Fund Managers Missing Rally Dump Bearish Bets Most Since ’08

Date: Monday, May 14, 2012
Author: Inyoung Hwang, Bloomberg

As individuals bail out of U.S. stocks at the fastest rate in three decades, professional speculators have cut bearish bets by the most since 2008.

Money managers are net short 19,375 contracts on the Standard & Poor’s 500 Index, down 82 percent from a four-year high in September even after the figure jumped from 3,584 last week, data compiled by Bloomberg and the Commodity Futures Trading Commission show. U.S. equity mutual funds recorded $18 billion of outflows in April, the most since at least 1984, according to preliminary data from the Investment Company Institute.

Hedge funds and other institutions are speculating the index will extend its 23 percent rally since October after 69 percent of S&P 500 companies beat first-quarter earnings estimates and economists projected accelerating U.S. growth this year. Bears say last week’s addition to bets on declines show short sellers have completed almost all of the buying they are likely to do, depleting demand for equities.

“For the professional side, stocks look pretty compelling,” David Goerz, chief investment officer at Highmark Capital Management Inc., said in a telephone interview from San Francisco on May 9. His firm oversees about $17 billion. “Underlying economic strength is much more resilient than anybody expected it to be this year.”

Trading Loss

Equities fell last week, sending the S&P 500 down 1.2 percent to 1,353.39, as JPMorgan Chase & Co. reported a $2 billion trading loss and investors speculated inconclusive Greek elections will lead the country to exit the euro zone. The loss trimmed the 2012 gain in the benchmark gauge for American equities to 7.6 percent and left it 16 percent from the all-time high of 1,565.15 reached in October 2007.

The decline has been biggest in companies favored by short sellers. A basket of 50 stocks compiled by Goldman Sachs Group Inc. with the highest short interest fell 8.5 percent since April 2, while the S&P 500 has slumped 4.6 percent since peaking that day. Futures on the S&P 500 expiring in June dropped 0.7 percent at 10:30 a.m. in London today.

Equities have slumped even as U.S. chief executive officers reported earnings that exceeded analyst estimates. A total of 297 companies in the S&P 500 from Walt Disney Co. (DIS) to Dean Foods Co. have posted results topping forecasts by an average of 6.2 percent since April 10, data compiled by Bloomberg show. That failed to keep investors from pulling out of U.S. stock mutual funds in April, according to data compiled by Washington-based ICI.

‘Still Carry Scars’

“Individual investors were so scared by the shock of the financial crisis and still carry those scars,” Neel Kashkari, who heads global equities at Newport Beach, California-based Pacific Investment Management Co., said by phone interview on May 10. His firm manages about $1.77 trillion. “You’re seeing professional investors get back into the equity market and buying individual names for fundamental reasons.”

Hedge funds and other large speculators have been dumping bearish bets on stocks since a month before the S&P 500 began a rally that has restored $3 trillion to U.S. equity prices since October. The last time they covered shorts on S&P 500 futures as much was in 2008, three months before equities began one of the biggest bull markets, data going back to 1997 show.

‘Fundamental Improvement’

“We are not in the midst of a boom in flows into equity funds, so where did the demand come from?” Kevin Caron, a market strategist in Florham Park, New Jersey, at Stifel Nicolaus & Co., which has more than $116 billion in client assets, said in a May 11 telephone interview. “To some extent, the improvement in market values probably did reflect short covering. But we also saw fundamental improvement and economic data move in the right direction.”

Now, hedge funds are speculating on a rally driven by additional stimulus by the Federal Reserve, said Kevin Shacknofsky, a fund manager at Alpine Mutual Funds, whose firm manages $5 billion. Pimco’s Co-Chief Investment Officer Bill Gross and Jan Hatzius, the chief economist at Goldman Sachs, said this month that investors should prepare for more bond purchases by the Fed to combat a slowing economy.

“This whole crisis, the hedge funds have been very bearish, and they’ve been squeezed every time by the policy response,” Shacknofsky said in a telephone interview from Purchase, New York, on May 9. “They’ve been short like crazy, like the world’s coming to an end, and then the policy response has come in and they’ve got crushed. They’re trying to avoid their previous experiences.”

Prescient Bets

Professional investors haven’t kept up with the rally in stocks since October. Hedge funds declined 5.3 percent in 2011, the third straight year they underperformed the S&P 500, according to data from Chicago-based Hedge Fund Research Inc. going back to 1990. They beat the index in April for the first time in seven months, the data show.

While speculators help fuel rallies by closing bearish bets, their trading hasn’t always been prescient. They went from being net long 82,670 S&P 500 futures contracts in December 2008 to the most bearish in four years in September 2011, according to CFTC data. The index rallied 30 percent over that period.

Money managers reduced bearish bets throughout 2000, becoming net long as the index peaked at 1,527.46 in March of that year, Bloomberg and CFTC data show. The gauge subsequently tumbled 49 percent through October 2002.

Short Covering

“Short covering following the weakness last year contributed to the rally,” Eric Teal, Raleigh, North Carolina- based chief investment officer at First Citizens Bancshares Inc., which oversees $4.5 billion, said in a telephone interview on May 11. “The bearish investors have completed their trades and pessimism can creep in.”

Stock market swings are getting bigger after Nicolas Sarkozy lost the French presidency and elections in Greece resulted in a divided parliament, heightening concern the euro area will fail to keep all of its members. The S&P 500 posted a decline of more than 1 percent only once in the first quarter, on March 6. Since the start of April, the index has slipped at least that much five times, data compiled by Bloomberg show.

“Even the most sophisticated investors can’t time the market,” Komal Sri-Kumar, chief global strategist at Los Angeles-based TCW Group Inc., whose firm oversees about $120 billion, said by phone on May 10. “If you’re very nimble you can say that you’re still going to do well banking on QE3 but overall, there’ll be downward pressure on the markets.”

U.S. Growth

Predictions by economists that gross domestic product in the U.S. will expand faster this year than the euro area, the U.K., Japan and Canada have driven American companies to their most expensive levels relative to the world since 2004. The S&P 500 trades at 2.14 times book value, or assets minus liabilities. That compares with 1.64 for the MSCI All-Country World Index (MXWD), the biggest spread in eight years, according to data compiled by Bloomberg.

The withdrawal of individuals may be a sign to get back into equities, according to Alpine’s Shacknofsky. While concern over Europe may spur volatility during the second and third quarters, investors should begin buying stocks with earnings tied to economic growth because their valuations are below historic levels, he said.

Companies that posted better-than-estimated earnings had the biggest declines in short interest in the past month. TripAdvisor Inc. (TRIP) had the largest drop in bearish bets out of S&P 500 stocks that had a minimum short interest of 3 percent, according to Data Explorers, a market research firm in New York.

TripAdvisor Revenue

The Newton, Massachusetts-based online travel- recommendation service spun off from Expedia Inc. in December has posted the second-biggest gain in the S&P 500 this year as first-quarter sales and profit exceeded analysts’ projections.

Investors slashed bearish bets on Chipotle Mexican Grill Inc. by 25 percent in the last month, the data show. Short interest (CMG) in the burrito seller was 5.6 percent on April 20, one day after the Denver-based company reported first-quarter profit rose as U.S. consumers dined out more. Shares borrowed have since fallen to 4 percent.

“Institutional investors are thinking more bottom up,” Leo Grohowski, the New York-based chief investment officer at BNY Mellon Wealth Management, which oversees $172 billion, said by phone on May 10. “Valuations are very reasonable. Earnings have been so strong. There are some investors out there are willing to say, ‘Now’s not the time to be exceedingly bearish.’”

To contact the reporter on this story: Inyoung Hwang in New York at ihwang7@bloomberg.net