Investors Lose Appetite For Risk In Midst Of Geopolitical Uncertainly

Jul 22 2006 | 1:48am ET

The crisis in the Middle East has caused a world-wide reduction in investors' risk appetite, according to Justin Dew, senior hedge fund strategist at Standard& Poor's. "It was obvious in May but it has accelerated recently," Dew said, referring to the decline in emerging markets currencies during that month.

He added that the risk reduction is happing more in the long-only space, rather than with hedge funds. "Oil prices are a strong factor in a lot of different decisions hedge funds are making," said Dew, adding that managers are attempting to be long-oil in the face of the uncertainly in the Middle East.

Frank Troise, managing partner at Soho Capital, which runs both traditional and alternative strategies, view the crisis as a market blip. "We've always been long-oil and will continue to be long-oil," he said, though he added that the firm has been taking some profits at these levels because he feels that it is overextended. "The reality is that economically and from a market standpoint, it is irrelevant in terms of changing the fundamentals that are there. There isn't any ambiguity about who is going to win," said Troise, citing Israel's enormous military budget compared to that of Lebanon's.

Carter Worth, chief market technician at Oppenheimer & Co., rejects the premise that long-only managers are being impacted by the events any more than long/short managers are. "I haven't seen anything that would suggest that," Worth said. "The presumption isthat the market has success fully priced in the developments. Eighty plus or minus a dollar per barrel reflects that." 

Garret Smith, general partner at Dallas-based hedge fund firm Spinnerhawk Capital Management, just returned from a trip to the Middle East and isn't so sure that the situation won't have a major impact on oil prices.

"It is hard to conclude that something like this can be priced in. Neither Israel or Lebanon produces nor consumes much oil, but it would be impossible for Hezbollah to do this by themselves," said Smith, believing that there is always the possibility that Iran is using the situation to create more uncertainly about the oil-producing nation's nuclear weapons program.

Spinnerkawk maintains a core length in oil, and the firm has not added to their position. As for the current situation with U.S. equities, Dew is seeing two camps: One that believes earnings are good, inflation is low, interest rates are reasonable and therefore it makes sense to be long, and another that is bracing for inflation. "There is an ever increasing sentiment that inflation is here, that it is getting more powerful, and that the Fed is likely to continue to raise rates, which will of course put the breaks on the economy."

Dew said that a number of managers are positioning themselves not so much to take advantage of a falling equity market, but to protect themselves against one. "Whereas they may have been on the aggressive side, 60-70-80% net-long, now they are looking at more like 20-30-40%. Obviously, that is a reduction in appetite for being long U.S. equities."

In terms of the dollar, many managers are just waiting for the decline to come. "Everyone knows that the dollar must decline," he said, "but it isn't, so it feels like there is a pent-up amount of capital ready to bet against the dollar."

Worth agrees that the dollar will go lower, and he thinks the biggest debates out there are how you play the consumer and how you play financials. "The consumer has been creeping by the graveyard for about six years now," he said. "The bet is that the consumer is going to continue to deteriorate." He said the consumer is over-leveraged, which is resulting is less discretionary spending, which is why there has been such a big sell-off in luxury goods retailers such as Tiffany& Co, he Cheese cake Factory, Nordstrom and Coach.

"In terms of financials, many are making the bet that financials are ok, hence the relative strength that you see in regional banks, money center banks and insurers," Worth said.

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