Sometimes the markets don't reflect what happened (a.k.a. the fundamentals), but who is buying and selling (a.k.a. supply and demand.)

Tuesday's rising Treasury bond prices and falling yields were more the result of Asian central bank-buying than a weak New York Empire State manufacturing survey, according to traders. Oil and other commodity prices continued to fall as hedge funds pull riskier investments off the table to ready themselves for a possible liquidity withdrawal.

Meanwhile, the earnings parade had a negative tint Tuesday, but the Dow Jones transports continued their rally -- growing ever nearer to "confirming" the Dow Jones Industrial Average's latest record close; the latter index closed up 0.2% to an all-time high of 12,582.59.

As 2006 came to an end, hedge fund investors recognized the boost that still-ample liquidity provided to financial asset prices around the world, particularly high-risk assets like emerging-market stocks, junk bonds and the commodities.

These short-term investors realize the biggest risk to their portfolios is a liquidity crunch, which could come as monetary policy in developed nations tightens to fight against the inflationary pressure that comes with all that liquidity. The Bank of England, for example, surprised investors with a rate hike last week for related reasons.

So, with bad memories of capital flight out of illiquid markets haunting them, hedge funds are "taking risk off the table" by "trimming positions" in oil and other commodities, says one hedge fund manager who declined to be named.

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