John Paulson: Bearish for Now

Hedge fund head John Paulson — who continues to make huge profits for his investors while other managers continue to drown in red — ink remains bearish going into 2009.

“The sharp contraction in the global economy, the instability of the global financial system and the ongoing credit contraction are unlikely to be resolved in the first half of 2009,” Paulson wrote in his year-end letter to investors.

Paulson's two credit funds were up 19 percent and 16 percent respectively last year, avoiding buying distressed debt such as mortgages and leveraged loans even though both were trading at what appeared to be attractive prices.

Instead, the fund essentially bet against the debt of several financial institutions by purchasing credit-default swaps.

Now, Paulson remains short financial stocks and slightly short of the equity markets in general but sees a big opportunity in buying distressed debt.

“The biggest driver for 2009 and 2010 will be in long distressed opportunities,” he says.

“We estimate the potential size of the distressed market to approach $10 trillion.”

Two-thirds of the several hundred asset managers who responded to a recent survey said they plan to raise more money and increase their investments in distressed debt this year, The Wall Street Journal reports.

One-third believe the first quarter is the right time to buy, and more than half are expecting it to pay off smartly, projecting 20 percent returns or more for the year.