Wednesday, May 18, 2005



Most everyone knows that the way to boil a frog is to put it in a pot of warm water and gradually turn up the heat. The frog sleeps until cooked. Put a frog in hot water and he immediately jumps out.

Hedge funds are getting cooked! Traders hop around quickly but hedge funds often take relatively long-term two sided positions that limit risk--to a point. Hedgers have recently been caught every which way they turn. The hook was set when the GM hedge exploded and long-term treasury rates went the wrong way. Another way of describing the current pain is Chinese water torture. Day after day, the hedge funds are being dripped upon.

Many of the hedge strategies involve bond-stock (sometimes preferred stock) arbitrage or option-stock arbitrage. However, few of these are true arbitrages. A price move in the stock will not exactly be offset by a price move in the bond (convertible bond). Another problem is the option side of some of these trades must be renewed at a higher cost.

The big gorilla facing some funds is the threat of redemptions. Redemption's coming at the end of the quarter are a real problem for those funds trying to meet margin calls. The scramble is on to unwind positions.

The good news is that my family is fully invested. We are enjoying the ride. If you are not fully invested in stocks, you are missing a very nice run. Don't sit like a frog, the heat is getting turned up. Funds are being forced to capitulate. It is impossible to know what all the cross trades are or how big the problem for the funds. What we do know is that short selling set an all time record last month. All those shares sold short provide the fuel for a rising market. I would certainly not want to be short with the Dow up 105 and the NASDAQ up 18.

Buy the big bull boom bubble. Conditions are ripe for a major stock move