Investment managers expect markets to survive Fed tapering

Survive, yes, but can they thrive?

Sep 18, 2013 @ 12:33 pm

Hedge-fund managers from Stanley Druckenmiller to Fortress Investment Group LLC's Michael Novogratz and Passport Capital LLC's John Burbank said U.S. stocks will continue to do well this year even as the Federal Reserve gradually reduces its asset purchases.

As long as the Fed prints money, stocks won't enter a bear market, and the exit of Lawrence Summers from the race to become Fed chairman has made it more likely that the central bank will continue to encourage risk-taking, Druckenmiller said.

The Federal Open Market Committee is likely to reduce assets purchases to about $75 billion a month from $85 billion when it concludes its two-day meeting Wednesday, according to a Bloomberg survey of 34 economists. The purchases have fueled a 20 percent rally in the Standard & Poor's 500 Index this year through yesterday, outpacing the growth in earnings of its underlying companies, even as investors started to flee bonds and emerging markets following Fed Chairman Ben S. Bernanke's comments in May that quantitative easing may end.

“Markets can definitely rally into December,” said Frank Maeba, managing partner of Toronto-based Breton Hill Capital Ltd., whose $260 million macro fund counts the California Public Employees' Retirement System as an early investor. Macro funds seek to profit from macroeconomic trends by trading a range of assets.

When the Fed exits the program in full, something Bernanke has said may happen by the middle of next year, markets may see a drop of 30 percent, according to Seth Klarman, who runs the $29 billion Baupost Group LLC in Boston.

'Big Deal'

The S&P has rallied more than 150% from its 12-year low in March 2009, with several rounds of the Fed's quantitative easing backing up moderate economic growth. U.S. gross domestic product is projected to grow 1.6 percent, the median forecast of 81 economists in a Bloomberg survey.

Over the longer term, an end to the Fed's asset purchase program will definitely be a “big deal,” Druckenmiller said last week. Druckenmiller, a former chief strategist to billionaire George Soros who now runs his own family office, had only a few small trades on as recently as last week as he waited to see who might replace Bernanke when he steps down at the end of January.

“How in the world does anyone think when the actual exit happens that prices are not going to respond?” Druckenmiller said Sept. 11, given the selloff in bonds and emerging markets in the past few months on the mere hint that the Fed might taper its purchases.

Now that Summers, who many thought would end quantitative easing quickly if appointed to the post, has withdrawn his name from consideration, Druckenmiller said he is more sure about the direction of U.S. stocks.

“I think one of the major uncertainties in the market has been cleared up,” which will have an impact on risk-taking over the intermediate term, Druckenmiller said in separate comments following Summers's announcement.

Klarman, a value investor known for his bearish views, said in a speech in June that an end to the central bank's quantitative easing, which Bernanke has said may come in the middle of next year if the economy performs as expected, could be followed by a 30 percent drop in the U.S. stock market.

“Equity investors who have embraced a momentum strategy are ill-prepared for a policy change that could reverse the market's artificial gains,” Klarman said at the time, according to a person familiar with the speech he gave at a private gathering.

Klarman's Views

Klarman hasn't altered his views, said two investors, who asked not to be identified because the information isn't public. He's holding 30% to 35% of assets in cash and has told clients he will return some capital at the end of the year, the investors said. Klarman has previously pledged to keep Baupost's assets at $20 billion to $25 billion.

More bullish managers are brushing aside those concerns, betting that U.S. stocks will continue to do well even as emerging markets, perceived as riskier, suffer.

Some of Breton Hill's biggest bets include a wager on rising U.S. stocks and long dollar positions versus the yen and the Canadian dollar, Maeba said. He's also sold short gold, wagering against the metal that resumed its retreat this month after coming within 3 percentage points of a bull market amid the threat of military strikes on Syria.

High-growth shares in the U.S. will outperform other stocks, according to Burbank, chief investment officer at San Francisco-based Passport, and Tim Garry, his co-portfolio manager on the firm's Long Short fund.

Burbank, who runs the San Francisco-based firm's global fund, increased his hedges in the second quarter by buying put options on exchange-traded funds that track the Russell 2000 and the S&P 500 indexes, according to regulatory filings. The fund added puts, which rise when the underlying asset falls, as an inexpensive means of hedging an exogenous market shock, according to an investor.

“Our two clearest views are emerging markets will perform poorly relative to the U.S., and over the long term industrial metals will do poorly,” Garry said last week in an interview.

Emerging-market currencies, which have rebounded this month from their biggest slide in five years, may resume their declines as the Fed's tapering dries up funds that were chasing higher-yielding assets outside the U.S.

Passport's $1.3 billion global fund climbed 18 percent this year through August and its $611 million long-short fund rose 16 percent, according to investors.

Emerging Markets

Managers who have profited from a rally in Japanese equities and a decline in the yen also expect to make more money from those trades, and they see emerging-market stocks and currencies falling further, said Arvin Soh, a New York-based portfolio manager at GAM, which allocates capital to hedge-fund managers.

Among the investors who have made money on the Japan trade is Novogratz, whose Fortress Macro Fund rose 8.8% this year through Aug. 31, and had $1.9 billion in assets as of June 30, according to regulatory filings. Novogratz expects markets to stay choppy but is generally positive about the U.S. economic recovery, said two investors who asked not to be identified because the macro fund is private.

U.S. equities may end the year 25 percent to 30 percent higher, Novogratz, head of liquid markets at New York-based Fortress, said in a Bloomberg Television interview in May. The yen may finish 2013 at 120 per dollar, he said at the time, citing monetary easing by the Bank of Japan.

“The broad sense is that tapering is happening, but the Fed won't be aggressive,” said Soh, whose Zurich-based firm manages more than $120 billion globally.

(Bloomberg News)

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