Kass: Selling Storm Might Be Clearing

This commentary originally appeared on Real Money Pro on Aug. 22 at 11:00 a.m. EDT.

The hedge fund de-risking and mutual fund redemptions will probably slow the growing ambiguity of worldwide economic growth, a negative feedback loop engendered by the political circus in Washington, D.C., and signs of an increasingly fragile European banking industry have (in large part) contributed to the recent selloff in the world's markets. I am convinced, however, that several noneconomic, temporary and artificial influences have conspired to accelerate the recent drop of stock prices.

A General De-risking by Hedge Funds

The recent selling bout has occurred at a time when, according to the ISI Hedge Survey, hedge funds were already reducing their net equity exposure. ISI's latest numbers (based on "the actual exposures at 35 funds capturing $86 billion in long/short assets") indicate that net hedge fund exposure has moved to about 45.8% -- that's the lowest exposure in two years. Hedge funds have cut back based on growing losses (and the trading associated with the discipline of limiting losses) as well as in response to the marked rise in the VIX, which creates a higher VAR (dollar value at risk per day). The swiftness and magnitude of the drop has begotten more and more selling by the hedge fund community.

Recent Hedge Fund Redemptions

I am personally aware of some large redemption requests in the hedge fund community. This has led to further selling pressure. Many of those hedge funds had a large exposure in the financial sector, and this could explain the outsized drop in bank stocks and other non-bank financials.

A Nearly Unprecedented Liquidation of Domestic Equity Funds

Last month, individual investors fled equity funds in a massive move toward the flight-to-safety trade. In July, over $25 billion was redeemed. A week ago, over $20 billion was pulled. Surprisingly, assets were taken out of every mutual fund asset class (equities, taxable and nontaxable bond funds) and went into money market funds. I estimate that individual investors will pull out at least $35 billion in August, representing the second-highest liquidation on record since the series of data began to be accumulated in 1979. It is almost a certainty that 2011 will represent the fifth consecutive year of liquidations -- something that has never happened in mutual fund history.