Bearish hedge funds like those led by Ray Dalio and Michael Burry run out of money after betting on a crash | Financial Markets

Taking advantage of a stock market crash is not a popular pastime. When stocks rise, it is a sign that the economy is doing well, that companies have good prospects, and that employees are not afraid for their jobs. That is why it is so difficult to be a bearish investor. It is to be a doomsayer, shouting about a stock market apocalypse to a crowd happily living with the revaluation…

Taking advantage of a stock market crash is not a popular pastime. When stocks rise, it is a sign that the economy is doing well, that companies have good prospects, and that employees are not afraid for their jobs. That is why it is so difficult to be a bearish investor. It is to be a doomsayer, shouting about the coming stock market apocalypse to a crowd that is happily living off the overvaluation of indexes.

In Wall Street parlance, bearish investors are called “bears” because they spend long periods of hibernation waiting for a major stock market correction — unlike “bulls,” who are always aggressive and act quickly. Bears have been dozing for years, waiting for stocks to fall, but this time, for many, the slumber has lasted too long and they are starting to run out of nutrients.

The S&P 500, the largest US listed company index, has been hitting peak after peak for a year now. After a 24% revaluation last year, many thought it had no chance; that it depended too much on the development of a handful of technology companies – the magnificent seven; that valuations were too high… But by the middle of this year, the select group had already achieved another 15% return.

The world’s most popular bearish investor is Michael Burry, who was able to predict and profit from two of the biggest stock market bubbles of our time: dot com in 2000 and mortgage loans substandard in 2008. Last year, he posted a clear message on the social networking site X: “Sell.” The manager had been warning for some time about how overheated the North American market was. Leading by example, Burry shorted the S&P 500 index by $1.6 billion. But the market insisted on continuing to rise, and the famous investor had to cover the bet to save his shirt.

And the markets’ most pessimistic forecasts have not come true. As Francisco Quintana, head of investment strategy at ING, explains, “All the analysts who took for granted a year ago that the US economy would go into recession have finally given up.” For a while, the market consensus took this economic downturn for granted. The very steep rate hikes intended to stop inflation were supposed to kill consumption and investment. The long-awaited soft landing seemed a chimera. But Jerome Powell, the head of the Federal Reserve, performed a miracle, and the North American economy continues to be the engine of global growth.

Another hedge fund One who was quick to predict a sharp decline in the stock market was Ray Dalio. The star firm of Bridgwaters Associates, the manager founded by the legendary investor, called Pure Alpha, had one of its worst years in 2023 due to its bearish bets. The fund fell 7.6% in a year when stocks and bonds rose around the world. The same happened to a large portion of North American free-floating funds, which had already predicted a correction that has yet to come. The best performers were firms like TCI, which chose traditional investments in big tech companies like Alphabet (the parent company of Google).

In Spain, there is no better example of a bear on the stock market than Antoni Fernandez, manager of Smart Social Sicav. Since the investment vehicle was created almost 10 years ago, he has always had a very bearish stance. In bad years for stocks, SICAV made some money, but overall its trajectory has been very negative, accumulating losses of more than 50%. In his latest monthly report, Fernandez continues to insist on his thesis: “Our main scenario is to see a strong bear cycle, similar to that of 2000 or 2008, when stock markets fell by 75% and 60% respectively.” To prepare for this cataclysm, the manager holds almost the entire portfolio in short positions on futures on the Nasdaq tech index. At the moment, SICAV is set to lose another 10% in 2024.

The thing is, Fernandez’s thesis seems reasonable. American tech companies are trading at an unprecedented rate. Hugo Ferrer, a stock market analyst, emphasizes how long this bull cycle has been, dating back to 2009. companies and others.” The investor assures that he is waiting for some macro data to change the pace and take positions with which to take advantage of the bear market.

One of the moments of maximum bearish momentum in the U.S. occurred in the fourth quarter of 2023, when the market consensus predicted a recession. The flow of short bets has increased by 20% so far this year, according to brokerage Goldman Sachs. Those bets were made by free-floating funds with macro strategies that base their activities on economic forecasts. Now, the S&P 500 Inverse Index, which measures the return on a bearish bet on the index, has shown a 21% decline since October 2023 (the date of greatest interest-rate stress). The index has lost 60% since the worst of the pandemic, in March 2020. If the investments are leveraged, as such positions typically are, the losses are multiplied.

This is the big problem with taking bearish strategies: it is very expensive when the exact moment of the correction is not quite right. To borrow shares or enter into a derivatives contract, you have to spend a lot of money or risk a lot of capital. Of course, the prize for whoever gets it right is very generous. According to calculations by Antoni Fernandez of Smart Social Sicav, if his forecasts are correct, his assets will be overvalued by 242%. The bad news is that by the time the hibernation ends, the bear may already be exhausted. In addition, there is another problem with bearish investing: the downside of shares (or indices) is limited (they cannot trade below zero), but the upside is not. So the potential losses when investing down are infinite.

In an essay by Michael Lewis Big Short Trade It tells how several managers decided to use various bearish strategies to take advantage of the subprime mortgage meltdown. suppress me in the United States. One of them is the aforementioned Michael Berry. As the story progresses, you can see how the manager accumulates in his hedge fund

loss after loss, waiting for the collapse. In fact, he fires all his employees and faces a revolt of fund investors who ask him to take the money, but he imposes a block. In the end, Berry got his way, but it remains to be seen whether this time the managers will get the timing right.

Meanwhile, bearish investors continue to suffer. In the UK, for example, several hedge funds They ended up getting scalded after trying to bet against several companies. The likes of Millennium Management, GLG and Gladstone Capital Management attacked several UK listed companies in 2024, hoping for a strong correction. Supermarket company Hargreaves Lansdown, cybersecurity company Darktrace and video game company Keywords Studios took a bearish stance on their stakes several times, but were eventually targeted for purchase by venture capital funds or larger rivals. This sent its price soaring and destroyed the bears’ strategy.

An experienced American bank manager explains that “short bets, despite the fact that they have a very bad reputation in Spain and are sometimes banned, play a very important role in the market because they point out weaknesses, inefficiencies and pricing errors.” What good does that do them? Of course they do, but it’s not that bad.” The banker remembers the important role it played hedge funds bearish to detect frauds such as Gowex in Spain or the Enron affair in the United States.

Fernández from Smart Social Sicav wakes up every morning in his home in Empordà to watch the stock market indices develop. He spends the entire day trying to spot market patterns that confirm the approach of the financial apocalypse. In the meantime, this summer, the bear will have to continue hibernating.

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