New giant on wall street: the explosive growth of hedge funds is being felt from stock trading floors to the fed boardroom.There are many ways to measure the impact of monetary policy on the economy: the growth of the monetary aggregates, bank lending and credit growth, the shape of the yield curve. And practically everyone keeps a close eye on the stock market. But Wall Street is no longer reacting in predictable ways to changes in monetary policy. Consider that the value of IPO's plummeted the first five months of 2001 to $12.3 billion from $38.3 billion during the first five months of 2000, yet there was a significant stock market rally during April and May. The depressed NASDAQ NASDAQ in full National Association of Securities Dealers Automated Quotations U.S. market for over-the-counter securities. Established in 1971 by the National Association of Securities Dealers (NASD), NASDAQ is an automated quotation system that reports on raillied by over one third. The level of trading activity also has expanded this year. In the cas of technolgy, trading velocity was 373 percent during the first four months of the year compared to 257 percent during 1996. The rally in the equity market against a backdrop Backdrop may refer to:
The profit earned on short-term trades of securities held for less than one year, subject to tax at normal income tax rates. trading profit . The dramatic growth of hedge funds is changing the behavioral response of the equity market to monetary policy. In 1999 and early 2000, the hedge funds were primarily long on the market and thus helped to drive prices sharply higher when monetary policy was accommodative because of concerns about the risk of Y2K See Y2K problem and Y2K compliant. Y2K - Year 2000 disruptions in the economy. When monetary policy finally caused the market to correct, the hedge funds began to short the technology sector and drove it sharply lower. This selling pressure persisted until March-April when Fed easing became so aggressive that the market stabilized sta·bi·lize v. sta·bi·lized, sta·bi·liz·ing, sta·bi·liz·es v.tr. 1. To make stable or steadfast. 2. and the hedge funds began to curtail cur·tail tr.v. cur·tailed, cur·tail·ing, cur·tails To cut short or reduce. See Synonyms at shorten. [Middle English curtailen, to restrict their short positions. The big stock market rally during late April and May resulted overwhelmingly from the hedge funds reducing their short positions. Hedge funds also have emerged as the dominant players in the rapidly growing convertible bond market. They are attracted to the market because it provides opportunities for arbitrage arbitrage: see foreign exchange. arbitrage Business operation involving the purchase of foreign currency, gold, financial securities, or commodities in one market and their almost simultaneous sale in another market, in order to profit from price with the equity market. As a result of hedge fund demand, the convertible market has expanded to a value of $187.5 billion from $154.7 billion one year ago and $128 billion in 1998. While there is no precise way to measure the hedge fund share of the market, traders Traders Individuals who take positions in securities and their derivatives with the objective of making profits. Traders can make markets by trading the flow. When they do this, their objective is to earn the bid/ask spread. estimate that it is about 50 percent. Hedge funds have been able to establish such a large position because the banks typically give them leverage ratios of 7 to 8 for convertible bond positions. On the basis of such ratios, the hedge funds could dominate the market with only $15 billion of equity capital. Hedge funds have a long history of collaborating with central banks This is a list of central banks. Contents A B C D E F G H I J K L M N O P Q R S T U V W Y Z and ministries of finance to manipulate markets. Japanese officials have long given private guidance to major hedge funds in order to influence the yen/dollar exchange rate. The famous Soros attack on the pound during September 1992 was inspired by the Bundesbank itself. In the week before Black Wednesday In British politics and economics, Black Wednesday refers to 16 September 1992 when the Conservative government was forced to withdraw the Pound from the European Exchange Rate Mechanism (ERM) due to pressure by currency speculators—most notably George Soros who made over , Bundesbank officials had told Soros consultants that they wanted the pound out of the ERM (Enterprise Relationship Management) An umbrella term with many shades of meaning over the years. It may refer to the management of information from any or all of an organization's customers, suppliers, business partners and employees. . They even provided confidential information Noun 1. confidential information - an indication of potential opportunity; "he got a tip on the stock market"; "a good lead for a job" steer, tip, wind, hint, lead about Italy's dwindling dwin·dle v. dwin·dled, dwin·dling, dwin·dles v.intr. To become gradually less until little remains. v.tr. To cause to dwindle. See Synonyms at decrease. foreign exchange reserves Foreign exchange reserves (also called Forex reserves) in a strict sense are only the foreign currency deposits held by central banks and monetary authorities. to encourage a devaluation devaluation, decreasing the value of one nation's currency relative to gold or the currencies of other nations. It is usually undertaken as a means of correcting a deficit in the balance of payments. of both the lira LIRA. The name of a foreign coin. In all computations at the custom house, the lira of Sardinia shall be estimated at eighteen cents and six mills. Act of March 22, 1846. The lira of the Lombardo-Venetian Kingdom, and the lira of Tuscany, at sixteen cents. Act of March 22, 1846. and the pound. Alan Greenspan Alan Greenspan Dr. Greenspan is Chairman of the Board of Governors of the Federal Reserve System. Dr. Greenspan also serves as Chairman of the Federal Open Market Committee (FOMC), the Fed's principal monetary policymaking body. does not appear to have a personal relationship with the hedge funds comparable to the one which the Bundesbank once enjoyed with Mr. Soros, but there is little doubt that the hedge funds are emerging as an important conduit conduit /con·du·it/ (kon´doo-it) channel. ileal conduit the surgical anastomosis of the ureters to one end of a detached segment of ileum, the other end being used to form a stoma on the of monetary policy. They are so momentum driven in their investment decision making that they tend to encourage market overshooting Overshooting The tendency of a pool of MBS to reflect an especially high rate of prepayments the first time it crosses the threshold for refinancing, specially if two or more years have passed since the date of issue without the weighted average coupon of the pool crossing the both ways in response to monetary policy changes. In 1999 and 2000, the hedge funds encouraged the market to rise to ridiculous levels of valuation. In 2000 and 2001, they caused the valuations of several large cap technology firms to implode To link component pieces to a major assembly. It may also refer to compressing data using a particular technique. Contrast with explode. . In April and May, their short covering caused many equities to rally sharply despite an absence of any change in fundamental news about profits and orders. If the Fed continues to ease, Mr. Greenspan will probably be able to force the hedge funds to remain more positive about the market than they were three months ago. The growth of the hedge fund sector has been so explosive that neither Wall Street nor the Fed fully comprehends how much it is changing the character of U.S. investment decision-making. The brokers certainly understand the impact of the hedge funds on their profitability because the funds typically have turnover rates three times higher than traditional institutions and now represent about 20 percent of daily trading volume Trading volume The number of shares transacted every day. As there is a seller for every buyer, one can think of the trading volume as half of the number of shares transacted. That is, if A sells 100 shares to B, the volume is 100 shares. . The hedge funds have also enjoyed preferential pref·er·en·tial adj. 1. Of, relating to, or giving advantage or preference: preferential treatment. 2. access to stock during the IPO (Initial Public Offering) The first time a company offers shares of stock to the public. While not a computer term per se, many founders, employees and insiders of computer companies have found this acronym more exciting than any tech term they ever heard. boom of 1999-2000 because of their importance to the bottom line of the brokers. But most traditional fund managers still do not grasp how important a factor the hedge funds have become in determining both the market's trading momentum and the new parameters for valuation when money is heavily focused on a few large cap high liquidity companies such as Cisco or Intel. What remains to be seen is whether the hedge funds will be able to continue attracting capital on a large scale when their role in the market is to increase volatility and the risk of trading losses The following contains a list of trading losses which eventually forced major corporations to go bankrupt or restructure parts of their organisation. This list is not exhaustive. . After a year of declining equity prices, it is not surprising that many investors want an opportunity to invest in a fund which can go short as well as long. Ironically, the major growth sector on Wall Street until recently was index funds which merely tracked the market's performance. But it is unclear how many investors will be able to exploit short-term fluctuations in the market when there are so many new hedge funds with similar trading strategies In finance, a trading strategy (see also trading system) is a predefined set of rules to apply. Usually, this refers to a means used to replicate an option in order to give it an arbitrage free value in the sense that the cost of buying some financial assets to give the same . The hedge funds have evolved into an electronic herd with a strong propensity to create trends that become self-reinforcing and thus encourage markets to overshoot o·ver·shoot n. A change from steady state in response to a sudden change in some factor, as in electric potential or polarity when a cell or tissue is stimulated. . In contrast to the Asian emerging markets of 1997, the New York New York, state, United States New York, Middle Atlantic state of the United States. It is bordered by Vermont, Massachusetts, Connecticut, and the Atlantic Ocean (E), New Jersey and Pennsylvania (S), Lakes Erie and Ontario and the Canadian province of market has sufficient depth and liquidity to absorb hedge fund buying and selling without becoming dysfunctional dys·func·tion also dis·func·tion n. Abnormal or impaired functioning, especially of a bodily system or social group. dys·func . But the level of trading velocity has still risen to levels that suggest we are experiencing an unprecedented institutionalization Institutionalization The gradual domination of financial markets by institutional investors, as opposed to individual investors. This process has occurred throughout the industrialized world. of speculation without any anchor in traditional valuation parameters. Mr. Greenspan has not spoken publicly about how the hedge funds are changing the character of the New York equity market. But in formulating monetary policy, he cannot overlook the fact that monetary policy has a new channel to influence the equity market and the economy--a burgeoning hedge fund industry that will create trend-reinforcing behavior in equity prices and thus cause markets to respond rapidly to any surprise developments in monetary policy. [GRAPHIC OMITTED]
TRADING VELOCITY
% Change
Turnover 1991 1996 2001 '01 vs '91
Consumer 74% 137% 132% 78%
Discretionary
Consumer Staples 50 58 85 69
Energy 45 71 115 158
Financials 71 69 119 68
Health Care 87 87 125 43
Industrials 54 64 132 146
Information 266 257 373 40
Technology
Materials 66 85 137 108
Telecom 36 61 141 291
Utilities 48 53 134 177
TOTAL 114% 128% 188% 65%
Source: Morgan Stanley Research. Turnover is defined as annualized
shares traded divided by shares outstanding.
1. There has been major expansion of
bond issuance during 2001.
U.S Dollar Fixed-Income Origination Summary
Investment U.S. High-Yield Emerging
US$ bil. grade Corporates Market
Jan 00 44.9 6.3 6.2
Feb 00 57.0 7.3 6.0
Mar 00 67.3 6.9 10.0
Apr 00 30.9 3.1 0.3
May 00 41.8 2.2 0.8
Jun 00 59.3 6.1 2.4
Jul 00 53.3 3.6 6.2
Aug 00 38.8 3.8 5.8
Sept 00 38.0 5.9 2.4
Oct 00 26.9 1.2 0.1
Nov 00 30.0 1.9 0.3
Dec 00 34.2 0.9 0.5
Jan 01 70.9 14.5 9.0
Feb 01 47.6 9.2 8.5
Mar 01 60.2 8.7 6.1
Apr 01 50.7 6.6 6.2
May 01 80.3 11.8 8.1
Sources: UBS Warburg LLC, Thompson Financial Securities
Data, MCM Market Watch, Capital Data Bondware
2. The growth of the asset based securities market has remained
positive.
Public Year 1995 1996 1997
($Bn)
Credit Card 46,906.40 47,445.00 37,916.06
Autos 21,157.80 32,547.20 33,292.50
Home Equity 15,612.40 37,787.50 67,875.60
Man. Housing 6,099.80 8,156.60 8,927.30
Student Loans 2,862.40 7,984.60 12,554.00
Other 8,759.10 18,343.60 24,908.40
Private Year
Credit Card 993.00 2,661.80 3,085.90
Autos 1,617.30 2,715.20 3,341.00
Home Equity 1,305.40 497.80 2,059.40
Man. Housing 65.80 15.90 332.30
Student Loans 25.00 62.90 18.90
Other 2,046.00 8,810.00 24,661.20
Total
Credit Card 47.9 50.1 41.0
Autos 28.8 35.3 36.6
Home Equity 16.9 38.3 69.9
Other 19.9 43.4 71.4
CDO
Other 19.9 43.4 71.4
113.5 167.0 219.0
Public Year 1998 1999 2000
($Bn)
Credit Card 36,954.90 38,016.60 $50.30
Autos 35,835.30 39,921.00 $61.50
Horne Equity 83,946.20 70,359.30 $68.50
Man. Housing 11,245.50 11,983.70 $ 9.60
Student Loans 9,464.90 8,788.00 $13.50
Other 18,408.50 28,868.80 $14.30
Private Year
Credit Card 6,173.00 3,434.80 $6.40
Autos 5,234.40 4,337.40 $6.40
Home Equity 3,596.70 4,414.40 $7.20
Man. Housing 666.00 3,051.30 $1.40
Student Loans 774.10 1,359.20 $1.50
Other 58,984.20 59,938.90 $17.00
Total
Credit Card 43.1 40.7 $56.7
Autos 41.1 47.4 $67.9
Home Equity 87.5 73.0 $75.7
Other 74.5 65.0 $57.3
CDO 32.6 $37.1
Other 99.5 97.6 $94.4
246.3 226.1 $257.6
3. There has been further growth of the asset backed markets in 2001.
Year 2000
Sum of Amount
Offered bn $ 1 2 3 4 5 6 7
Auto Leases 0.0 0.0 1.05 0.0 1.15 1.09 0.0
Auto Loans 2.60 3.32 6.13 3.84 4.12 7.71 2.75
Credit cards 1.77 3.62 6.41 2.07 3.38 5.78 2.95
Home Equity 1.19 2.26 5.01 2.30 1.77 5.63 1.71
Residential Mortgages 0.0 2.56 9.41 1.74 2.06 .786 3.54
Student Loans .884 2.04 2.06 2.56 1.20 .635 .150
Sum of Amount
Offered bn $ 8 9 10 11 12
Auto Leases 1.19 1.04 .256 2.21 .151
Auto Loans 5.91 5.81 6.21 8.81 3.52
Credit cards 5.47 6.82 6.70 6.07 4.38
Home Equity 2.73 5.70 3.78 3.11 3.18
Residential Mortgages 3.24 .381 3.99 1.89 .308
Student Loans 0.0 2.68 0.0 0.0 0.0
Sum of Amount Year Year
Offered bn $ 2000 2001
Total Total
Auto Leases 8.16 2.81
Auto Loans 60.78 31.96
Credit cards 55.46 37.12
Home Equity 38.37 22.19
Residential Mortgages 29.95 9.82
Student Loans 12.23 4.24
4. Equity IPO activity is still very subdued
compared to the last three years.
IPOs
Date Amount ($m) Number
1991 25,928 380
1992 39,841 595
1993 69,762 868
1994 47,379 769
1995 38.103 719
1996 81.811 971
1997 80,595 683
1998 52,480 429
1999 94,226 561
2000 100,698 439
2001 * 48,634 89
* 2001 annualized
Source: Bloomberg
David D. Hale is Chief Global Economist with Zurich Financial Services Zurich Financial Services Group is a major financial services group based in Zurich, Switzerland. Global operations North America The US consumer market is served primarily by Farmers Insurance Group the third largest personal lines property & casualty insurance . The content of this of article is solely the pesrspective of Mr. Hale and not necessarily that Zurich Financial Service. |
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