This was a piece about the underside of the hedge fund business, a piece designed to take a good hard look at what really goes on when you make the wrong bet. I think that was behind a lot of the buying this week. This was the week where the market was supposed to crash. It didn't. It didn't because of the things described in this piece.
What was that tech bear case again?
(Here was the big question of the week. A week that turned out to be a fabulous one for the bulls. One that was so great that the bears even stooped to using Maria Bartiromo to float a "Cisco (CSCO) - Get Report to preannounce bad numbers" rumor at the bell because it was such a tough week!! That's bending to the 52-week lows of short-selling portfolio management!!)
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One of the most difficult issues facing hedge fund managers is what to do when the worst comes true, and there is not much money to be made. Let's say I knew that
were all going to be bearers of bad news. Had I known that going into this week I think I would have presumed, safely, that all of tech will get whacked. I would bet that
would get killed.
(Let's talk about each aspect of this paragraph. IBM missed its numbers because during the last month of the quarter, when companies "go quiet" or stop communicating how things are going because of SEC laws forbidding the leaking of how a quarter finished, business turned very soft. They blamed Y2K. I saw no reason why not to believe them. But that led to big estimate cuts and the stock got hammered. Dell, on the other hand, indicated demand was fine, it is just that they were getting hit by the rising costs of DRAMs. This is a different, not nearly as dire problem as IBM, and the stock barely got nicked. Lexmark bagged the Street. It indicated that there were a bunch of competitive problems out there and I don't think they are going away soon, so many points were clipped. (For many years, tech all traded together. The linkage of these three large tech companies would be felt in the far reaches of tech land. I think that many of the hedge fund managers who short can't resist the big negative bet. They all pride themselves on making money when the market goes down. I know I have done this. If I think that a bunch of tech companies are going to implode, then I think. "who in his right mind is going to buy anything tech?" But the world has changed. There is so much dedicated tech money, meaning money that has to be in tech, that it simply cycles out of one portion of tech and goes into another. That's why these three collective disasters have no legs whatsoever. )
. And pretty much everybody in the Nasdaq or
Morgan Stanley High Tech Index
(I was wrong about Sun. The very next day Don Young basically said that Sun could not be unscathed by IBM's problems. We did not sell Sun but we worried internally that Sun could go down and it did. The others simply reflected themselves. AOL reported a very strong quarter and Intel had a new chip about to be introduced so it went higher on that. Plus, Dell never said demand was bad, and demand is the chief consideration when dealing with Intel.)
I would think that this great run the NDX has had will have to end. I would probably make a giant anti-tech bet because the kingpins of tech are about to roll over.
(Here again is the big hubris bet. The market is overvalued. It has been overvalued for years. What comparison am I using? How about any comparison? To bonds. To earnings. To revenue. To return on equity. Doesn't matter. We all know that the whole shooting match has been pretty out of control for years. But anybody who has bet against it big since the 1970s has lost his shirt. No matter, we all want to do it. It is in the hedge fund manager's nature to make it on the short side. It is much more satisfying and it also shows that you are not a monkey with a buy key. )
I would buy a massive number of NDX or MSH puts and sell calls and, maybe, even go to a trading desk and say, "You know what? Craft me a derivative bag of tricks made up of the ten most important tech names and I want a put on that basket."
(Here is another side of the business that doesn't get much exposure. You can go to any of the major houses and create a security. That security can then be bet against. A lot of people use securities of their own choosing to make that bet. When you choose to buy a put on that basket and the basket is done going down, unwinding the position causes a violent sharp upward move. It has been my experience with these proprietary baskets that taking them off, especially when the market is going against you, is a lot harder than putting them on. You tend to impact the market in the worst possible way for you.)
Then a day like today happens. IBM blows up. You figure the spillover will be tremendous. You are going to break the market's bank, you probably say to yourself.
It gets better. You go home and IBM is at 100. But by the time everybody knows the story it can't even hold 90. You have counted the money you are going to make and you are feeling flush.
(When the news came out about the quarter, an investment house was asked to make a bid on a couple of hundred thousand shares of IBM. The after-hours broker bid "too tight," meaning he bid too close to the last sale. The account whacked him. And the firm was long 200,000 shares at the way-too-high price of 102. As soon as that print occurred sellers came out of the woodwork and the firm had to boot the stock out to other buyers at a much lower price and take a very big hit. As soon as that print didn't hold, I knew the stock would not hold 100. I didn't expect it would go to 90. Wow, what a decline.)
And then the nightmare scenario occurs. The bears gave a party and nobody attended. Nobody panicked. The stocks in those indices or in your proprietary basket don't go down. You are in disbelief, but as the morning drags on, the day where you thought you would be sipping 18-year-old Macallan all by yourself while everyone else flirts with jumping out the window, you come to realize that the nuclear winter's not dawning.
(So many hedge funds are blind to the idea that anyone might be doing what they are doing. In reality, dozens of firms have the same call and are doing the same strategy. When they decide to unwind their positions all at once they get screwed. The discipline of trading says if your thesis happened, you then have to take the trade off even if you didn't get the results you wanted. Them's the rules.)
By noon you get the sense that not only is nuclear winter not dawning, but conventional winter's not even starting. You think that AOL and
are just arrogant $&%^#^ for refusing to go down, but you are scared to put out more stock or buy more puts because something doesn't feel right.
(We speak a lot internally about the notion of stocks being arrogant. That means they are going up in the face of imminent danger. We are sometimes conspiratorial about it and wonder whether certain mutual fund managers, eager to show they are not being blasted, deliberately walk up a few big stocks to affect their performance. I can't prove it but I bet it is done.)
Intel's rallying. Microsoft has some traction. And those darn four-letter tech jobbies are exploding.
(Here's those Red Hots again. They were amazing. They were rallying even when IBM was still in freefall, which was quite long, by the way.)
By 3 p.m., you give up. You know that there will be no big victory. You are happy that you got IBM right but your losses away from I-BEAM on the rest of the shorts are cutting into your profits big time.
So you throw in the towel. But you know you can't just call up your broker and say, hey, I want out of those baskets or puts. You are in one of those situations where everybody knows you are short and they begin to take the Soft and the 'Tel ahead of you. You have ignited your own personal squeeze.
(This is that underside problem again. The guy who put on the basket, he knows your positions. What is to keep him from telling his buddies that you are about to panic and take off your basket? What is to keep him from running ahead of you? Of course, running ahead is a crime, but crimes do occur.)
Nevertheless, you have no choice but to take The Big Short off. What's the bear case now? Is there another IBM going to blow up tomorrow?
(Indeed that's why Friday was a decent day in tech, there were no more shoes to drop. None!)
Nah, everybody important has reported. Is someone who has reported going to 'fess up tomorrow about something they wouldn't own up to last week?
(This was the Cisco raid. I hate stuff like this. It is so easy on Fridays to raid things down and the company is in quiet so it can't defend itself.)
Next thing you know the NDX, on a day when IBM is down billions and billions of dollars worth of points, is up for the day, and your fund is the reason for it.
(Yes, one fund, positioned incorrectly on a $100 million bet, can translate into a mega-rally. And if you are running multiple billions you can't do the bet for less. You just can't. It won't make a difference to your performance.)
I bet that's what happened today. Just felt like it. Because it has happened to me.
It feels awful.
(Yeah. I used to be addicted to making the big bet. It paid off in 1990 and people thought I really was a short-side king. But it hasn't paid off since unless you were incredibly nimble for a couple of weeks in '97 and '98. If you weren't nimble you have up all of your short-side profits anyway. So much of the strength in the market is simply some hedge fund manager positioned the wrong way on a big SPX or NDX bet. I know that few of you believe it. But having made them for $50 million-$60 million, I can tell you that when you are wrong you can cause a real spike in the charts of just about any index.)
James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. At the time the original piece was published, his fund was long Yahoo!, AOL, Intel, Sun Microsystems, Microsoft and IBM calls. At the time of this rewrite's publication, his fund was long Yahoo!, AOL, Intel, Sun Microsystems, Microsoft, Cisco, Exodus, Redback and IBM calls. Cramer's fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column at firstname.lastname@example.org. As originally published, this column contained an error. Please see our Corrections and Clarifications for details.