U.S. market gurus who predicted selloff say current calm an illusion

NEW YORK (Reuters) - You ain’t seen nothing yet.

Some veteran investors who were vindicated in calling for a pullback in shares and a spike in volatility could now be cheering. Actually, they’re looking at the risks that still lie ahead in the current relative calm.

The last week’s wild market swings confirmed that the market was in correction territory - falling more than 10 percent from its high. The falls were triggered by higher bond yields and fears of inflation but came against a backdrop of a stretched market that had taken price/earnings levels to as high as 18.9. Adding to downwards pressure was the unwinding of bets that volatility would stay low.

The fall had come after a growing number of strategists and investors said a pullback was in the offing - although the consensus opinion was that the market would then start rising again.

The big question is: what comes now?

“Do you honestly believe today is the bottom?” said Jeffrey Gundlach, known as Wall Street’s Bond King, last week, who had been warning for more than a year that markets were too calm. Gundlach had been particularly vocal in his warnings about the VIX, Wall Street’s “fear gauge,” which tracks the volatility implied by options on the S&P 500.

The sell-off in U.S. stocks derailed some popular short volatility exchange-traded products, which contributed to more downwards pressure on the market. Gundlach in May last year warned that the VIX was “insanely low.”

Hedge fund manager Douglas Kass from Seabreeze Partners Management Inc was short SPDR S&P 500 ETF and said he “took a lot of small losses” last year but says he still sees more stress ahead. He said he is now re-shorting that ETF.

Investors who bet low volatility would continue will need time to unwind their strategies, Kass said.

FILE PHOTO: Traders work on the floor of the New York Stock Exchange (NYSE) in New York, U.S., February 8, 2018. REUTERS/Brendan McDermid

Dan Fuss, known as Wall Street’s Warren Buffett of bonds, has been warning for years that Treasuries were vulnerable to a vicious sell-off and set for much higher yields and lower prices. “I‘m not trying to be an ‘end of the world person’ here, but it is a possibility,” Fuss told Reuters last November.

In a telephone interview this week, Fuss, the vice chairman of $268-billion Loomis Sayles and one of the world’s longest-serving fund managers with six decades of experience, said he had built cash and cash equivalent reserves to their most extreme levels in his Loomis portfolio and had put some of that money to work last week.

His biggest worry in 2018: “The geopolitical side. Nothing beats peace.”

Veteran short-seller Bill Fleckenstein, who ran a short fund but closed it in 2009, said that “last week’s action was an early indication that the end of bull market is upon us.”

Fleckenstein said there was a lot of money in the market with no conviction behind it, for example, buying index funds and ETFs just “to be part of the party” which was an element of “hot money.”

“Last week was just the preview to the bigger event that we’ll see this year probably,” Fleckenstein said. Fleckenstein said he is not short at the moment - although he did make “a couple of bucks” last week shorting Nasdaq futures. He said he is looking for an opportunity to get short again. He said he has “flirted with the idea of restarting a short fund”.

“I’m not short at the moment, because the action was such that I covered, but I expect that I’ll be short aggressively at some point this year. It’s not quite time, but it’s pretty close.”

Many strategists have been bullish about the market’s potential to stretch the near-nine-year-old bull market further. Many had said they expected a pullback, but then a resumption of gains.

The drop in the benchmark S&P 500 last week did not dent strategists’ expectations for mild to moderate gains in the U.S. stock market by the end of the year, as they cited strength in corporate earnings and interest rates not expected to derail equities.

Byron Wien, longtime Wall Street strategist who is vice chairman in the Private Wealth Solutions group at Blackstone, said in his predictions for 2018 that this year the S&P 500 would have a 10-percent correction.

“I don’t think we’re done,” said Wien, who ultimately thinks the bull run will continue some more and that the S&P would end the year above 3,000. But the path there could be bumpy. Wien thinks the correction “did not cleanse the optimism sufficiently” and sees further downside beyond the 10-percent fall - which has since been partially recouped.

“Everyone says: ‘Oh, well, now we’ve had the 10 percent correction that everyone was waiting for, then we go back up again’,” said Wien. “But it’s not as simple as that.”

(This version of the story was refiled to remove the erroneous “percent” from P/E level in paragraph 3)

Reporting by Jennifer Ablan and Megan Davies; Editing by Nick Zieminski