“Managed Malaise” is the order of the day... and the big boys are placing their bets accordingly..

Amusing headline of the week: “Terror as mall shark tank cracks.” As the U.K. Sun breathlessly reports (annoying capitalization theirs),
           
ENGINEERS in the Middle East battled to shore-up a shark-filled aquarium gushing torrents through a crack.

Shoppers at the Dubai Mall fled in terror today fearing that they were about to be engulfed by 10 MILLION gallons of water holding 33,000 sea creatures.

Among the sea life in the tank were 400 SHARKS and killer stingrays.

Mall security men donned life jackets and stores were ordered to shut up shop.

But the break in the 30-inch thick acrylic viewing panel managed to hold and prevent a certain disaster...

On reading that, your editor could not help thinking of a line from Monty Python and the Holy Grail: “On second thought let’s not go to Camelot. ‘Tis a silly place.”

Over-the-top shopping malls, 10 million gallon aquariums, killer stingrays and “SHARKS”... could there be a sillier place on earth than Dubai? And could there be a better market metaphor for the troubles we now face, as torrential gushers of far-too-cheap capital pour forth from the gaping cracks in human hubris?

Like Dubai’s emergency repairmen, the world’s governments have managed to “hold and prevent a certain disaster” through the hasty application of unprecedented stimulus. But the cracks are still there... and growing... and no one has yet thought to say, “Hey, you know, maybe this giant shark tank we’re trying to preserve was a really dumb idea in the first place.”

Whales Buy Banks

Sticking with the maritime theme, there are many denizens of the market deep. If the mom-and-pop investor counts as krill – a tiny crustacean that populates the ocean in very large numbers – then the largest and most successful hedge funds are like whales.

These creatures are notable for their appetite. A single hedge fund whale of sufficient size and maturity is capable of eating millions of krill in a single gulp.

It seems notable, then, that the whales are buying banks. Some of the largest and most successful hedge fund managers have been taking down massive share quantities in the likes of Bank of America (BAC:NYSE), Wells Fargo (WFC:NYSE), and Citigroup (C:NYSE).

David Tepper is one such whale. He and his tightly knit ten-man team at Appaloosa Management racked up trading and investing profits of $6.5 billion (that’s billion with a ‘B’) in the first three quarters of 2009.

Here are Tepper’s top five holdings, ranked by percentage of assets, as of Dec. 31, 2009:

David Tepper / Appaloosa:
Top 5 Holdings by % of Assets (Q409)

1. Bank of America (BAC): 20.4%
2. Citigroup (C): 19.2%
3. Wells Fargo (WFC): 12.46%
4. Fifth Third Bancorp (FITB): 9.97%
5. SunTrust Banks (STI): 7.27%

A recent “hedge fund trend monitor report” from Goldman Sachs further reports that, of the 10 stocks most commonly held by hedge funds, three are banks – Bank of America, JPMorgan Chase and Wells Fargo.

Last but not least, George Soros, aka “The Man Who Broke the Bank of England,” aka “The Palindrome,” initiated a sizable position in Citigroup (C:NYSE) in Q409.

So what’s going on here?

Managed Malaise

What you are looking at is a rather unconventional chart. It shows the money center banks (represented by KBE) as priced in gold stocks (represented by GDX).

The KBW Bank Index ETF (KBE) is dominated by the likes of BAC, Citi, JPMorgan and Wells Fargo. Top holdings of GDX include Barrick Gold (ABX), Goldcorp (GG), and Newmont Mining (NEM).

The recent upward trend in banks versus gold stocks confirms an expectation your editor has dubbed “Managed Malaise.” For those unfamiliar with the term, malaise is defined as “a condition of general bodily weakness or discomfort.” A midsummer address by President Jimmy Carter, which you can view here, was famously dubbed “The Malaise Speech” back in 1979.

And what is Managed Malaise in the here and now, you ask? As your humble editor defines it, Managed Malaise is an expectation that the U.S. economy will stay weak... that the Federal Reserve will continue to apply its healing medicine in response... and that this medicine will be diverted from its intended target, more or less flowing into the coffers of the banks.

When Pain Is Gain

In this manner, the pain of consumers becomes the gain of the banks.

Imagine a very sick patient – the U.S. consumer – with an IV drip in his arm. Fed Chairman Ben Bernanke, in his reassuring white lab coat, promises oxygen-rich liquidity infusions to get the patient feeling better.

But there is a bait and switch going on. In the bed next to our ill consumer, there is a cigar-chomping banker who has managed to siphon the consumer’s IV bag. All the nourishment – or the vast majority of it – flows to the banker rather than the truly ill fellow.

In this manner the record steep yield curve and zeroed out interest rates thus do wonders for the connected financial class, but very little for the Average Joe. If anything, the pain and suffering of the consumer becomes necessary, because it is the excuse by which further doses of “healing medicine” are justified.

Against such a backdrop, the cynical hedgies – who make no bones about morals, and focus wholly on profits instead – have decided to buy the money center banks in size. They expect the “healing” to continue... but not in the manner as advertised or intended.

Fed Chairman Bernanke, the great healer himself, confirmed the logic of this strategy with testimony to Congress this week.

“Notwithstanding the positive signs, the job market remains quite weak," Bernanke said. "The [Federal Open Market Committee] continues to anticipate that economic conditions – including low rates of resource utilization, subdued inflation trends, and stable inflation expectations – are likely to warrant exceptionally low levels of the federal funds rate for an extended period."

Ah yes, the magic words: Extended Period.

Neither Inflation nor Crisis?

In betting on the banks (to the short-term exclusion of gold stocks), the big hedgies have revealed a few more embedded expectations. First, they are not expecting inflation to be a problem anytime soon. And second, they are not expecting the banks to blow up.

The low inflation expectations make a certain kind of sense. Most of the liquidity being pumped into the system is still being hoarded by the banks. By and large it is flowing back into Treasuries, or otherwise sitting stagnant. It is hard to have meaningful inflation when wages are flat or falling, companies are scaling back or standing pat on hiring, and consumers are making grim resolution to hold on to savings and pay down debt.

The second embedded expectation is a little bit more aggressive – and a lot more dubious. The big hedge funds apparently believe the banks are “out of the woods” as far as toxic assets go... that the worst balance sheet days are behind them.

This, too, could count as a bet on “Managed Malaise.” As long as things stay bad, but refrain from getting too bad, the banks can continue to paper over their toxic asset problems. It’s okay to still be loaded up with sweating crates of dynamite, the thinking goes, as long as you have a cool dry basement to store the stuff in.

Not unlike the hare-brained mall aquarium scheme in Dubai, at some point we will be staring down the barrel of another crisis – quite possibly one bigger than before. But for now, “Managed Malaise” is the order of the day... and the big boys are placing their bets accordingly.

Other Related Topics: Banks , Economic Crisis , Justice Litle , Macro Trader

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