by Louis Basenese, Small Cap and Special Situations Expert
Thursday, August 19, 2010: Issue #1327
Second quarter earnings season is officially over – and almost 80% of the companies in the S&P 500 beat their earnings expectations.
You’d think that would be enough to propel the markets higher. But not so fast.
Investors remain confused. Forget solid corporate profit growth. They don’t know what to make of persistent European debt woes, a floundering real estate market, looming tax hikes, or stubbornly high unemployment.
In short, they’re more uncertain about the future than Brett Favre. And as you know, the stock market hates uncertainty…
That uncertainty and confusion is manifesting itself in the form of increased market volatility.
But what’s happening beneath the surface is more consequential and potentially profitable…
The Precarious Plight of Too Much Cash
Is there such a thing as too much cash?
In this case, yes.
- According to Moody’s, U.S. non-financial companies are sitting on $1.84 trillion in cash. As a percentage of total assets, that represents the highest amount in over half a century.
- Hedge funds are holding 24% of their assets in cash (or roughly $450 billion), according to surveys.
- American households have just under $1 trillion parked in money-market funds, according to the Investment Company Institute.
I’m sorry… but with cash yielding next to nothing, such passivity cannot persist. Eventually, people need to put the money to work.
Or as Credit Suisse recently opined in a 200-page “brief” on the markets: “Cash in a difficult time is like blubber on a seal: protecting the animal during the harshness of winter, but turning bothersome in spring and summer.”
With the worst of the recession behind us, we’re definitely entering the extremely “bothersome” period. And the situation is the most bothersome for hedge fund managers…
These Guys Need to Start Spending Like Sailors on Shore Leave
If these guys don’t put their cash to work and try to earn a profit on it, investors will say “sayonara” and withdraw their funds. After all, you don’t pay a hedge fund manager a 2% management fee and a 20% performance fee to act like a certificate of deposit.
And since half of the 2,000 funds tracked by Hedge Fund Research’s composite index are still below their high-water mark, these managers won’t get to collect that juicy 20% performance fee if they don’t deliver serious profits.
And there’s just no way they can hit a new high-water mark with 24% of their assets in cash-based investments. In addition, I can assure you that hedge fund managers won’t be content earning a 2% management fee indefinitely.
The good news is this: as they inevitably put their cash to work, we can profit from it…
It’s Time to Start Tracking 13-D Filings
I expect the most aggressive hedge fund managers to put their cash to work and become “activists.”
By that, I mean they’ll take a 5% (or more) stake in specific companies and start demanding aggressive changes. This includes things like seats on the Board of Directors… ditching the company’s top brass… the payment of special one-time dividends… or even the outright sale of the company.
In other words, they’ll do anything and everything to unlock value, stat!
Research proves that it’s an effective strategy, too. The latest academic studies, including the most recent one from New York University, finds that stocks targeted by activists enjoy an average 18% gain.
So how do we profit from these activist situations? Simple…
We follow the lead of the most aggressive hedge fund managers. You see, the SEC requires these guys to disclose when they take a 5% (or more) stake in publicly traded companies within 10 days.
And they do so by filing a form 13-D, which you can easily track for free on the SEC’s website.
But I prefer to visit Barron’s website. Every week, it provides a quick rundown on the latest filings, including a brief summary of the details surrounding each company.
You need to be a Barron’s subscriber to get this information, but as far as I’m concerned, it’s a worthwhile investment if you want to uncover stocks with the potential to return 18% (or more). Especially since the S&P 500 is down 1% this year.
Bottom Line: Executives, hedge funds and everyday investors – almost the entire investment and corporate community – are gun shy. They’re all stockpiling cash and if you’re not tracking the moves of the most aggressive hedge fund managers already, you need to be. It’s an easy way to determine when all the cash on the sidelines is being put back to work – and how to profit from the moves. So don’t delay.