Hedge-Fund Managers Seek Gains Amid ‘Slow-Moving Train Wreck’

NEW YORK (Dow Jones)–If hedge funds have any consensus coming out of Thursday’s more than 500-point selloff, it probably is that they aren’t going to bet on a U.S. economic recovery gathering steam or the equities market stabilizing anytime soon.

“The market is now down 10% on the quarter and recently broke through the 200-day moving average. This is a key technical indicator and could portend a significant correction in the near term as each time this has happened in the past the market has gone down an additional 5% to 20% in short order,” said Russell Abrams, founder of volatility arbitrage fund manager Titan Capital Management.

Short volatility positions accumulated over the past two years–that is, bets the markets will stabilize, such as shorting “fear indicators” like the Chicago Board Options Exchange Volatility index, or VIX–could produce a severe jolt if investors are forced to reverse those trades and cover their short positions, he said.

Asset managers and investors until now had been split about what to focus on: positive corporate earnings or macroeconomic woes. Thursday’s plunge brought the nation’s fragility back in focus.

“The U.S. is a house of cards now,” said Steve Shafer, chief investment officer of global macro fund manager Covenant Investors. “It is a slow-moving train wreck. The problem of rising debt to GDP will be with us and periodically inflict pain on us in a recurring manner just like what we saw yesterday.”

His fund suffered modest losses Thursday as a short position in U.S. Treasurys backfired and investors fled to the instrument for safety.

But Shafer said the long-term thesis of a weak U.S. still holds and has gone to add more short positions in U.S. Treasurys and long positions in hard assets and natural resources amid the selloff.

“We’re layering positions in hard assets, natural resources like copper, corn, coal, crude oil and natural gas. These are assets where China will over time move from net exporter to importer because of their rising per capita income and urbanization,” he said.

He said investors were caught up in an overly pessimistic view about the possibility of China having a hard landing–a notion that proved to be irrelevant as China’s weak growth is still “quite strong compared to the U.S.”

Stephen Jen, a managing partner at SLJ Macro Partners LLP who was Morgan Stanley’s head of global currency research until 2009, said on the currency front, the U.S. dollar will likely stay weak, partly as the Fed willed it to be. “The Swiss franc and Japanese yen remain good safe havens, and the fact that their central banks intervened gave investors a better entry point,” he said.

While many investors are tiptoeing in the U.S. equities market out of fear, Titan’s Abrams is being bolder. “In 2008, we had a lot of currency options that fared quite well. The issue now is investors are clearly more levered in equities than currencies, so the volatility and gains probably are in equities this time,” he said.

The VIX spiked as much as 35% Thursday and lingered around 38 Friday. While the climb was fast and furious, it is still off the near-80 high at the peak of the financial crisis.A possible reprieve, however, could be on the way.”The debt-ceiling debate means that if the U.S. government is to commit to austerity, the scope of further fiscal stimulus would be very limited. This would in turn make it more likely for the Federal Reserve to adopt QE3,” SLJ Macro Partners’ Jen said.

-By Amy Or, Dow Jones Newswires; +1-212-416-3142; amy.or@dowjones.com

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