Hedge Funds Most Bearish Since 2009

Date: Friday, August 19, 2011
Author: Nikolaj Gammeltoft, Bloomberg

Bets global stocks will fall have surged at hedge funds to the highest level since July 2009 as the economic slowdown and European debt crisis spur the biggest losses in almost three years.

An index of hedge fund assets from International Strategy & Investment Group dropped to 45.8 on Aug. 16, showing the most short selling in two years, down from a 2011 high of 54.2 in February. The research company and broker-dealer surveys 35 firms with about $84 billion under management every week.

Professional investors are pessimistic after the MSCI All- Country World Index dropped 15 percent since July 22 and the Standard & Poor’s 500 Index had record swings. Equities fell yesterday after Lars Frisell, the chief economist at Sweden’s financial regulator, said it won’t take much to freeze interbank lending and data showed the U.S. economy is slowing.

“Hedge funds are sensing a European fiscal denouement on the horizon and they understand that contagion can hit the U.S. very quickly,” Steve Shafer, who helps manage $300 million as chief investment officer of Oklahoma City-based Covenant Investors, said in a telephone interview. “They are pretty nimble traders with a short-term focus, so they’re protecting what they’ve got and they are preparing for a potential capitulation of the market.”

Shafer’s hedge fund sold stocks in the past 10 days to raise cash and reduced its use of borrowed money to pay for equities, he said yesterday.

‘Dangerously Close’

Stocks tumbled yesterday after Morgan Stanley said the U.S. and Europe are “dangerously close to recession.” The New York- based bank reduced its forecast for global gross domestic product growth in 2011 to 3.9 percent from 4.2 percent. The S&P 500 slumped 4.5 percent, and the Dow Jones Industrial Average posted its fourth loss in August exceeding 400 points.

The index from ISI, based in New York, tracks hedge-fund investments on a zero through 100 scale. Readings of zero show “maximum” short selling, the sale of equities with the hope of profiting by buying them at lower prices later, while 100 means “maximum” bullish bets. At 50, hedge funds are deploying a “normal” allocation to short and long investments.

The ratio of bullish to bearish investments in U.S. equities has dropped to 11.7 from this year’s peak of 13.2 in May, according to New York-based Data Explorers, which provides research on short sales and stock lending. The measure sank to 6.5 in September 2008 after Lehman Brothers Holdings Inc.’s bankruptcy spurred the worst financial crisis since the 1930s.

Getting Nervous

“Hedge funds are bringing down their bullish investments,” Chris Baggini, who manages the long-short Turner Titan Fund at Berwyn, Pennsylvania-based Turner Investment Partners Inc., said in a telephone interview. His firm oversees about $18 billion. “When you are nervous you reduce your long position first, and when you’ve figured out the direction of the market, then you can start to beef up the short side.”

Hedge funds, largely unregulated investment vehicles that aim to make money whether markets rise or fall, are putting themselves at risk of missing out on gains fueled by takeovers and earnings growth, said Uri Landesman, managing general partner of Platinum Partners LLP.

“Being this short probably doesn’t make sense unless you think the market is going to set new lows, which at this point I do not,” Landesman, who helps oversee $1 billion at the New York-based hedge fund, wrote in an e-mail. “M&A, particularly in energy, software and biotech, will eventually lead the market higher, as long as earnings don’t fall apart.”

Profit Forecasts

Profit at S&P 500 companies is forecast to rise 17 percent to $99.08 a share in 2011 and 14 percent to $112.90 in 2012, according to average analyst estimates compiled by Bloomberg.

Warren Buffett’s Berkshire Hathaway Inc. accelerated stock purchases on Aug. 8 as the S&P 500 plunged the most since December 2008, the billionaire investor said during an Aug. 15 interview with Charlie Rose on PBS. He bought as this month’s decline drove the price-earnings ratio for the S&P 500 down to 12.2, the lowest since March 2009 and below its average since 1954 of 16.4, according to data compiled by Bloomberg.

“I like buying on sale,” said Buffett, Berkshire’s chief executive officer. “Last Monday, we spent more money in the stock market buying than any day this year.”

History shows the S&P 500 may sink after closing at 1,140.65 yesterday, up 1.9 percent from the 11-month low of 1,119.46 reached on Aug. 8. The index plunged 16 percent between July 25 and Aug. 8. The eight declines of that size over similar amounts of time since 1928 led to additional losses averaging 17 percent, according to data compiled by Bespoke Investment Group LLC, a Harrison, New York-based research company.

“It makes perfect sense for hedge funds to take down risk,” Ryan Bend, who oversees $1.6 billion as money manager at Federated Investors Inc.’s Prudent Bear Fund, said in a telephone interview from Pittsburgh. “We’ve gotten more aggressive with our shorts in the past month,” he said. “The bear case is really about European banks, European sovereign debt and then contagion effects to the United States.”

To contact the reporter on this story: Nikolaj Gammeltoft in New York at ngammeltoft@bloomberg.net