Hedge Funds Capitulate on European Shorts?
Hedge funds that base investment decisions on economic trends are unwinding bets against European stocks (SXXP) at the fastest pace in three years, speculating policy makers will step up the fight against the debt crisis.
The degree by which macro funds are trailing the Euro Stoxx 50 Index (SX5E) is narrowing at the fastest rate since 2009, a sign managers are covering short sales by buying shares, according to data compiled by Bloomberg and JPMorgan Chase & Co. The proportion of shares on loan in the Stoxx Europe 600 Index, an indication of short interest, has fallen to 2.9 percent from 3.4 percent in May, data from London-based Markit show.
Bulls say professional investors buying back shares that were borrowed and sold short are fueling a rally led by European Central Bank President Mario Draghi’s pledge to defend the euro. The Euro Stoxx 50 is up more than 12 percent in three weeks, twice the gain of the MSCI All-Country World Index (MXWD), even as the euro-area economy is forecast to slide into recession. Bears point to a drop in earnings estimates after profit fell about 10 percent last quarter as a sign stocks in Europe may fall.
“Macro hedge funds missed collectively the policy news of June, and with the prospect of central bank interventions they are now capitulating,” Nikolaos Panigirtzoglou, head of global asset allocation at JPMorgan in London, said in an Aug. 7 phone interview. JPMorgan has $2.3 trillion under management. “For positions to unwind, a trigger is needed. And the trigger was all this policy news.”
Hedge funds last closed short bets this fast in April 2009 just before a 35 percent rally in the Stoxx 600. Macro funds have failed to keep up with the market this year, rising 0.1 percent compared with an 8.1 percent advance in the MSCI World Index of equities in developed economies, according to data compiled by Bloomberg.
The Euro Stoxx 50 gained 2.1 percent last week, extending its advance this year to 5 percent, as investors speculated the U.S. Federal Reserve, ECB and the People’s Bank of China will add to measures to revive their economies. The gauge rose 0.1 percent to 2,425.66 at 10:02 a.m. in London today. The Hedge Fund Macro Index, a gauge of the returns of global macro funds compiled by Chicago-based Hedge Fund Research Inc., was little changed last week. Hedge funds are largely unregulated pools of capital that can bet on falling as well as rising asset prices.
Investors betting against equities are posting losses as companies with the most short interest, from Aixtron SE (AIXA) in Herzogenrath, Germany, to Stockholm-based Elekta AB and Logitech International SA in Morges, Switzerland, each rose at least 10 percent in 2012. They are among the top 10 most-shorted stocks in the Stoxx 600.
Moore Capital Management LLC’s Louis Bacon said this month his main fund will give back $2 billion to investors, about 25 percent of the money in his main hedge fund, after returning just 1.6 percent through July. Ray Dalio, who runs Bridgewater Associates LP, lost 2 percent in his $54 billion macro fund through July 20, according to investors. Alan Howard, who runs Brevan Howard Asset Management LLP, lost 1.3 percent in his Master Fund.
“It’s been a challenging year,” Anthony Lawler, a portfolio manager who helps oversee hedge-fund strategies at GAM in London, said in a phone interview on Aug. 10. Macro funds’ “returns have been disappointing. Across all asset classes risk levels have been low, but especially in equities.” GAM manages $48 billion in total.
By measuring the difference in returns between the HFR Macro Index and the Euro Stoxx 50, JPMorgan’s strategists estimate how heavily managers are invested in European equities and other assets tied to economic growth. The ratio, known as beta, shows the degree to which a fund or security fluctuates relative to a benchmark gauge.
The Macro Index’s beta to the equities gauge narrowed to minus 0.04 on Aug. 3 from a three-year low of minus 0.19 on June 21, according to data from Bloomberg and JPMorgan. That’s the steepest reduction since April 2009, the data show. A ratio of 1 denotes lockstep moves, while minus 1 means two securities are moving in opposite directions.
“People don’t feel very committed to any shorts,” said George Papamarkakis, a fund manager at North Asset Management LLP in London, which follows macro strategies and oversees about $200 million. Investors “are reluctant to get long at these levels, but at the same time people are concerned about being short because of the continued policy activism,” he said.
In a short sale, speculators borrow and then sell securities on expectations they will be able to repurchase the shares at a cheaper price before returning them to their owners. Last month, Spain and Italy reinstated a ban on short-selling stocks as bank shares plunged to record lows.
European stocks bore the brunt of a global slump earlier this year as the debt crisis sent borrowing costs surging in Spain and Italy and concern grew more governments would have to accept bailouts following rescues of Greece, Portugal and Ireland. The Euro Stoxx 50 fell 8.5 percent in the first five months, compared with a 4.2 percent gain for the Standard & Poor’s 500 Index in the U.S.
Spiraling budget deficits in Europe’s weakest economies forced Greece to accept a 110 billion-euro ($135 billion) rescue package in May 2010. Ireland and Portugal followed with requests for bailouts, culminating in 100 billion euros of support for Spain’s banks in June this year. The deepening crisis pushed the Euro Stoxx 50 into the first back-to-back annual losses since 2002 last year and has driven the euro down 5.2 percent versus the dollar in 2012.
Investors retreating to safer assets pushed yields on two- year German notes below zero for the first time on July 6. Yields below zero mean investors are willing to pay Germany to hold their money without any returns.
Pessimism about the outlook for the euro region has eased as German Chancellor Angela Merkel and French President Francois Hollande joined Draghi last month to reiterate that policy makers will do whatever is needed to preserve the single European currency.
In a 45-minute span on July 5, the ECB and the People’s Bank of China cut their benchmark borrowing costs, while the Bank of England raised the size of its asset-purchase program. In June, the Federal Reserve expanded a program lengthening the maturity of bonds it holds and Chairman Ben S. Bernanke has indicated more measures may be taken.
The Euro Stoxx 50 has climbed 17 percent from its 2012 low on June 1, compared with gains of 10 percent and 11 percent for the S&P 500 and the MSCI World, respectively.
“This shift in leadership indicates that we have moved into a more constructive phase,” Dominic Rossi, who helps oversee $125 billion as global chief investment officer for equities at Fidelity International in London, said in an e-mail. “The tide is beginning to turn for equities.”
Still, economic data in Europe is pointing to a slowdown. Euro-area services and manufacturing output contracted for a sixth month in July, adding to evidence the economy is headed toward a recession. German business confidence, measured by the Ifo institute in Munich, fell more than economists forecast in July to the lowest in more than two years. The euro-area economy is forecast to contract 0.5 percent this year, according to the median estimate of 45 economists polled by Bloomberg.
Greece, Italy, Portugal and Spain are currently in recessions and Germany, which accounts for about 27 percent of the euro area’s output, saw slower growth in each of the past four quarters through March. Economic expansion in Europe will be less than 50 percent that of the U.S. in 2013 and 2014, economist forecasts compiled by Bloomberg show.
Analysts have cut European profit forecasts at the fastest rate since 2009. They project Euro Stoxx 50 earnings will rise 5 percent this year, down from the 19 percent gain predicted at the start of the year, according to more than 12,000 estimates compiled by Bloomberg. Earnings fell 9.7 percent for the 41 companies that have reported this quarter, data compiled by Bloomberg show.
“What we’ve seen is a significant downward shift in earnings expectations, and that would lead to softer share prices, all things being equal,” said Stewart Richardson, who helps run macro strategies as chief investment officer of RMG Wealth Management in London, which oversees about $70 million. “Equity investors are complacent and desperate in trying to front-run any further central-bank stimulus. Further quantitative easing will have a diminishing-returns effect.”
Richardson said equity investors may see more losses in September should central banks fail to move. The ECB is scheduled to meet on Sept. 6 and the Fed convenes a week later. Germany’s Constitutional Court is set to rule on the future European bailout fund on Sept. 12.
Amid the uncertainty, even bears say European equities aren’t expensive. The Euro Stoxx 50 trades at 10.3 times projected profit, compared with the six-year average of 10.7, data compiled by Bloomberg show.
Logitech has surged 16 percent in 2012 as the world’s biggest maker of computer mice reported in April that fiscal fourth-quarter earnings topped estimates. About 17 percent of the company’s shares are on loan, according to short-interest data from Markit.
Elekta has advanced 11 percent this year as the Swedish maker of medical products said in March that third-quarter net income doubled to 390 million kronor ($59 million). Markit estimates 18 percent of Elekta’s stock has been lent. Aixtron, a German manufacturer of production equipment for semiconductor and lighting makers, jumped 25 percent as the short interest came down to 21 percent from 26 percent.
For Navik Patel, who helps oversee more than $4 billion in funds of hedge funds as senior strategy analyst at Aberdeen Asset Management Plc in London, central-bank action will support equity prices, boosting the risk of losses for investors with bearish positions.
Draghi “has effectively said that the ECB will act as and when they need to,” he said in a phone interview on Aug. 8. “There is probably a floor for at least the short to medium term.”
The tide is turning ever so slowly in Europe and hedge funds are doing the splits, covering their short positions. I have long argued that there is exaggerated pessimism in Europe and in China where investors are still fretting over a slump.
What I find particularly positive is US homebuilder shares are appreciating at a record rate this year, reflecting confidence the housing rebound from a six-year slump can accelerate with new-home sales still 50 percent below the 40-year average.
And if you're still not convinced, bolting out of equities, consider Michael Gayed's latest comment, Wal-Mart indicator says rally just getting started:
A little under a month ago in my July 16 article titled " Wal-Mart Indicator Goes Critical ," I highlighted the significant outperformance Wal-Mart WMT +0.42% had relative to broader stock market averages as leadership went vertical following the May mini-correction I called for in early April .
The idea here is relatively simple, but important, from the standpoint of gauging market sentiment. Wal-Mart tends to perform comparatively better than most other stocks when investors fear coming volatility, and sense a deflation pulse ahead.
Conversely, when Wal-Mart underperforms, that coincides with increased risk-taking in broader market averages. As I noted on Bloomberg alongside Gary Shilling on April 11, Wal-Mart is very much a "deflation retailer" which money favors when markets turn difficult.
I specifically made the case mid-July that "the speed of the outperformance [in Wal-Mart relative to the broader stock market] ... indicates that either we are about to undergo another collapse [in equity averages] ... or a significant reversal at any time. If the trend reverses, it could mean another significant rally in broader equities takes place, making the "Summer Surprise" of the end to the end of the world likely to occur."
The Summer Surprise was an idea I laid out on June 20 as an extension of my " melt-up " call made the day of the low on June 4. Given the behavior of other intermarket trends at the time, I stated that I believed a reversal in strength was the likely outcome.
With that said, take a look below at the updated price ratio of Wal-Mart relative to the S&P 500 IVV -0.04% . As a reminder, a rising price ratio means the numerator/WMT is outperforming (up more/down less) the denominator/IVV. For a larger chart, visit https://twitter.com/pensionpartners/status/234852893927276546/photo/1# .
Notice what I have circled in the chart here. After an immense spike in outperformance during the May correction (signaling money poured into Wal-Mart as a "safety" trade during the decline in stocks), the ratio now appears to have hit a wall. Failure to get past the July peak, combined with what appears to be a rolling over pattern of relative performance, suggests that leadership may now be over.
With the ratio back to 2009 levels, there appears to be quite a lot of room for the ratio to fall, as the negative narrative and fear trade unwinds in the face of rising stocks, and as money re-allocates to higher risk areas of the investable landscape.
What is perhaps most interesting here is that this ratio relationship appears to be very early on in its infancy of underperforming and trending down relative to the S&P 500. With many making the case that the stock rally is near its end, the above chart suggests the "risk-on" period is just getting started as Wal-Mart only just now begins to underperform.
Perhaps the contrarian trade here is to bet not on the stock market uptrend's end, but on the persistence of the trend higher for equity averages, as Wal-Mart underperforms, and scared money begins to get scared of missing out on further gains ahead.
Surprise surprise ...
Yes, surprise, surprise! The world isn't coming to an abrupt end, it's not summer 2011 all over again, and we're setting up for an early Christmas rally, which may be one reason why Carl Icahn just handed his 33 year old son $3 billion to prove his mettle.
Below, Bloomberg's Dominic Chu reports that hedge funds that base investment decisions on economic trends are unwinding bets against European stocks at the fastest pace in three years, speculating policy makers will step up the fight against the debt crisis.
And Bloomberg's Linzie Janis discusses how hedge funds and private equity firms have amassed an unprecedented 60 billion euros ($74 billion) to invest in distressed debt in anticipation that Europe’s sovereign-debt crisis will push banks into the biggest fire sale in history. The problem is few are selling.