Funds leery of growth under Trump
STOCKS have marched higher and higher – up 5 percent since President Donald Trump took office six weeks ago – and the rally has become one of his favourite boasts. And there is plenty of economic data to justify the ebullience.
So why are some hedge fund managers bracing for a sell-off? It’s all in the details. The economic indicators are certainly heartening, they say, and Trump’s ambitious policy agenda – which includes a market-friendly triad of rolling back regulations on businesses, overhauling corporate taxes and spending $1 trillion in infrastructure projects as top priorities – looks encouraging, too.
That is, if they come to pass as they have been described.
If deep cuts to regulation and a tax overhaul are pushed off to next year, for instance, or if no clear plan emerges anytime soon to rebuild the nation’s physical structures, there is plenty of room for disappointment.
“The stock market may be currently expecting a best-case scenario for policy implementation,” Alan Fournier, the founder of the multibillion-dollar hedge fund Pennant Capital Management in Summit, New Jersey, said in an interview shortly before the Dow Jones industrial average closed above 21,000 for the first time, on Wednesday.
A closer examination of what it would take to put into effect Trump’s initiatives, like a proposal to impose new import taxes, he added, suggests that market participants might be overly excited.
“A lot more scepticism” exists in currency and bond markets, said Fournier, who looks at the prices of those assets, rather than at stocks, when he needs a powerful gut check. He declined to discuss his current investments in detail.
But the market chatter in recent days has been similarly sceptical.
In interviews with more than a doz- en money managers in the past week, nine senior investment managers or hedge fund executives predicted that a market decline of at least modest size was likely to occur in the near future.
Protecting the stocks, bonds and other positions that money managers hold from unexpected market moves in either direction is their business. It is the very essence of hedging, and is critical to preserving investor capital.
Some of those money managers are using options – trades that give their initiator the right, but not the requirement, to buy or sell stocks in the future – to bet that the benchmark Standard & Poor’s 500 index will fall 1 to 2 percent in the coming weeks. Such positions can be cheap to build, and can lock in favourable prices if the market declines.
Others, like the Chicago investment firm Citadel, which is known for its aggressive risk management, are adding the effects of Trump policy implementation to their lists of factors that could create market volatility, company officials say. (One example: a meaning- ful rollback of the 2010 Dodd-Frank financial regulation overhaul that improves the share prices of banks and related companies.)
And a number of the money managers interviewed are looking at online betting sites that allow participants to place wagers – offbeat as they may be – on whether Trump will be impeached before the end of his current term as one indicator of popular perception that could depress stocks in the coming months or years.
Ladbrokes, a British gambling com- pany, offers a market for bets that the president will resign or be impeached before the end of his first term. On Sunday, that market implied that the odds of such an outcome were more than 55 percent.
At Paddy Power, an Irish competitor running hundreds of markets related to the Trump presidency, the implied probability of impeachment was 40 percent. Other betting opportunities ranged from the likelihood of a third Trump divorce before the end of his presidency to the chance of Trump and President Vladimir Putin of Russia sharing a Nobel Peace Prize.
“Our customers are so interested in Trump that we’ve created, basically, a microsite dedicated to him,” said Lee Price, a Paddy Power spokesman.
And some funds have made hedging against risk their primary aim. Known as “tail risk” investment vehicles because they are on the lookout for highly unlikely market moves, they buy instruments like options and other insurance policies that can pay out when prices move in unexpected directions.
“Historic valuations and record complacency in today’s markets make them extremely vulnerable to shocks, regardless of who is in office,” Mark Spitznagel, the chief investment officer of the Miami-based Universa Investments, one of the best-known tail risk funds, said in an emailed statement. “The current low cost of protection makes a tail hedge an easy decision for asset holders, who are all exposed to the inevitable and increasingly dangerous unwind.”
Spitznagel recommended the use of S&P options known as puts, which are the right to sell that index at a future point in time at previously determined prices.
But without knowing more about how such policy measures will look, many hedge fund managers say it is hard to do more than simply wait until they can read the fine print.