A decade ago, they were the masters of the universe, moving stocks and entire markets with a mere gesture. Now, adding insult to years of underperformance in central banker-planned markets, soaring redemptions and declining fees, America’s hedge fund gurus find their world turned upside down, trading on the defensive at the unpredictable whims of every Trump tweet. As a result, as the WSJ writes, “Many hedge funds are loading up on cash and sheltering their portfolios from the risks of an unknown future.”
In short, unable to find “an edge”, the “smartest people in the room” are increasingly seeking to boycott the market – which makes new record highs every day – altogether.
The reason is clear: Donald Trump: “Wall Street’s early exuberance at the election of President Donald Trump is giving way to reticence and in some instances outright hostility.”
Billionaire hedge-fund managers and day traders initially cheered Mr. Trump’s surprise win, propelling major U.S. indexes to all-time highs on the hope of increased government spending, tax cuts and loosened regulation.
Such Wall Street-favored tax and economic policies, however, are taking an early back seat to Mr. Trump’s polarizing moves on immigration and a predilection for intemperate interactions with foreign powers and would-be congressional allies.
As a result, some of the most prominent names in the hedge fund world, and closely followed traders are warning in letters to their wealthy clients that all isn’t as rosy as it seems.
And, as the WSJ puts it, “some warnings are rather more colorful than others.”
As profiled previously, one of the biggest legends in the hedge fund world, Elliott Management’s Paul Singer has cautioned about the risk of “deep underlying complacency” in the face of U.S. stocks that continue to reach record highs.
Another iconic name, Seth Klarman of the Baupost Group, best known for his sermons on value investing, advised that “the cynical exploitation of fake news is a threat against which we must all remain vigilant.”
Basso Capital Management’s Howard Fischer, a 30-year hedge-fund veteran, summed up the investing world as a “stew of uncertainties.” His take on Mr. Trump’s first few weeks: “Dizzying, startling and amazing.” In an interview, he added another adjective: “Disorienting.”
Quoted by the WSJ, Fischer summarized how most traders feel these days: “I have to divorce how I personally feel from the way I trade and invest,” he said. “You can call it somewhat of an internal conflict.” He would have add “just BTFD” if there were any dips to buy.
Some are simply avoiding any asset class that may be impacted by a Trump tweet. One such example is Paul Tudor Jones, who is shying away from trading some currencies, including the Mexican peso, in part on the belief that Mr. Trump’s unpredictability may lead to severe market swings, according to people close to the firm.
Tudor has set up email alerts to instantly blast its traders when Mr. Trump writes on the social networking website Twitter, the people said.
Another prominent investor – Corvex Management’s Keith Meister, a protege of Trump’s personal advisor Carl Icahn – said he now holds “a healthy degree of skepticism around both the ease by which the Trump administration’s plans may become a reality and the odds of a major acceleration of the economy,” according to a February investor letter. He has an eye on “misunderstandings that will inevitably result” from Mr. Trump’s trade policies, the letter indicates. Another prominent name which has warned in recent days about the downside risk of Trump’s policies, is none other than the bank which spawned virtually all of Trump’s economic advisors: Goldman Sachs.
Angry or not, hedge funds have no choice: they have to stay invested to earn their fees – ideally by finally outperforming the market – and that makes them “terrified” as the following excerpt confirms:
“You see all time new highs day after day, a trajectory with very low volatility, valuation metrics that scare you. You’re terrified when you’re in and terrified when you’re out,” said David Kotok, chief investment officer at Cumberland Advisors, in Sarasota, Fla. He held 20% or more cash in some accounts in recent weeks, much of which he subsequently invested.
Ironically, the backlash against Trump comes even asTrump’s election has been “manna hedge funds desperately needed” after a poor stretch of performance. The average hedge fund gained 3% over the past three months, according to HFR. The S&P 500 is up 4% this year. According to early prime broker data from JPM, the majority of hedge funds are once again underperforming the S&P.
Those who react too quickly to the perceived effect of Mr. Trump’s actions have been caught off guard lately.
Making matters more complicated, is that in recent days stocks have reacted in an opposite direction to Trump’s rhetoric: last week Nordstrom soared by the most in over a year, rising 4% after Trump lashed out at the retailer for droping Ivanka Trump’s fashion label. “I think the market’s becoming immune to that,” said Erik Davidson, chief investment officer at Wells Fargo Private Bank, referring to Mr. Trump’s tweets.
The uncertainty resulting from Trump’s executive style has led some of the most influential investors “typically content to keep a low profile” to come out forcefully against Trump and the impact of his policies. The best example of this was Seth Klarman who slammed Trump in his latest letter:
Exuberant investors have focused on the potential benefits of stimulative tax cuts, while mostly ignoring the risks from America-first protectionism and the erection of new trade barriers… The erratic tendencies and overconfidence in his own wisdom and judgment that Donald Trump has demonstrated to date are inconsistent with strong leadership and sound decision-making.
The big picture for investors is this: Trump is high volatility, and investors generally abhor volatility and shun uncertainty. Not only is Trump shockingly unpredictable, he’s apparently deliberately so; he says it’s part of his plan.”
Unpredictable he may be, but paradoxically so far this has resulted in the lowest level of volatility since the financial crisis, which incidentally is even worse for traders who desperately need sharp market moves to generate alpha. Still, Klarman’s warning goes beyond just daily P&L: “If things go wrong, we could find ourselves at the beginning of a lengthy decline in dollar hegemony, a rapid rise in interest rates and inflation, and global angst about the stability and wisdom of American leadership.”
As the WSJ concludes, “this isn’t the first time in recent years that hedge-fund managers, among others, have warned of trouble ahead, only to be later forced to play catch-up to surging stocks. Many money managers have an incentive to put out gloomy prognostications because they are pitched as portfolio protection in a down market.”
To be sure, in the past on every preivously occasion when the market attempted a mean reversion and dropped, it was immediately bailed out by central banks. It remains to be seen if Yellen et al will step in just as forcefully after the next – inevitable – market correction, Trump’s first.