Equities Headed for 'Cataclysmic Crash'

Interesting article about the upcoming demise of the equity capital markets.

LONDON (Reuters) Nov. 7th; Equities are set for a four- to five-month rally before a "cataclysmic crash" next year, Alex Allen, chief investment officer at fund of hedge funds boutique Eddington Capital Management, said.

"At the edges where markets are liquid we've been willing to call the bottom. We're bullish on equities for the next four to five months and then we expect to see the final cataclysmic downleg," Mr. Allen said. "Equities will go to at least 50% below where they are now. It's going to be as bad as 1929. Equity markets are extremely expensive."

Analysts are currently forecasting average operating earnings for 2008 of $72 for the Standard & Poor's 500 stock index.

"At its current level that would put the index on a PE [price-to-earnings] ratio of 14 which is around the long-term average of the market," Mr. Allen said.

In a best case scenario operating earnings will hold up at $72, so for the market to bottom-out on a PE of 10 it would have to go to 720, Allen said. The index closed at 952.77 on Wednesday, a loss of 5.27% on the day.

But this seems to rosy a scenario, Mr. Allen said, with earnings forecasts likely to be downgraded further next year. "Markets have, with few exceptions, rarely bottomed-out on a double digit price to earnings ratio," he said.

The bottom will see "mass liquidation" as investors look to sell every position because they think the world is ending, Mr. Allen said.

Eddington, which manages $290 million across three funds of hedge funds, is positioning to take advantage of the big moves in equity markets, Mr. Allen said. The firm has set up several managed accounts to ensure greater transparency and liquidity in its portfolio but also to take advantage of market moves.

Managed accounts are owned by a single investor and provide greater transparency and liquidity than a normal hedge fund while also allowing the account owner to specify their requirements.

With one manager, the firm has set up a put-buying account and a call-writing account whereby the manager goes long and short of equities using options.

The Eddington Triple Alpha Fund, which has 180 million dollars in assets under management, has 20% of its portfolio in equity long/short managers. The fund, which runs a high-volatility strategy, is down 7.11% year-to-date compared with the Hedge Fund Research Inc. fund of hedge funds composite index which is down 12.28% in the same period.

By James Molony

James.Molony@ThomsonReuters.com