From SocGen’s Andrew Lapthorne
Aided and abetted by QE, the last three years has seen the MSCI World Index rise by 38% whilst reported profits have risen by just 3%. This complete disconnection with fundamentals has been painful for short-funds looking to generate returns out of companies with weak business models.
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With the global equity markets up almost 150% since the 2009’s low, fuelled by cheap money and central bank QE, it is little wonder investors have lost interest in shorting. Indeed, many dedicated short funds have simply closed up shop recently or have returned investor’s cash whilst awaiting richer pickings or at least some return to a market more focused on fundamentals, rather than central bank largesse.
Long/short equity strategies have struggled in this environment (see below) and dedicated short funds have suffered most. That short funds suffer during rising markets is not unusual, minimizing the pain in the good times and then delivering during a crisis is usually the objective. However the last few years have been particularly painful. For example during the bull market run in equities during 2003/07, whilst dedicated short funds underperformed, they held their ground in absolute terms. This allowed long/short equity to do well even despite the rapid market rise, i.e. the short side did not detract from the overall performance. The same cannot be said of more recent performance, where short strategies performance has been so painful that we suspect many have simply given up.
QE has helped kill off the dark arts
Why have short-strategies suffered so much? We suspect QE may be part of the problem. As is now well recognised QE has helped drive up equities, but has done little to improve underlying earnings, as such it has pushed up share prices well in excess of what might be justified by fundamentals.
We are still amazed by the chart [below], but it summarises the problem for those seeking to short stocks with fundamental weaknesses. In the last three years, the MSCI World Index has risen by 38% (11% per annum) whilst reported profits have risen by just 3% (that’s just 1% per annum!). As the events of last month attest, central bank actions–not profits–are driving equities forward.
