(Bloomberg News) David Gerstenhaber, founder of $1.6 billion hedge fund Argonaut Capital Management, said Portugal may be the next casualty of Europe's debt crisis.

"Portugal is structurally weak," he said in a telephone interview from New York. "There's a 90 percent chance that they will get some form of help" to keep concern over the country's creditworthiness from spreading to Spain and Italy, he said.

Gerstenhaber, 50, is among hedge-fund managers who say Europe's debt woes pose one of the biggest risks to a global economic outlook that has only gradually improved this year. Stocks and the euro retreated in the past month as the crisis worsened, forcing Ireland to follow Greece and ask for a bailout. Standard & Poor's said it may cut Portugal's credit rating on concern the country may have to seek a bailout, something Prime Minister Jose Socrates has rejected.

John Taylor, founder of FX Concepts LLC, the world's biggest foreign-exchange hedge fund, forecast the euro region will enter a recession next year and the euro will weaken as the debt crisis worsens.

"The risk that Spain and Italy will get into trouble is going to cause the euro to get quite weak," Taylor said Thursday at the Hedge Funds New York conference hosted by Bloomberg Link. Investors should sell German stocks because efforts by governments to cut back spending will hurt the region's economy next year, he said.

Selling Euros

Macro hedge funds, which seek to profit from broad economic trends by trading currencies, bonds and commodities, have been selling the euro, commodities, emerging markets, and Standard & Poor's 500 Index futures while buying the dollar and U.S. 10- year notes, Bank of America Corp. analyst Mary Ann Bartels said in a Nov. 29 report.

Colm O'Shea, founder of $5.9 billion Comac Capital LLP in London, and Brevan Howard Asset Management LLP, the $32 billion hedge fund run by Alan Howard, both told clients in investor letters last month that problems in Europe's "peripheral" countries may force the European Central Bank to stimulate the economy longer than planned.

"Fiscal issues and financial stress in some of the euro- zone peripheral countries are worsening even as the German economy strengthens," O'Shea wrote. "These stresses argue for the ECB to delay its steps away from extraordinary policy."

Europe is "on the verge of collapse," James Melcher, founder of New York-based hedge fund Balestra Capital Partners LP, said Thursday at the Hedge Funds New York conference. "Germany may leave the euro with a couple of stronger countries."

'Headwinds'

Stocks and the euro rose today after ECB President Jean- Claude Trichet said the central bank will delay the withdrawal of emergency liquidity measures and keep buying government bonds as the debt crisis creates "acute" tensions in financial markets.
Brevan Howard, which is run out of London, said efforts by the U.K. to reduce borrowing may undermine the economic recovery in that country.

"The intended reduction of the structural deficit by 2.3 percent of GDP next year creates substantial downside risks to the economy, given already weak underlying growth and ongoing private sector deleveraging headwinds," the firm said in the letter.

The Brevan Howard Master fund returned 1.75 percent this year through October, according to the report.

Stymied

Hedge funds returned 5.4 percent this year through October, according to data compiled by Bloomberg.
"Macro managers have been mainly using currencies and credit default swaps to make money," said Rickard Lundquist, portfolio strategist at

Stockholm-based SEB AG's private banking unit, which invests about $6 billion in hedge funds for clients. "They have started taking on more risk than they were earlier in the year, when there was more economic uncertainty."

Hedge-fund managers were stymied earlier this year as the European debt crisis, concern about U.S. government borrowing, uncertainty about new financial regulation and fears of an economic slowdown in China prompted investors to cut back risk. While stocks markets stabilized in the second half and fears of another recession abated, asset managers will have to contend with volatile markets into next year, said Bank of America's Bartels.

QE2

"This year, the bulls have been frustrated and the bears have been frustrated," she said in an interview. "Just when investors thought that there's a trend, it reverses. These choppy markets are going to continue into next year, though with a bias to the upside."

Global stock markets, as measured by the MSCI World Index, have gained 17 percent since the end of June, spurred in part by the U.S. Federal Reserve's decision to buy an additional $600 billion in Treasuries to lower borrowing costs and stimulate the economy.

The Fed measures will encourage investors to take more risk and keep the dollar from appreciating against the euro, Fortress Investment Group LLC's Michael Novogratz and Adam Levinson said in a Nov. 15 letter to investors. The program hasn't been enough to ignite a sustainable economic recovery in the U.S., they wrote.