At a time when the US financial market is debating the timing of interest rate cuts, a tail risk hedge fund warned that investors should take advantage of the recent economic optimism that continues, because the Fed's shift to lower interest rates just heralds a sharp collapse in the market.

Mark Spitznagel, chief investment officer and founder of Universa, said, “This is an example of being careful about your wishes.”

Universa is a $16 billion hedge fund that specializes in mitigating the risk of a “black swan” incident.

Spitznagel was a former trader and protégé of Nassim Nicholas Taleb (Nassim Nicholas Taleb), the author of the 2007 bestselling book “The Black Swan.”

Spitznagel's views are not universal. In recent months, although stubborn signs of inflation have weakened expectations that the Federal Reserve will cut interest rates in 2024, expectations that the Fed will move to a less restrictive monetary policy have boosted stocks and bonds.

According to Spitznagel, this transformation is only possible if economic conditions deteriorate and the market environment is challenging. In an interview with Reuters, he said:

“People think the Fed is dovish, because that means they will cut interest rates... but they only cut interest rates when the economy clearly enters recession, and when the market crashes, they cut interest rates in a panic.”

Funds like Universa often use credit default swaps, stock options, and other derivatives to profit from severe market chaos. Generally speaking, they are cheap bets that place large, long-term returns, otherwise they will drag down the portfolio, just like paying an insurance policy every month.

Some funds, including Universa, were big winners in 2020 when the market was extremely turbulent in the early days of the COVID-19 outbreak. Today, Universa doubts that the US economy has entered a so-called “no landing” scenario. “No landing” means that the economy will continue to grow rapidly despite high interest rates.

He said, “It's the same this time. Higher interest rates will eventually burst the biggest credit bubble in human history.”

Since the beginning of 2022, the Federal Reserve has raised interest rates by 525 basis points to prevent a surge in inflation. However, Spitznagel believes that since the 2008 global financial crisis, the excess bubble accumulated by the ultra-loose monetary policy implemented by the US over many years has not been squeezed out of the economy.

He said, “The economy is built on low interest rates. Resetting interest rates like ours would have a delayed effect.” He also said that the market hopes that the Federal Reserve can lower consumer prices without harming the economy, and investors should take advantage of the current “Goldilocks” environment. “I think there will be more positive excitement before this environment ends.”

Editor/Jeffrey