Stock Market Foreclosures -- The Whole World Is For Sale

I have tried traveling around the world, searching for the solution to the meltdown in the financial system and stocks markets, and I am sad to report that I haven't found it yet.

I was in Hong Kong last week ushering in the Jewish new year with my son Sam who works for Goldman Sachs there. We not only had to watch the market collapse, we had to do it in a state of exhaustion in the middle of the night. We Jews view the ten days between Rosh
Hashanah and Yom Kippur as the Days of Repentance. The holiday spirit is truly upon us.

This has been a horrible year for the stock market with all of the major averages down well over 20 percent. As I sit here on Monday morning, all the Asian and European markets are down another 6 to 8 percent and our market is trading down dramatically as well. As bad as it has seemed for most of the year, the truth is that most of the damage has been done over the last few weeks.

The depth and magnitude of the financial crisis has certainly come into sharper focus in recent weeks. I sat in Hong Kong at 3 a.m. last Monday as Congress voted down the rescue plan and $1 trillion in wealth vaporized in an hour. On Friday I sat in Tucson at noon as Congress approved the rescue plan and $500 billion in wealth vaporized in an hour. It seems pretty clear that neither the facts on the ground nor time of day nor geography seem to matter much in this
market.

All this leads me to the point I want to make about what's really going on. The gut-wrenching drops in stock prices are not related any more to economic prospects or the decisions of Congress. Stocks, like real estate prices before them, are in a foreclosure mode and values
have been destroyed by forced selling -- major repentance for past sins.

We have all heard a great deal about the impact of massive foreclosures on the housing market. We understand that the price of a house can drop dramatically in foreclosure because it immediately goes for sale on the market without regard to price. It doesn't mean that there is
anything wrong with the house. It just means that the owner is in the horrible position of having to take whatever he can get.

In many markets around the country -- and particularly here in Arizona -- many homes have lost 20-40 percent of their value during the last year due to forced sales. Since most investors put 10 percent down or less, they have lost their entire investment and the banks are on the hook for the rest.

We have heard virtually nothing about a similar phenomenon that is taking place in the hedge fund world. Hedge funds are private investment funds which in many cases are not hedged at all. When I started the Gellman Growth Partners 13 years ago, there were a few hundred such funds in the world. Now there are thousands.

The managers of these funds now typically receive 2 percent of the assets as an annual fees and 20 percent of the profits as a bonus. As a result, the managers of these funds often take on great risks since they don't personally participate in the losses but they get a big chunk of the profits. To enhance those returns, virtually all these funds -- like our recently failed financial institutions -- take on huge leverage.

Many of them are down 30 percent or more for the year and are now either suffering through massive redemptions or going out of business altogether. As a result, they are selling anything and everything they have to raise cash before either shutting down completely or sending big chunks of their remaining capital back to dissatisfied investors.

What's the proof that this is going on? Look at where the huge losses are being suffered in the market over the last couple months. They're coming in the sectors that were the best performers over the last few years where all the hedgies plowed in. Energy, commodities, global infrastructure plays, technology, basic materials and emerging markets stocks are all down between 40-60 percent in recent months. The BRIC complex (Brazil, Russia, India, and China) markets are down an average of 50 percent this year.

Meanwhile, against all logic, the home builders and many financials -- those that haven't gone broke -- are trading at or near their 52-week highs even as the fundamental news
about those sectors has been just horrible. That's because most of the hedge funds either didn't own those sectors or, more likely, were short them and have been buying those stocks to cover their positions.

So what is a person to do in this environment?

I can tell you that the smartest real estate people I know are selectively buying properties at foreclosure sales, confident that over time they will do extremely well. I believe they are right, but they may have to watch prices decline ever more before the market gets flushed out.

I feel the same way about the stock market. Incredible opportunities present themselves during times such as this because the markets become so inefficient. But they are opportunities that are only appropriate for those investors who are willing to take a long term perspective. The forced selling could end tomorrow or it could end weeks or months from now at lower levels. But when it does, the turn will come.

The biggest problem most of us face is that technology now enables us to watch our portfolios on a real time basis all day long. During times like this, the drops in value can keep us awake at night and cause us to cry "uncle" at the worst possible time.

There is no doubt that our economy faces problems that won't go away for a long time. But there is also no doubt that this wave of forced liquidations is creating outstanding long term opportunities for patient investors. The only question is how patient we will have to be. I'd like it to happen in my lifetime.

One thing's for certain: there will be plenty to think about on Yom Kippur this week.