on the way down. It's time-honored, and it can make your investors a ton of money. When you do it, as stocks break down, as I did with my hedge fund in 2000, when I was just staying short all the dotcom stocks, something I knew because of the work I was doing with TheStreet, you can make a name for yourself as the manager who made big money when the averages got obliterated. That's what every manager wants; it's what every investor craves.
I hung it up when I did it, and went to Disney (DIS) World, well not literally, but you get what I mean, and I retired from money management for journalism.
This brings me to what happened in the last two weeks of the market. It's been a halcyon time for hedge fund managers who were betting against the market for their investors. Given that the pandemic simply made many businesses completely uneconomic, these managers just kept pressing and pressing their bets.
Think about it. Oil companies that were struggling to make money at $30, were now confronting not $20 not ten but minus $37. They are going to bleed from their eyeballs at those prices. Or how about airline travel? You are getting load factors that are 90% empty. Unheard of. Cruise ships? They aren't even allowed to cruise. Restaurants are mandated to be shuttered. Whole malls are closed.
You know what that's called?
Shooting fish in a barrel, that's what. The shorts couldn't help but make money. These companies by nature have a ton of debt. They have cash, but not enough cash to get through a coronavirus pandemic. Without enough cash, without access to capital, these companies were done.
The shorts forgot one thing. The Federal Reserve. You see, Jay Powell, unlike his predecessors, decided he was not going to let these perfectly good businesses die, given that it wasn't their fault. This wasn't like 2007. There weren't greedy bankers and stupid housing speculators and bogus securities all over the place with impossible derivatives tied to them. It wasn't American Airlines' (AAL) fault that people decided that planes were filled with Covid. It wasn't Royal Caribbean's (RCL) fault that coronavirus causes one of the most contagious diseases doctors have ever seen. Don't blame Halliburton (HAL) or Diamondback Energy (FANG) for their obliteration, all because of a lack of demand caused by Covid-19.
Forget trying to bottom fish with what can't be valued without being a clairvoyant epidemiologist.
So the Fed decided to become a bank. A bank of last resort. Just like the Payroll Protection Plan from the Treasury kept people on the payrolls, the Fed decided to bankroll or backstop pretty much any public company that was running out of money.
Suddenly the fish in the barrel disappeared. They were replaced with leaping, short-eating piranhas that wreaked revenge this week that was so horrendous that they crushed all of those shorts who overstayed their welcome.
Think of it like this: If you are shorting airline stocks and they have no hope of staying alive and then one day the Fed says, they shall live, how do you value them?
We don't know.
But we do know this: We value them higher than they were.
Some hedge funds doubted this and held out, maybe for the airlines, maybe for the restaurants, perhaps for the oils, certainly for the retailers.
But this week they met their match and then were overmatched. I know, in fact, that some hedge funds actually lost not only their whole year, but their companies because they stayed short and were forced to cover these shorts, cash out empty-handed or owing money on what looked like the best shorts ever.
The problem now is that once the shorts have covered, did the stocks move up too much? Are they all on quicksand, the quicksand that the panic created? Think of it like this: If you owned stocks and they went too high and they corrected, what's the right level to buy them back.
We actually don't know. If we do have a vaccine as quickly as the White House says one can be make, they are longs. If not, they are shorts. To me that's too hard. A better idea? Buy good stocks, with good earnings. And forget trying to bottom fish with what can't be valued without being a clairvoyant epidemiologist.