Bubble and boom

Short the Dow, bank on China


Two very important trends are set to dominate hedge-fund strategy in 2019 – the all-too plausible prospect of a recession, and the rise in popularity of the Asia Pacific region as a destination for hedge fund allocation.

Rumours of a recession in 2020 or 2021 are rife – according to Nobel Prize winner Robert Shiller, the wheels will come off in the next 18 months. One hedge fund has a strategy to capitalise on the looming end of the economic cycle.

Crescat Capital LLC was one of 2018’s best-performing hedge funds, with a consistent track record of outperforming the S&P 500 Index (its Global Macro Fund returned 41% last year alone). Crescat global macro analyst Tavi Costa told Bloomberg that they expect the recession to come sooner than that. Warning signs include a potential bubble burst indicated by a glut of stocks sold by corporate insiders. CNN reports that executives are selling their own company stock at a rate of 5:1 compared to buyers, with 2 600 executives selling shares in February – the highest level in two years. While those investors also sold heavily in early 2017 and 2018 while the S&P 500 kept going up, Crescat clients were told that “the third time should be the charm for the stubborn U.S. market”.

According to Crescat, measurement of “multiple yield spreads across the curve from Fed Funds to 30-year Treasury bonds” revealed that “45% of the curve is inverted” – a situation that resulted in asset bubbles disintegrating “[t]he last two times the credit markets had such a high distortion”. The close-to 19% rebound in global stocks in 2019 is dismissed as little more than a bear-market rally – insider selling is a tell-tale sign that a rally is running out of steam.

This sentiment is echoed by MoneyStrong founder Danielle DiMartino Booth, quoted by CNN as saying, “History is replete with examples of major recoveries following big sell-offs, many of which turn out to be head fakes otherwise known as bear market rallies.”

If this prediction is accurate, the rational question is what to do about it. According to Crescat’s Costa, the answer is to bet against the Dow: 75% of the firm’s strategy is based on going long on gold in yuan terms and shorting global equities. Trade visualisation is modelled by means of the MSCI World Index in models to visualize trades; for its short position, the firm bets against selected individual stocks and exchange-traded funds.

“Soon the buy-the-dip mentality and bull-market greed will turn to fear. Selling will beget more selling. That’s how bear markets work,” Crescat wrote to its clients. “There is so much more ahead to profit from the short side of the market. The bear-market rally is running out of steam!”

Investor influx expected for China-focused funds

If the wise money is on shorting the Dow, it’s also safe to bet on China. The Financial Times reports that hedge fund investors are looking to Asia for the best opportunities to make money this year and are planning to increase their allocations to managers who know the region – and know China in particular.

According to a new Deutsche Bank survey of 425 allocators from 28 different countries, pension funds, sovereign wealth funds, endowments and other investors with substantial hedge fund holdings are seeking out managers “able to deploy bread-and-butter hedge fund strategies such as equity long/short investing in Asian markets”, with China equity long/short being 2019’s second-most popular hedge fund strategy.

Europe has ceded its place as the world’s hottest investment region to the Asia Pacific area. Some 36% of investors will allocate more funds to managers trading in Asia Pacific this year; 26% are going to allocate more to China-focused managers; and 20% plan to increase their exposure to global emerging markets.

Survey respondents manage or advise on hedge fund assets amounting to US $1.74tn, which represents more than half the industry’s total assets under management. Respondents included allocators working for sovereign wealth funds, public and private pension funds, insurance companies endowments, foundations and consultants.

The FT quotes Marlin Naidoo, Deutsche Bank’s global head of capital introduction and consulting (a unit that works with prime brokerage to bring hedge fund clients and investors together), as saying, “A lot of what we used to see was allocators being very skewed to developed markets,” said. “In the last few years, there’s been a catalyst to look elsewhere. People have spent less time in Asia and they’re starting to look now.”

According to Naidoo, the Hong Kong Exchange’s announced launch of MSCI China futures, combined with an increase in stock inventory, has afforded hedge funds easier access to the Chinese market.

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