The last remaining bears almost a decade into a recovery will be hoping that with the arrival of 2018 they will finally be proven right
With markets starting January without missing a beat from a barnstorming 2017, these are happy times for fund managers, with one notable exception — the increasingly small number of investors who have been doggedly betting on a crash in financial assets.
Such was the continued ferocious rise of all manner of stocks and bonds that being a “bear”, or believing that markets are poised to tumble and betting money on it, has become an increasingly lonely pursuit. Some have argued repeatedly for years that central bank policy following the financial crisis has created vast distortions in asset prices that will eventually dive once this stimulus comes to an end.
Now, as central banks across the world are preparing to pull back from ultra-loose monetary policy and vast bond-buying programmes, the last bears standing are hoping that their predictions will finally come true. Most of the small number of fund managers who are both bearish and unconstrained enough to express this view in their portfolios will need a very large fall for markets this year to get close to making back the performance they have lost.
Investment bankers, who enjoyed a vintage 2017 as large numbers of companies have issued debt to yield-hungry investors, acknowledge that ebullient sentiment could change quickly in the event of an unexpected market shock.
“Valuations do feel quite toppy, corporate spreads are extremely tight with looser covenants than before and people are buying assets at higher Ebitda multiples,” says Demetrio Salorio, global head of Debt Capital Markets at Société Générale. “This means there could be an important correction if something derails the markets.”
Crispin Odey, the London hedge fund manager, has long argued that a near decade-long experiment in monetary policy will trigger a catastrophic denouement for financial assets, and has backed up his belief by heavily betting against equities and government bonds. His conviction, however, has resulted in painful losses for his fund, which has lost a further 20 per cent in 2017 following a 50 per cent loss in 2016.
In a recent letter to clients, Mr Odey reiterated his conviction that monetary policy is doomed to fail, noting how “the bond markets are refusing to take any notice of the central bank’s advice that inflation is coming and interest rates are headed higher”.
John Hussman, an American fund manager who has been predicting a stock market crash since the last one in 2008, has also steadfastly stuck to his view that equities are vastly overvalued and will collapse. In November, he wrote how “the more investors speculate, the more they tend to become impressed by the outcomes of their own speculation, which temporarily results in self-reinforcing bubbles”. His Strategic Growth fund has lost 9.7 per cent over the past five years when the S&P 500 has returned more than 85 per cent.
Russell Clark, manager of the Horseman Capital global fund, has suffered losses last year in spite of getting several important calls right. Mr Clark is rare among those who have held large short positions in equities for several years because he has also managed to make money for his clients.
His fund made 20 per cent in 2015 while being short stocks by carefully picking the right emerging markets and sectors to bet against, while also being helped by a long position in bonds. However, in 2016 his fund lost 24 per cent, while last year it is narrowly down by 3.1 per cent.
“Why are we not making money?” he asked clients in a recent update. “The main reason is that corporate bonds have performed much better than I expected . . . The signals are there, but everyone is making too much money to care. Your fund remains long emerging markets, short developed markets.”
Yet the idea that higher interest rates and less bond buying by central banks will be the catalyst for a severe correction is not shared by all.
“Historically, market tends to under-price the pace of Fed rate rises virtually every cycle, but risk assets have still tended to outperform,” says David Riley, head of credit strategy at BlueBay Asset Management. He cites the example of the US rate tightening of the mid-1990s as failing to derail a significant rally for American stocks.
“Emerging markets took a hit with the Tequila crisis in Mexico, but the S&P 500 did well,” he says. “Markets are underpricing how quickly the Fed may act, but as long as growth validates higher global rates then risk assets may be wobbly, but growth will trump this.”
The last remaining bears almost a decade into a recovery will be hoping that, with the arrival of 2018, they will finally be proven right, in spite of what appears to be a rosy outlook for the global economy. If the market fails to play out in the way they envisage, then they are likely to face a renewed battle to keep hold of their long-suffering clients.
**This article has been amended to show that Horseman Capital’s global fund lost 24 per cent in 2016.