Hedge Fund Sibilla ‘Truly Scared’ as Catastrophic Risks Rise

  • After "dust settles," New York firm will short U.S. equities
  • Underlying weakness in global economy could lead to recession

Hedge fund firm Sibilla Capital Management said it is "truly scared" that the U.K.’s extraordinary vote last week to exit the European Union could spur a global recession and increase the risks of a credit crisis in the next two or three years.

“A forced repricing due to increasing disintegration risks would be catastrophic for credit, banks and the global economy,” Lorenzo Di Mattia, chief executive officer and chief investment officer of the New York-based hedge fund firm, which manages $165 million, wrote in a June 27 investor letter. “Risks are enormous considering that due to extreme intervention by the European Central Bank in the fixed-income market, many government bonds and corporate bonds in Europe are extremely overvalued and mispriced.”

Britain’s vote to leave the EU after almost a quarter of a century has roiled global markets. The pound, which plunged to a three-decade low, stopped declining after falling 11 percent for two trading days since Friday and was up 0.6 percent to $1.3303 as of 11 a.m. Tokyo time. The S&P 500 Index fell 5.3 percent following the vote.

For a QuickTake on why Britain is voting to leave the EU, click here.

Sibilla wrote that its fund was positioned to have low correlation with the outcome of the Brexit vote, helping it gain 70 to 75 basis points on Friday. The fund is up about 40 basis points so far in June. A basis point is one-hundredth of a percentage point.

Italian Short

The fund will explore “low risk” trades including shorting Italian sovereign bonds, and will find attractive entry points for such bets, according to the letter.

"Italian bonds would collapse if there were a referendum on the Euro currency,” Di Mattia wrote separately in an instant message. “They are currently trading as risk free.” 

After the initial panic subsides, the fund believes the best trade to be “long” on Nikkei 225 Stock Average futures. Later this year, the fund sees a “great opportunity” to short U.S. equities, Di Mattia wrote.

The Nikkei, which is down about 20 percent year-to-date, is “even more depressed than in Europe with better earnings and less political uncertainty,” Di Mattia wrote. In Japan, the firm expects “a strong, new policy response” to extreme moves in the yen and the absence of inflation.

"I expect Japan to mention -- not necessarily launch -- a fiscal stimulus financed by the central bank," Di Mattia said in the instant message. That could happen as early as July, when the Bank of Japan will hold its next policy meeting, he said.

Sibilla noted that any rally in risk assets will lack the ingredients of a new bull market, largely because underlying weakness in the global economy and high debt levels will curb earnings growth. This will increase the possibility of a recession, bank crisis or emerging-market crisis, a risk that would have been present even had the U.K. voted to remain in the EU, Sibilla said.

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