Get Used to Volatility, Says Hedge Fund That Called August Rout

Article in Bloomberg

Inyoung Hwang

September 15, 2015 — 12:00 AM BST

  • Fed's call this week won't calm new normal of turbulence
  • Valuations and emerging-market woes give clues, 36 South says

Anthony Limbrick, whose hedge fund profited on bearish wagers during the August rout, says the recent turbulence in markets heralds a new era in increased volatility.

One clear sign to Limbrick: U.S. stocks are expensive -- valuations for U.S. stocks when compared to earnings before interest, tax, depreciation and amortization hark back to the dot-com bubble era. Another: Emerging markets will continue to plague developed peers for years to come, mirroring the Asian financial crisis of the 1990s, he says. Limbrick’s firm, 36 South Capital Advisors, saw trouble brewing in developing economies back in 2013.

And he says the Federal Reserve won’t do anything to calm equities after the twin concerns about China and a rate hike sent the VIX soaring 135 percent last month.

“It may well be ‘sell the rumor, buy the fact’ into the Fed meeting,” with stocks initially rising, but “how long that relief rally lasts for is an important question,” said Limbrick, the head of quantitative research at 36 South in London. “Markets may have an upward bias for a while, but we’d expect to see another leg down.”

Take U.S. initial jobless claims, data that he monitors closely. When applications for unemployment benefits have hit lows, it’s historically a good time to sell equities since the trend emboldens the Fed to lift rates, he said. Also, shorting volatility became a popular, then crowded, trade earlier in the year and now a reversal is due.


Jobless claims at lows signal stocks will follow, Limbrick says


“When the consensus is built around one side of the market, then it’s vulnerable,” said Limbrick. “That was one reason we started to get confident that a low in volatility had been made ahead of this summer.”

36 South, a volatility hedge fund, reacted to technical signals in June that markets were vulnerable by building up bearish positions. Its [flagship strategy gained] in August, outperforming 98 percent of peers, according to data compiled by Bloomberg. Still, the fund is [down] so far in 2015, a sub-par performance relative to rivals.

Morgan Stanley’s Andrew Sheets has a more bullish outlook. The firm’s chief cross-asset strategist wrote in a report Sunday that the current turmoil in markets is similar to ones in 2010 driven by Greece, in 2011 by the U.S. debt ceiling, in 2012 by the euro-zone debt crisis and in 2014 by Ebola.

All of these events turned out to be buying opportunities, even though higher volatility typically lasted for 60 days after each period, and Sheets says this time is no different. He cited well-behaved credit markets, stability in bank funding and the divergence of equity price swings versus other measures of volatility.

Exchange-traded funds and products that wager on volatility -- which have boomed since the financial crisis -- will contribute to wilder price swings, Limbrick said.

“I’m suspicious a lot of these products could have significant problems in a serious risk-off event,” he said. “They add volatility, and some of the more complicated strategies haven’t really been tested in a risk-off environment.”