Why the World’s Alpha Investors Are Nervous

Last week, I popped into London’s restaurant and bar of the moment, Novikov, located in the heart of Mayfair, London’s hedge fund alley. Founded by Russia’s most famous and successful restaurateur, Arkady Novikov, who already heads an empire with more than 50 restaurants throughout Moscow, Novikov is where London’s global hedge fund glitterati now gather after a hard day of extracting money in the markets. I even spotted one of Russia’s “alpha” oligarchs quietly sipping vodka in the downstairs lounge — surrounded by an obligatory bevy of beauties and henchmen.

Alas, as a working stiff and non-billionaire (except in Zimbabwe), I was there not to show off my money, but for monthly joint drinks with Harvard Business and Harvard Law School alumni. Not surprisingly, I was the only representative of the Law School. As any investment banker will tell you, when evening rolls around, bankers are out for drinks at places like Novikov, while the lawyers stay behind dotting i’s and crossing t’s.

Once there, I quickly buttonholed one of my hedge fund manager contacts to get his current view on the perplexing state of global financial markets.

Here’s what we discussed.

The current market has both of us scratching our heads. By every technical measure we both look at, the market is as overbought as we can remember. The market’s remarkable staying power is unprecedented. Yet, the unquantifiable aspect — what some managers call “market tone” — is extraordinary. No matter how bad the news is, the market just seems to shake it off, and continues on its relentless climb. “Fear” is rapidly “transforming” into greed.

We also discussed the most surprising sector — European banks. With the European financial crisis dominating the headlines, you’d think that the European financial sector would be getting hammered. Yet, it seems that the more bombed out the bank, the better the performance. You need only look at the performance of two of my recommendations in Bull Market Alert — the National Bank of Greece (NBG) — which at one point doubled since Jan. 1 — and the Bank of Ireland (IRE), which has soared 75%.

And, always, with risk back on — emerging markets are on fire. He told me that his top-performing stocks have been in India — a market that is up by almost one third after a disastrous 2011. His holding in ICICI Bank (IBN) was up more than 40%. I had to confess I had stopped following India six months ago, frustrated by its lagging performance. Hedge fund managers investing in such risky assets are having a field day. One of the United Kingdom’s best-known hedge fund managers, Crispin Odey, whose offices are just down the street from me, runs a fund that was up over 14% in January alone.

At the same time, it’s hard to avoid the feeling that the market is just waiting for an excuse to roll over. And when it does, the fall will be as spectacular as the rise, for some of the reasons I outlined two weeks ago here.

In search of historical precedents this morning, I ran across some relevant statistics about the current state of the U.S. markets. According to research by Sentimentrader.com, the S&P 500 has now gone 29 days without trading in negative territory for the year. That performance is only the 14th time that the S&P 500 has been on such a winning streak since 1928.

The London Financial Times also examined how often the S&P 500 has remained above its opening January level for the entire year. It turns out that this accomplishment only has happened eight times since 1928. The last time was in 1979 when Jimmy Carter was president.

But when the market did maintain its gains, the market’s median gain was 21.5% at its high point during the year. Of the other five occurrences that didn’t last the entire year, the market went an average of 92 trading days before falling below the previous year’s close.

So, if 2012 turns out to be average in this regard, we still have another month and a half to go before markets fall back to those levels. That action would cause the S&P to slip to 1,255, based on 2011’s close on the S&P 500.

So, where does this historical market information leave us?

If I could sum up my discussion in the bowels of London’s hedge fund alley in a few words, it would be this:

Never have we been so nervous about making so much money, so quickly.

It seems that we are all still waiting for the other shoe to drop.

Sincerely,

Nicholas A. Vardy
Editor, The Global Guru