February 1, 2018
Stocks have grown more vulnerable to a steep decline that’s difficult to predict, making hedging strategies to protect wealth more necessary, Michael Lewitt, manager of the Third Friday Total Return Fund, said in a monthly report.
Investor optimism can wear off quickly in a market correction, typically a decline of 10 percent from recent peaks.
“With sentiment readings at what can only be described as hysterical highs, the markets are unprepared for even a mild correction,” Lewitt wrote in Feb. 1 edition of his Credit Strategist newsletter. “That means that investors are poorly positioned for any kind of sell-off. This increases the chances of a mild sell-off morphing into something more severe.
Lewitt sees signs of market euphoria in cryptocurrencies such as bitcoin, whose value rose twentyfold last year before losing half of its value in the first month of 2018.
“When cryptocurrencies claim market caps of hundreds of billions of dollars based on valuation arguments that would embarrass Mary Meeker or Henry Blodget, rational thinking is a handicap,” Lewitt said, referring to two former stock analysts who embodied the mindless excesses of the 1990s dot-com bubble.
The biggest concern for investors is the policy of central banks that have supported the global economy and asset prices by pumping trillions of dollars into the world’s financial system to cope with the 2008 financial crisis. As central banks like the Federal Reserve seek to raise interest rates while reducing their debt holdings, investors will demand higher yields from the U.S. Treasury just as the government seeks financing for an estimated $1 trillion deficit.
“The U.S. economy sits on more than $60 trillion of public and private debt,” Lewitt said. “The post-crisis economic recovery and market rally are constructed on a foundation of low interest rates and runaway debt….but markets are pushing off any concerns into the future because central banks are moving very slowly to unwind the debt-based boom they created.”
Lewitt’s Third Friday hedge fund has generated an annualized net return of 7.1 percent since starting on May 1, 2007, through the end of 2017. That compares to an 8 percent total return for the S&P 500 and 3.5 percent for the HFRI Hedge Fund Index. Only accredited investors are allowed to put money into the market-neutral fund