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Novogratz to Burbank See Stocks Surviving First Fed Taper

Druckenmiller Sees Stocks Surviving First Taper as Klarman Warns
Stanley "Stan" Druckenmiller, chairman and chief investment officer of Duquesne Family Office LLC. Photographer: Scott Eells/Bloomberg

Hedge-fund managers from Stanley Druckenmiller to Fortress Investment Group LLC’s Michael Novogratz and Passport Capital LLC’s John Burbank said U.S. stocks would continue to do well this year even if the Federal Reserve gradually reduces its asset purchases, a move the central bankers resisted today.

As long as the Fed prints money by buying assets, stocks won’t enter a bear market, Druckenmiller said. The exit of Lawrence Summers from the race to become Fed chairman has made it more likely that the central bank will continue policies that encourage investors to take risks such as buying equities, he said.

The Standard & Poor’s 500 Index shot to a record high today after the Fed unexpectedly refrained from reducing the $85 billion pace of monthly bond buying, saying it needs to see more evidence of improvement in the economy. The Fed Open Market Committee had been predicted to reduce purchases of Treasuries and mortgage bonds to about $75 billion a month when it concluded its two-day meeting, according to a Bloomberg survey with 34 estimates.

The asset buying has helped fuel a 21 percent rally in the Standard & Poor’s 500 Index this year, outpacing the growth in earnings of its underlying companies, even as investors started to flee bonds and emerging markets following Fed Chairman Ben S. Bernanke’s comments in May that quantitative easing may end.

Sustained Rally

“Markets can definitely rally into December,” said Frank Maeba, managing partner of Toronto-based Breton Hill Capital Ltd., whose $260 million macro fund counts the California Public Employees’ Retirement System as an early investor. Macro funds seek to profit from macroeconomic trends by trading a range of assets.

If the Fed ends its asset purchases in full, something Bernanke has said may happen by the middle of next year, markets could see a drop of 30 percent, said Baupost Group LLC’s Seth Klarman in a recent speech, citing research by David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates Inc.

The S&P has rallied more than 150 percent from its 12-year low in March 2009, with several rounds of the Fed’s quantitative easing backing up moderate economic growth. U.S. gross domestic product is projected to grow 1.6 percent this year, the median forecast of 81 economists in a Bloomberg survey.

Summers’s Withdrawal

Over the longer term, an end to the Fed’s asset purchase program will definitely be a “big deal,” Druckenmiller said last week. Druckenmiller, a former chief strategist to billionaire George Soros who now runs his own family office, had only a few small trades on as recently as last week as he waited to see who might replace Bernanke when he steps down at the end of January.

“How in the world does anyone think when the actual exit happens that prices are not going to respond?” Druckenmiller said Sept. 11, given the selloff in bonds and emerging markets in the past few months on the mere hint that the Fed might taper its purchases.

Now that Summers, who many thought would end quantitative easing quickly if appointed to the post, has withdrawn his name from consideration, Druckenmiller said he is more sure about the direction of U.S. stocks.

Klarman’s Views

“I think one of the major uncertainties in the market has been cleared up,” which will have an impact on risk-taking over the intermediate term, Druckenmiller said in separate comments following Summers’s announcement.

Klarman, a value investor known for his bearish views, cited Rosenberg’s analysis that 30 percent of the market’s gains can be attributed to quantitative easing in a speech he gave in June at a private gathering.

“Implicit is that a 30 percent drop might follow a full reversal of QE policies, but equity investors who have embraced a momentum strategy are ill-prepared for a policy change that could reverse the market’s artificial gains,” Klarman said at the time, according to a person familiar with the contents of the talk.

Klarman, hasn’t altered his views, said two investors, who asked not to be identified because the information isn’t public. The $29 billion Boston-based Baupost is holding 30 percent to 35 percent of assets in cash and Klarman has told clients he will return some capital at the end of the year, the investors said. Klarman has previously pledged to keep Baupost’s assets at $20 billion to $25 billion.

More bullish managers are brushing aside those concerns, betting that U.S. stocks will continue to do well even as emerging markets, perceived as riskier, suffer.

Hedging Bets

Some of Breton Hill’s biggest bets include a wager on rising U.S. stocks and long dollar positions versus the yen and the Canadian dollar, Maeba said. He’s also sold short gold, wagering against the metal that resumed its retreat this month after coming within 3 percentage points of a bull market amid the threat of military strikes on Syria.

High-growth shares in the U.S. will outperform other stocks, according to Burbank, chief investment officer at San Francisco-based Passport, and Tim Garry, his co-portfolio manager on the firm’s Long Short fund.

Burbank, who runs the San Francisco-based firm’s global fund, increased his hedges in the second quarter by buying put options on exchange-traded funds that track the Russell 2000 and the S&P 500 indexes, according to regulatory filings. The fund added puts, which rise when the underlying asset falls, as an inexpensive means of hedging an exogenous market shock, according to an investor.

Emerging Markets

“Our two clearest views are emerging markets will perform poorly relative to the U.S., and over the long term industrial metals will do poorly,” Garry said last week in an interview.

Emerging-market currencies, which have rebounded this month from their biggest slide in five years, may resume their declines when the Fed tapers if that dries up funds that were chasing higher-yielding assets outside the U.S.

Passport’s $1.3 billion global fund climbed 18 percent this year through August and its $611 million long-short fund rose 16 percent, according to investors.

Managers who have profited from a rally in Japanese equities and a decline in the yen also expect to make more money from those trades, and they see emerging-market stocks and currencies falling further, said Arvin Soh, a New York-based portfolio manager at GAM, which allocates capital to hedge-fund managers.

Japan Trade

Among the investors who have made money on the Japan trade is Novogratz, whose Fortress Macro Fund rose 8.8 percent this year through Aug. 31, and had $1.9 billion in assets as of June 30, according to regulatory filings. Novogratz expects markets to stay choppy but is generally positive about the U.S. economic recovery, said two investors who asked not to be identified because the macro fund is private.

U.S. equities may end the year 25 percent to 30 percent higher, Novogratz, head of liquid markets at New York-based Fortress, said in a Bloomberg Television interview in May. The yen may finish 2013 at 120 per dollar, he said at the time, citing monetary easing by the Bank of Japan.

“The broad sense is that tapering is happening, but the Fed won’t be aggressive,” said Soh, whose Zurich-based firm manages more than $120 billion globally.

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