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Hedge Funds, Smelling Blood, Got Short Europe Last Week

As global stocks surged last week, sending the S&P 500 Index on its way to its best monthly percentage gain since 1991, hedge funds with a macro focus increased their bets against Europe, analysis by Bank of America Merrill Lynch shows.

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“Based on our exposure analysis, macros aggressively sold EAFE (Europe, Australasia & Far East) exposure to a crowded short zone for the first time since July 2010,” wrote Mary Anne Bartels, a technical analyst with the firm, in a note Wednesday. Her analysis is based on the most available data as of a week ago.

The group’s increasing short exposure to European debt and equities hurt their performance last month, but it’s paying off big time the last three days. For example, Germany’s equity benchmark — the DAX — has given up half of its October gain during this week alone. Bank of America’s macro hedge fund index was little changed last month.

Greek Prime Minister George Papandreou fueled the losses after he called for a referendum on the bailout plan which everyone thought he and the major European leaders had agreed upon last Thursday. The bailout calls for a 50 percent haircut for Greek debt holders and will lever up the European Financial Stability Fund to 1 trillion euros .

Besides direct bets on a Greece collapse, plays around the periphery that are more liquid also paid off for macro funds astute enough to take the right position. Deutsche Bank’s U.S.-traded shares fell 7 percent on Tuesday benefiting macro funds who sold the shares short. The stock was up eight percent in October and even more before Monday’s drop.

“Options are now saying that Deutsche Bank is the riskiest major bank,” said Scott Nations, an options trader for NationsShares, a division of Fortress Trading. “For much of September and October options on Morgan Stanley and Bank of America were more expensive than Deutsche Bank, but not anymore.”

Macro funds betting against Italian debt were also richly rewarded this week. The spread between Italy 1-year bonds and its benchmark, the German Bund, widened to more than 4.5 percentage points.

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