Market bears detect a scent of honey

A number of high-profile investors have reversed course and now see value in shares, writes PROINSIAS O'MAHONY.

JOHN PAULSON, the billionaire hedge fund manager who last year made one of the most successful bets in Wall Street history after predicting a collapse of the subprime mortgage market, has started to buy mortgage-backed securities.

The Financial Times reported that Paulson has told investors that he started to buy the troubled securities at the end of last week, following price falls seen in the wake of the US government's decision to abandon its plan to buy toxic mortgage assets.

It's a notable volte face for the hedge fund manager. He began to bet on a fall in mortgage investments as far back as 2005, setting up two funds focusing on the credit markets over the following two years.

Last year's subprime meltdown saw those funds return 590 per cent and 353 per cent to investors, netting Paulson $3.7 billion in the process.

He remained bearish on the financial sector this year and was one of the largest short sellers of British financials, betting on share price falls for four of the five largest British banks.

That Paulson was watching for signs of an eventual turnaround became clear when it emerged some months ago that he was looking to launch a fund that would take equity stakes in battered financial institutions. However, he has been careful not buy in too early, turning down an approach to invest in Washington Mutual last April.

The Paulson Recovery Fund was eventually launched last month. A real-estate fund is also thought to be in the pipeline.

Paulson, who was one of a number of hedge fund chiefs to defend themselves before a congressional committee in Washington last week, has over $36 billion under management and his funds have operated profitably in 14 of the last 15 years.

He's not the only high-profile bear to reverse course of late. Jeremy Grantham, the legendary value fund manager who last year warned that the world's "first truly global bubble" in asset prices would cause "at least one major bank" to fail, said last month that investors are "looking at the best prices in 20 years".

Grantham has earned himself reputation as a so-called perma-bear, having been negative on the prospects of stocks for more than a decade - so many heads were turned by his prediction of inflation-adjusted stock returns of 7-9 per cent in the coming years.

John Hussman, another renowned value investor, agreed that stocks are now undervalued. "I realise how unusual that might sound, given my persistent assertions during the past decade that stocks were strenuously overvalued," Hussman recently wrote, adding that the recent market collapse "completely changes the game".

The contrarian approach was also taken by strategists at Morgan Stanley last week, issuing a "full house buy signal" for European stocks.

Despite being in the "worst earnings recession of the last 40 years", they said that market-timing indicators measuring valuation, fundamentals, risk and capitulation suggest that stocks are soon set to outperform.

The indicator has a "near perfect" track record since 1980, said analyst Teun Draaisma, most recently in the months prior to the financial crisis last year, when a "full house sell signal" was issued.

Some bears remain apocalyptic, however.

Albert Edwards, the Société Générale analyst whose predictions of equity Armageddon have hit the headlines this year, continues to insist that heavy falls await investors, with both the FTSE and the SP 500 looking at further falls of 30 to 40 per cent.

"Equities will not bottom out ahead of the economy", he told clients. Those looking to pick a bottom "can afford to be late", he said.

In the hedge fund world, too, many of the biggest players remain cautious.

Steve Cohen, the enormously successful manager of SAC Capital, moved approximately half of the fund's assets to cash last month after unprecedented market movements persuaded him to opt for the safety of the sidelines.

Cohen's moves mirror the "dash for cash" among bamboozled hedge fund managers, with notable decreases in stock holdings also seen at Paul Tudor Jones' high-profile Tudor Investment Corporation. Jones said that the market selling is not over.

An "overrun on the downside" would not surprise Grantham or Hussman either, with both cautioning that market-timing is not their forte. Even market-timer Teun Draaisma admitted that there was "probably no hurry", with "many short-term risks" remaining. Like John Paulson, however, the one-time bears are now positioning themselves for a market turnaround.