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Stefan Keller, Lyxor AM

Summer rally

Hedge fund managers are lagging the current summer rally, says Stefan Keller (pictured), head of MAP research & external relations at Lyxor AM…

And the market climbs the wall of worry. Who did not read recently that the financial crisis started five years ago? And that we're now actors of "Crisis (season 6)"? We continue reading hedge fund managers reports expecting a 50% chance of a eurozone breakdown, noting that the reality of the crisis in Europe is no better (worse, in fact, as banking system fragmentation accelerated significantly in July), wondering if the upcoming ruling by Germany’s Constitutional Court on the ESM is a mispriced risk in the market, expecting ECB’s inability to execute and therefore introducing systemic risk into markets, indicating how challenging the expected downgrade for Spain to below IG mid-September will be and contemplating the coming French depression.

Presumably, the market knows all this and, let's keep the example of France over the last three months, has been remarkably solid: the CAC40 index has risen by 15% since mid-May and its 5y CDS has rallied 90bps.

So, why are hedge fund managers lagging the current summer rally?

A simple statistical way to answer that question is to compare the risk appetite of hedge fund managers to the fear gauge on Wall Street, CBOE’s VIX volatility index. The latter is now at a level three times below that registered one year ago (even if the term structure suggests less calm weeks ahead). The former is clearly below the historical norm of the last two years. At 8.3%, the median equity beta of the 100+ funds on the Lyxor MAP is currently more in line with a VIX in the 20-30 range. If history is any guide, the current cautiousness could well reverse this autumn and equity exposures increase by 10-20 points further. Remember – the market climbs the wall of worry.

Up from Down

When Central bankers and monetary policy economists meet in Jackson Hole 30 Aug through 1 September this year, they will not only reflect on short term interest rates. Contemplating a 3% rise in bonds (JP Morgan GGB index) and a 9% rise in equities (MSCI World) since the start of the year, while credit growth is expanding at a slower pace (if only, in Europe) and unemployment is stuck at historically high levels on both sides of the Atlantic, gives enough food for thought about the monetary policy transmission channel.

ECB President Draghi may use Jackson Hole to discuss how the ECB plans lowering Spanish and Italian borrowing costs. Intra euro-zone imbalances are in the spotlight as staff at the ECB is reportedly analysing Target2 dynamics ahead of the September 6 governing council meeting, to determine whether credit risk or convertibility risk is driving the intra-EU flows. (German) ECB board member Asmussen gave some hints earlier this week when saying that “a currency can only be stable if there are no doubts about its survival”. Hedge funds, as mirrored by various risk indicators on the Lyxor MAP, have kept some dry powder this summer for better times as discussed above. Clearly, at current levels markets need a new catalyst to go further up. In recent history, the Fed has used the symposium in Wyoming to telegraph policy shifts – this year it could be ECB’s turn.

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