Assume The Position! 'Dumb' Money Edition

| About: SPDR S&P (SPY)


Things are looking kind of scary out there.

But you can count on the 'smart' money, right?

Let's see how active managers and the 2 and 20 crowd are positioned.

As you might have noticed, it's been tough sledding for the 2 and 20 crowd of late.

Multiple high-profile flameouts (Valeant comes to mind) and a generalized lack of any actual hedging across the space led the likes of David Einhorn to lose more than 20% in 2015. Similarly, Bill Ackman has been living a veritable nightmare. Pershing Square was down more than 25% through March. Have a look (from the May letter):

(Source: Pershing Square)

Even the zen master himself, Ray Dalio, had a rough go of it late last summer when risk parity proved no match for the generalized carnage that swept across global financial markets following China's "surprise" yuan devaluation.

Here's a look at the HFRI Fund Weighted Composite Index:

Click to enlarge

(Chart: Bloomberg)

So yeah, pretty terrible lately, but note that it's only up around 15% over the past six years. You could have just bought the S&P (NYSEARCA:SPY) and doubled your money over the same period just by riding the central bank put. And you would have paid basically nothing in fees.

Note also that through mid-May, long/short hedge funds had significantly underperformed the broad market:

(Chart: Goldman)

What's behind the underperformance? "Volatile factor and sector rotations beneath the surface," Goldman says. In other words, the kind of things hedge funds are supposed to mitigate. Funds' most popular long positions (the hedge fund hotels) have lagged the S&P by 15 percentage points since last August. As Goldman goes on to note, that matches a record set in 2008.

Similarly, 86% of actively managed funds in Europe underperformed their benchmark over the last decade. In the US, 82% of large cap funds lagged the S&P over the same period.

So that's over the long term. Here's a quick excerpt from Deutsche Bank (NYSE:DB) which gives you an idea of how wrong-footed they've been caught lately:

The move in rates, in divergence from macro data surprises, hammered actively managed equity and bond funds. Equity mutual funds underperformed significantly over the last two weeks by a median -64bps, with 76% of funds underperforming. Long-short equity hedge funds were down 1.5%.

It gets better:

... funds were caught long the Financials and short the bond-like defensive sectors.

Right. They were long financials (which need a steeper curve) and short bond proxies going into an ultra-dovish Fed meeting. So basically, they're not getting any better at this.

I bring this up because it's looking more and more likely that things are about to get messy - to put it colloquially.

First off, June might well have been it in terms of Fed credibility. The abrupt about-face, following a month straight of hawkish rhetoric, was a bad move and the continual evolution of the dot plot shows just how wrong they've ultimately been:

(Chart: Deutsche Bank)

The market's loss of confidence in central bank omnipotence couldn't come at a worse time. The FOMC has finally come to terms with its role as steward of global capital markets. But just when the reaction function changed as the Fed explicitly took the reins, the market ceased believing they were in control. Now, we're effectively rudderless in an environment where all manner of dislocations and misallocated capital are littered across markets. Markets which are beset by HFTs and beholden to monetary authorities that have lost their legitimacy.

Meanwhile, the global economy is about to hit stall speed as trade grinds to halt. Here's a look at BofAML's Global Financial Stress Index:

Click to enlarge

(Charts: BofAML)

So coming back to where we began, the question I have is this: if "rockstar" hedgies and active managers couldn't even manage to lever up and ride the wave over the past five years, what are they going to do when it gets scary out there?

Let me show you how confused the "smart" money is. Let's take a look at positioning for a second.

On equities, "mutual funds are overweight Financials and underweight Consumer Staples, Telecom and Utilities; long-short equity HFs are overweight cyclicals ex Consumer Discretionary and underweight defensives," Deutsche notes. Overweight financials and underweight defensives. Make a mental note of that and time stamp it in your head.

(Chart: Deutsche)

Ok, how about bonds? Have a look:

(Chart: Deutsche)

So basically they were the second most net short in half a decade going into a week when global bond yields plunged to new record lows.

And here's where it gets really schizophrenic. Here's yen (NYSEARCA:FXY) positioning:

(Chart: Deutsche, my annotations)

And here's oil (NYSEARCA:USO):

(Chart: Deutsche, my annotations)

And finally, here's gold (NYSEARCA:GLD):

(Chart: Deutsche, my annotations)

Not sure what to make of it all? Me neither. But my gut tells me you'll still be better off in an index fund.

Trade accordingly.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.