Investors ‘relying on hope and optimism’ – why now is the best time to short stocks for several years

The current market environment in the UK is ideal for strategies which can go short of stocks, according to Smith & Williamson’s Mark Swain, with stretched valuations and years of gains combining to create a fertile hunting ground for long/short strategies.
With UK markets having seen a sustained bull run over the last two years, many investors are sitting on significant gains and being forced to revisit their portfolios, particularly after the global sector rotation that has been seen in recent days.
As extraordinary support is turned off by the Bank of England and the slow process of normalising rates begins, Swain, co-manager of the £136m Smith & Williamson Enterprise Fund (as at December 2017), says companies that miss expectations are being more harshly treated than in previous years.
“Investors have made a lot of money in the bull market, but as we move from a period of extensive quantitative easing into one where such support is being wound up, it creates an even more supportive environment for funds like ours,” he said.
“Long only managers can try to avoid the increasing number of bullets, but they can no longer rely on hope and optimism, particularly as stocks which fail to meet the market’s expectations are getting more harshly treated than they have for years.”
Examples of this harsh treatment are being seen on a weekly basis, according to Swain, with stocks including TalkTalk and Provident Financial down sharply in recent months.
Swain said such extreme falls (Provident Financial was down nearly 70% over 2017) are taking place because valuations of the broad market are elevated, leaving little or no room for disappointment.
“There is asymmetric risk to the downside now in UK equities, and it is creating as fertile an investment environment for funds which can go both long and short, as we have seen since the peak of the eurozone financial crisis in 2012,” he said.
Swain added while volatility has been muted so far at a broad index level, this has masked stock dispersions within sectors which have been increasingly aggressive.
In such an environment, the Enterprise Fund is currently running at just 14% net exposure to equities, near the bottom end of its historic range.
“Our net exposure is currently at this low level because there are so many shorting opportunities,” he said.