By David Moenning
Chief Investment Strategist
At the beginning of the year, the global macro outlook was nothing short of bleak. Although stocks had rallied a bit into the end of the year, a very long line of high profile fund managers had publicly stated that they were not optimistic about the prospects for the global economy coming into the New Year celebrations. In short, the outlook was overtly negative and almost universally accepted as just about anyone could rattle off the problems plaguing the globe.
The pervasive gloom was, of course, followed by an impressive rally in the stock market (SPY, DIA, QQQ, MDY, IWM) as those big-time hedge fund managers who are responsible for countless billions of investor capital didn't see that a BTE theme was developing in the U.S. data. Although it was surprising, a steady stream of better-than-expected data from the good ol' USofA began to materialize and by February, the bulls had something concrete to hang their collective hats on. As a result, the performance data for the first four months of the year showed a lot of those big-name hedge fund managers were not participating in the market's joyride to the upside.
However, it turns out that the BTE theme was short lived and after four tough months, those seeing the glass as half empty began to recapture their lost mojo. You can blame it on the weather (many economists argued that the warmer than normal winter weather simply pulled economic activity forward) or whatever you'd like, but over the past two months, the BTE theme has morphed into WTE in a big way. A quick review of the key economic reports makes this obvious as Existing Home Sales, Philly Fed, Flash PMI, Housing Starts, Consumer Sentiment, Industrial Production, Empire Manufacturing, Retail Sales, NFIB Small Business Optimism, ISM Manufacturing, Nonfarm Payrolls, and Q1 GDP reports were all below consensus expectations.
Then when you toss in the debt mess across the Atlantic and the inability of European leaders make any headway in fighting the crisis, the impending "fiscal cliff" in the U.S., and the fact that the central bankers of the world are out of ammunition, those folks who aren't terribly optimistic about the macro view are once again back in vogue.
The point is that this is precisely the time of year when we start to see window dressing take hold. Although the practice of bidding up stocks you own at the end of a month and/or quarter to boost performance is technically illegal, there doesn't seem to be any way to keep fund managers from putting a little of the cash they may have laying around to work at the end of the quarter. As such, stock prices have a propensity to rise in the last week of each quarter.
However, there is another part of the window dressing game that doesn't get a lot of attention. It is easy to forget that the direction of the window dressing typically is determined by the performance of the overall stock market during the period in question. In short, if stocks are up during the quarter, the windows tend to get dressed up. But when stock indices are down during the quarter, window "undressing" can also occur. The key is that managers want to make their portfolios "look" as good as they can at the end of quarters (when they have to disclose their holdings to the public).
So, given that we've got a down quarter on our hands AND the macro view is once again pretty abysmal, it wouldn't surprise me if managers start to do a little window undressing into the end of the week (having an above average cash position allows a manger to argue that they were exercising prudent risk management). I'm not saying that window undressing will happen of course, as Ms. Market can do any darn thing she pleases on any given day. I'm merely suggesting that it might be something to look out for amongst all the doom and gloom.