Triumph of the Market Pessimists

By Anonymous

The 10th anniversary of the financial crisis is a natural time to fret about the next bust, but betting against the market is usually a loser’s game. Or is it?

Record stock prices, bubbling trade wars, Donald Trump’s legal peril and sputtering emerging markets give some teeth to fears of another market rout. So did a host of mostly forgotten crises—Brexit, the fiscal cliff, the taper tantrum—that turned out to be great buying opportunities. The S&P 500 has returned over 200% since the day Lehman Brothers went bust—more fodder for the investing classic “Triumph of the Optimists” that underlines the benefits of staying in the market through thick and thin.

So why is a man who has made a huge wager on another market collapse so happy? It isn’t because he sees an imminent crash, though he doesn’t rule it out. It is because almost no one else is preparing for one.

“I spend all my time thinking about looming disaster,” says Mark Spitznagel, chief investment officer of hedge fund Universa Investments, who predicts a major decline in asset prices but can’t say when. He admits that the bull market could keep going for years. “Valuations are high and can get higher.”

Talk is cheap in investing punditry and predicting a decline without saying when it will happen is cheapest of all. Yet Universa’s stance warrants attention, and not only because it backs its views with billions of dollars and is advised by author Nassim Nicholas Taleb of “Black Swan” fame. Mr. Spitznagel isn’t betting on some unpredictable event causing a crisis but instead a predictable one—an eventual blowback from unprecedented central-bank stimulus.

What sets the fund apart and why investors should pay attention is that Mr. Spitznagel’s clients have done well without a crisis. Founded in 2007, Universa was among a handful of funds that made huge gains in 2008. Unlike some crisis-era legends such as John Paulson, David Einhorn and Steve Eisman who have struggled mightily since then, Mr. Spitznagel has enjoyed mini-bonanzas along the way. In August 2015, for example, his fund reportedly made a gain of about $1 billion, or 20%, in a single, turbulent day.

A letter sent to investors earlier this year said a strategy consisting of just a 3.3% position in Universa with the rest invested passively in the S&P 500 had a compound annual return of 12.3% in the 10 years through February, far better than the S&P 500 itself. It also was superior to portfolios three-quarters invested in stocks with a one-quarter weighting in more-traditional hedges such as Treasurys, gold or a basket of hedge funds.

Good Times, Bad Times

Top monthly returns for CBOE Eurekahedge Tail Risk Hedge Fund Index

Triumph of the Market Pessimists




S&P cuts U.S. credit rating

Aug. 2011


Chinese stocks crash

Aug. 2015


AIG rescue

Oct. 2008


S&P on brink of bear market

Sept. 2011


Lehman bankruptcy


Sept. 2008

Flash crash

May 2010


Being skeptical and making money on that view are two different things. Fellow financial crisis standout John Hussman predicted both the 2000 and 2008 bear markets and also is convinced an even worse one is coming, yet his eponymous fund has performed dismally since 2009, eroding its crisis gains and then some.

While Mr. Hussman tries to identify dangerous junctures and hedges his fund accordingly, Mr. Spitznagel has no view on timing. Instead, he buys hedges, typically put options, particularly when they are cheap. These options rise in value when the market falls but usually expire worthless. The approach is a variation on the well-proven strategy of value investing—buy cheap, unloved assets. By pointedly ignoring headlines and embracing long stretches when his fund loses small sums for months on end, he draws on similar patience and conviction.

In a banner year for U.S. stocks like 2017, buying crash insurance was like throwing money away. But Mr. Spitznagel says he was “like a kid in a candy store” because volatility, and hence options prices, were so subdued.

Just sitting out the market in the long run is costly, which is why optimists triumph. Universa’s typical client suspects that the end may be nigh but wants to stay fully invested anyway. The occasional windfall, such as the one in 2015, is icing on the cake.

Ordinary investors don’t need to understand Mr. Spitznagel’s math to grasp a valuable lesson. While human nature causes us to be more confident after a long stretch of smooth sailing and hefty gains for markets, that is when the odds of something going horribly wrong are highest.

“This is a very good time for us,” he says.

Write to Spencer Jakab at [email protected]