"Markets Are Wrong": Hugh Hendry Shuts Down His Hedge Fund; Here Is His Farewell Letter

Tyler Durden's picture

In the beginning, Hugh Hendry was the consummate contrarian bear, which helped him make a killing a decade ago when everyone else was blowing up. Unfortunately for him, he did not realize just how far the central planners were willing to take their monetary experiment, so after the market troughed in 2009, he kept his bearish perspective, which cost him dearly in terms of missed gains and lost capital under management, until one day in November 2013, he capitulated and turned bullish, infamously saying "I cannot look at myself in the mirror; everything I have believed in I have had to reject. This environment only makes sense through the prism of trends."

Since then, the reborn Hendry who would never again fight central banks, gingerly made his way, earning his single digit P&L...

.... even as many of his formerly loyal LPs deserted the former bear. It culminate with July and August, when Hendry posted some of his worst monthly returns on record which ultimately sealed his fate, and as he writes in a letter sent to investors today, Hendry decided to shut down his Eclectica hedge funds after 15 years, following a 9.8% YTD loss and massive redemptions, which left the fund which as recently as a few years ago managed billions with just $30.6 million as of August 31. As he best puts it "It wasn’t supposed to be like this."

The final P&L:

So what is Hendry's parting message to his investors and fans? Surprisingly, perhaps, he disavows the original Hugh Hendry, and goes out long (if not quite so strong). Below we repost his full final letter in its entirety, and wish Hendry good luck in his next endeavour.

* * *

CF Eclectica Absolute Macro Fund

Manager Commentary, September 2017

What if I was to tell you I wasn’t bearish on anything? Is that something you would be interested in?

It wasn’t supposed to be like this and it is especially frustrating as nothing much has gone wrong with the economy over the summer. If anything we feel more convinced that our thesis of a healing global economy is understated: for the first time in an age all parts of the world are enjoying synchronised economic momentum and I can’t see it ending for some time. It’s just that our substantial risk book became strongly correlated over the short term to the maelstrom of President Trump and the daily news bombs emanating from the Korean Peninsula; that and the increasing regulatory burden which makes it almost impossible to manage small pools of capital today. Like I said, it wasn’t supposed to be like this…

But let me bow out by sharing my team’s views. For the implications of a sustained bout of economic growth are good for you. It’s good because it should continue to underwrite a continuation in the positive performance of global equities. I would stay long. It’s also good because I can’t see interest rates rising abruptly to interrupt the upward path of equities. And commodities have already acknowledged the upturn in the fortunes of the global economy and are likely to trend higher still. That’s a lot of good news.

But it is bad news for me because funds like mine are required to demonstrate negative correlation with risk assets (when they go up like this I go down…), avoid large drawdowns and post consistent high risk adjusted returns.

Oh, and I forgot, macro fund clients don’t like us investing in the stock market for the understandable fear that we concentrate their already considerable risk undertaking. That proved to be an almighty puzzle for a fund like mine that has been proclaiming the stock market as a “safe-ish” bet ever since 2013.

Let me explain the “markets are wrong and we boom now” argument. To begin with, and for the sake of clarity, I think we have to carefully go back and deconstruct the volatile engagement between capital markets and central banks for the last ten years for an understanding of where we stand today.

The first die was cast by the central bankers in early 2009: having stared into the abyss of a deflationary spiral in 2008 the Fed and the BoE announced a radical new policy of bond purchases named Quantitative Easing. The bond market hated the idea as it was expected to cause a severe inflation problem.

Thankfully Bernanke, a student of the great depression knew better.

Markets primed themselves for inflation yet even with a ripping stock market in 2009/10 they were disappointed. QE rescued the financial system but the liquidity created was distributed to the very rich who have a very low monetary velocity and so the expected inflation fillip never materialised as the liquidity injection came to be stored rather than multiplied by the banking system.

Several years later, in 2013, the Fed suggested a reduction in the pace of its QE program. They wanted to tighten credit conditions gradually. However, capital markets beat them to it and the ensuing “taper tantrum” tightened monetary policy on their behalf. Within four months the market had taken 10 year treasuries from a yield of 1.6% to 2.9%, a move of far greater impact, and much more rapid, than anything the Fed had contemplated doing.

Markets initially thought the US could cope with this higher level of rates, but with a slowing economy, an unfortunately-timed oil price crash, and persistent ghosts in the machine (like the substantial Yuan devaluation fear which never materialised) they were proven wrong. Back then, with a 7.6% national unemployment rate and tepid wage inflation, this tightening always looked a little premature to us and so it proved with the rate of price inflation inevitably sliding lower to present levels.

And so last year, following many years of berating the Fed for its easy monetary policy regime, investors collectively threw in the towel. This rejection of the basic tenets of the business cycle by those who direct the huge pools of real money is proving particularly onerous to attack as it seems that the basic macro fund model is broken: there are just not enough “coins in them pirates’ chests” to challenge the navy of this flawed real money doctrine. Managers, and I must count myself in this camp, feel compromised by our poor absolute returns since 2012 and we find ourselves unable to put up much resistance to this FAKE NEWS.

Why should you fight it? Well let’s look at the last few times American unemployment dipped below 4.5% like today. I would largely ignore 2000 and 2006 when monetary policy was tightened and the economy buckled under the duress of the dramatic reversal in what had been credit fuelled misallocations of capital in the TMT and property sectors. No, for me 1965 is far more illuminating. Then, like today, there was no epic bubble or set of circumstances whose reversal could cause a slump; people forget but recessions don’t come out of thin air. No, in 1965, economic growth got choked by a tight labour market; a market as ominously tight as today’s.

In the middle of 1964, CPI core inflation was running at 1.7% and indeed dropped to just 1.2% in 1965; unemployment was 4.5%, the same as today. And yet by the end of 1966 inflation had essentially got out of control and didn’t dip below 2% again until 1995, almost 30 years later.

It seems to me that wage or cost push inflation is far more difficult to prevent and contain than asset price inflation. It tends to bear comparison with how Hemmingway described going broke: slow at first and then devastatingly quick. It may prove especially potent right now as the labour market is tight and there are no catalysts to generate a self-correcting US recession with both central bankers and markets now  united in their desire for loose policy.

Look at the graph below, the unemployment rate (red) is at lows, job openings (blue) have increased beyond the hiring rate (teal) and are now approaching the unemployment rate for the first time since the Job Openings and Labor Turnover Survey data began. Ultimately robust GDP growth plus this labour tightness will lead to wage hikes and conceivably a self-sustaining inflationary cycle.

This is all the more ominous as the Fed has been reluctant to unwind its balance sheet. The largesse of this program fell to those already wealthy (“the global creditor”) and who had a low propensity to spend:
financial markets boomed, less so the real economy. However the legacy of QE plus wage gains would turn this equation on its head. It would distribute incremental dollars to those with a much higher propensity to spend. The boost to monetary velocity from widespread wage increases would start to look much more like the helicopter money that Chairman Bernanke promised back in 2002 and subsequent central bankers dared not distribute.

The macro shock would not necessarily be the subsequent inflation but, that by waiting to respond until later, higher policy rates might fail in the first instance to induce a recession setting off a loop begetting higher and higher rates. Let me explain: companies will continue to employ staff, and with wages increasing, it is likely that sales will hold up and, depending on whether they achieve productivity gains or not, corporate profitability might also remain firm. So companies will commit to pay staff more whilst raising prices to meet higher wage and interest payment demands where possible. Like I said, wage or cost push inflation is a very different beast to contain.

I have to say that should this scenario unfold then capital markets will be as culpable as the Fed. This year, bond investors have aggressively flattened the US yield curve. The clear message is that 1.25% overnight rates threaten to pull the US economy into recession. I disagree. I think they are undermining the ability of the Federal Reserve to respond proactively; the Fed is simply not going to hike rates under such conditions having learnt the hard way back in 1999 and 2005. But what if such flatness has more to do with the commercial investment pressure brought on by QE rather than a genuine recession threat? Could it be that the bond market’s cautionary recessionary indicator is stuck flashing RED whilst the US economy goes from strength to strength? I fear so.

Clearly of course no one knows. However if an inflationary path like 1966 is gestating then I fear there is very little chance that anything timely will be done about it. Rate hikes will continue to be sparse, we only have one quarter point hike predicted between now and the end of 2019, which if fulfilled will be highly unlikely to spark a severe recession. Most likely the US economy will continue to grow and the labour market will tighten making a larger adjustment to rates in the future inevitable.

And so QE could conceivably end up doing what it was always supposed to do in the first place: find its way through the financial system to increase, not decrease, interest rates. This scenario would diminish greatly if bond curves steepened a lot now and gave the Fed the credibility to hike. Sadly I just don’t see this happening. They will steepen of course but I fear only after the virus of cost push inflation is released into the global hothouse.

This potentially leaves us in a strange environment. In the absence of any recognisable asset bubble set to burst, and the Fed grounded, the US economy is unlikely to slip into recession. China continues to rip. And now the European continent is recovering. Risk assets should continue to trend positively. And with the bond market, wrongly in my opinion, infatuated with the likelihood of an approaching US recession, the Treasury market is unlikely to move much. This is simply not a good time to offer a risk diversifying portfolio.

However, perhaps being long fixed income volatility isn’t such a bad idea. It has not been persistently lower than this for almost three decades. And unlike equity volatility it does not tend to trade in lengthy and definable regimes; it is never a great idea to go long equity volatility just because it happens to be low. The same cannot be said of its fixed income counterpart.

The collapse in volatility since 2012 seems to resonate with the drawn out process of QE in the US and its slow spread across the world. However that era is clearly now abating as this year’s synchronised global growth gradually shifts the debate from looseness to gradual global tightening. And yet fixed income volatility resides on the floor…

Looking at the one year implied volatility on 10 year swaps, the cost of entry seems reasonable even compared to the narrow trading range we have seen this year. That is unless you expect volatility to crash and  the trading range to contract even further. With only one Fed hike priced in until the end of 2019 any further contractions are likely to be driven by outright recession. In that case volatility will rise across all asset classes. On the other hand, if our thesis is right, and the market and Fed are too complacent on inflationary pressures, then it is likely that we see more hikes from the Fed alongside yield curves steepening from their currently very low levels. Fixed income volatility will surge. When the status quo priced in is this boring, fixed income volatility really has only one direction it can go.

With inflation still weak and government bond prices unlikely to crack just yet it is too early to seek a short fixed income trade in disguise. In the past, correlations have, just like in the stock market, typically been negative between the price (SPX or Treasury) and the implied volatility (VIX or swaption vol.). Now however the correlation is mildly positive. So being long fixed income volatility is not necessarily the same as  being short fixed income. My contention is simply that fixed income volatility has over shot to the downside, that such moments are fleeting and that you are not necessarily dependant on a correction in treasury prices.

Sadly I will be unable to participate with such trades during the next upheaval in global markets with the Fund but I hope that this commentary has at least roused you into contemplating scenarios that are presently deemed less plausible.

It remains only that I thank you for the great honour of having been responsible for managing your capital and to wish you all great financial fortune.

Hugh Hendry and team

* * *

Finally, for one last dash of perspective from Hendry as he turns off the light, below is a podcast he just recorded with Erik Townsend of MacroVoices.

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Blacksunday3's picture

trading isn't about being "right." it's about being right

BurningFuld's picture

Never bet against the house Huge.

Richard Chesler's picture

It's a big club and you ain't in it.

 

hedgeless_horseman's picture

 

QE rescued the financial system but the liquidity created was distributed to the very rich who have a very low monetary velocity and so the expected inflation fillip never materialised as the liquidity injection came to be stored rather than multiplied by the banking system.

 

Truth, bitchezzz!!!

We all should have gone long super-yacht builders and Aspen real estate.  

Enjoy your days, Hugh!

 

 

Life of Illusion's picture

I think we have to carefully go back and deconstruct the volatile engagement between capital markets and central banks for the last ten years for an understanding of where we stand today

 

AND THE NEXT 10YEARS OF THE SAME???

 

OOOOOOO SHIT

Stuck on Zero's picture

"Return to the mean" is clearly an outdated financial strategy when everything is going exponential.

38BWD22's picture

 

 

I always did poorly trading.

Buy and hold a diversified financial portfolio that includes stocks, bonds, gold and even Bitcoin for those so inclined.  Real estate too, a small business is also OK.

Avoid debt.

It is all rigged.  The gold and BTC will help protect you.

*   *   *

More radical steps include buying guns & ammo, water treatment equiment, farmland, etc.

YUNOSELL's picture

Another one calling it quits. Starting to feel like Atlas Shrugged with the producers going on strike from producing so the parasites can no longer use a corrupt lsystem and laws to steal from them

Bigly's picture

If the producers started bowing out at a reasonable rate, the whole economy would implode on itself at a certain critical mass. I guesstimate only about 20% could do it.

Tax donkey revolt, strike, going galt, whatever. If you can do so, you may want to consider in the next year or so. Especially if trump becomes schumer or pelosi like as this baby will be going down 

 

BringOnTheAsteroid's picture

For the life of me I cannot understand how someone as smart as this can have the notion that the economy is doing great. Sure, if you are prepared to borrow trillions of course things look rosy. Someone, please, put me out of misery, how the fuck is it possible that virtually everyone from the dumbest fuck to the smartest in the room ignore debt.

BaBaBouy's picture

The SM is just another tentacle of the CB`s... Its not rocket science.

Commodity trading also looks very suspicious, thats how they could set Inflation Rates to Targets...

fockewulf190's picture

Not to mention unfunded liabilities, under funded pensions, and untold trillions of derivative all waiting to blow up and take the entire system out. It's like those in power know a twenty mile long asteroid is incoming, so we might as well keep everyone dumb and happy before it hits. Seriously, I can't think of any other logical reason why the supposed "smart people" continue pursuing fiscal genocide.

The Ram's picture

The 'smart' people have always wanted to keep the party going.  They did so in the 'roaring 20's' and will do so today.  They will never voluntarily give up their comforts.  Change starts at the bottom.  I am not sure what will happen....my guess is that we have enough spare capacity to keep the lights on for some time.  In the interim, many formerly middle class members will just slip under the waves largely unnoticed.  With a wimper, not a bang!

Giant Meteor's picture

Well, as good a place as any to drop this gem ..

Assume the crash position, head down ..

Papering shit over has only got so much room, before reality takes charge ..

1914 I believe, the unsinkable Titanic, “God Himself could not sink this ship!” 

Todays Titanic, monumental hubris, built upon lie, after lie, after lie ..

Lying with no seeming nor apparent end  ..

Thats the biggest tell of all ..

CPL's picture

Yes, now he can recite the mantra with everyone else.

Die Lael Brainard, Die

Die Gary Cohen, Die

Die Jamie Diamond, Die

Die Mario Draghi, Die

Die Janet Yellen, Die

Die Alan Greenspan, Die.

Pool Shark's picture

Exactly.
He tries to compare today with the 1960's (right before we went off the gold standard) to show how inflation will run rampant.
Inflation ran rampant in the 1970's only because we abandoned Bretton-Woods and for the first time, began the ctrl-print function. But at the time, we had also only just begun the accumulation of DEBT.
Today, we are stuffed to the gils with debt, so the availability of credit no longer expands the economy like it did 50 years ago; pushing on a rope.

Hendry then talks about wage-push inflation.
Seriously???!!!
There is little pricing power to labor given the new global arbitrage (offshoring).
He seems to have surrendered to the 'inflationistas' forgetting about the deflationary overhang of all that outstanding debt.

Escrava Isaura's picture

Pool Shark,

Beautifully, and correctly stated post.

How will this end?

It reminds me of this Polish movie that went something like this:

Jewish woman: Why did you kill my brother, the doctors, the teachers, ……

The Christian (Catholic) peasant: Because we were left with nothing while they took everything.  That’s why we killed them.

 

 

7againstThebes's picture

Pool Shark: Good post. 

There is also the obvious point that a 4.5% rate of unemployment in 1966 is not the same as a 4.5% rate of unemployment today.  The numbers may be the same, but the yardstick used to measure them is not.  Plus there are  many other obvious differences.  Then: baby boomers were coming into adulthood.  Now: the great wave of baby boomers is retiring and drawing on resources.  Then: low rates of immigration.  Now: a vast and destabilizing mixing of peoples.  

     I am not sure that Hendry has a vision of world that is coherent.

     It seems to me that part of what is happening is that central banks have found ways to insulate the financial world of stocks and bonds from  the chaotic world of living human beings.  Somehow, sooner or later, the chaotic world of life is going to break in on the insulated world of finance.  How and when?  The person who can predict that moment will make a packet.

 

Giant Meteor's picture

Excellent points, yours and those immediately above.

Mr. Hugh lived in his very own bubble ..

It is fascinating to see how blinded they are themselves, living in the bubble, they cannot see the bubble ..

junction's picture

Yes, but where are his customer's yachts?  

Eyes Opened's picture

It's ALL about "cashflow" & "volume"..... lol

Ace Ventura's picture

+10  It's perfectly plausible that I misread the jist of the letter, but it seems like this supposedly smart guy is saying the market will boom pretty much forever. Thus, he's tapping out because his 'bear fund' has no future. In the same letter he seems to cast praise on Chopper Ben for his saavy actions borne of some sort of 'expertise' regarding the great depression. No current bubbles waiting to burst? Say what?!

My simple peasant's take: The entire thing is a giant, rigged vegas casino. The entire market trades/operates on insider information and management of perception. Reality has ZIP-ZILCH-NADA to do with anything. The fact these type of guys believe there is anything remotely accurate about the 'official' inflation and employment numbers tells me they're not as smart as they pretend to be.

Relayer74's picture

I know right? When is the last time you heard MSM mention what will happen to payments on the national debt as interest rates return to 'normal'?

Totally blows me away.

ByTheCross's picture

Try deducing that it is you that is ignoring something - or that there is something that you are ignorant of.

It is understandable that you are ignorant of it, as most are. However, once you know what it is, once you undergo that epiphany, you will understand the expediency of trillions in debt as if it were self-evident.

Unfortunately, such understanding won't do much for your misery...

Not Goldman Sachs's picture

Cause "debt does not matter", dick c. I believe.

BarkingCat's picture

Same here. With the exception of a few lucky streaks, my trading record is horrible.

I have better results playing roulette.

However, I stay away from bonds. Let's not forget what Obama did to the bondholders of GM.

Law?? What law?

Pinto Currency's picture

Hendry's lengthy letter could have been one sentenc:

 

"Central banks have destroyed price discovery - goodbye!"

 

Nothing wrong with the markets.  It's the c.b.'s

new game's picture

or CB put...bye.

simple shit maynard

fuk this econ, rigged bullshit for the club GS.

oh, and fuk politicians that let this go on...

may all these cocksukers meet a fate that is ugly...

fukers...

Raging Debate's picture

Pinto - Ya but add one more sentence..CBs also destroyed purchasing power so now America is 3rd world. The very rich dont seem to pay that much mind. 

mkkby's picture

Never EVER invest with idiots like this. This wasn't even a real hedge fund. Just a long/short guess on macro trends based on what some arrogant douche read in fake news.

A real hedge fund would have a mathematically balanced portfolio of most/all US and global stocks, bonds, futures and currencies.

After running losses for 9 years he still doesn't understand ctr-print. Sad and not worth the read.

Next to go down is "nickels" boy, who's still pressing his losing shorts on japan and china.

aurum4040's picture

For years I've said that when the last of the bears tap out, the market is near a top. Many others have said similar. Hendry closing shop is big. We are closer then many think. Look how complacent we all are. I could see the inflation playing out. Dollar has been crushed lately. Oil just pushed about very strong resistance. Gold is awakening. Hendry has always been right, the timing, as we all are aware is incredibly difficult to predict. The market will push rates up without the Fed, if inflation is serious enough. Oil will keep rising if inflation is serious enough. Oil eats everything in it's path and the market is no different. It will be like 2007 all over again except Fed funds will be at 1 - 1.25%. And US will be well over 20 trillion in debt. What does the Fed do then? This is when the dollar collapse becomes very possible. Market initially collapses then rockets to new record highs when the realization of dollar problems hit. Perhaps not the entire market but the stocks that have low risk revenue and real assets, hard and digital. But before the US collapses, the rest of the highly developed world Europe England Japan will collapse. Money will have nowhere to go but US stocks. The one thing we can do to contain inflation is blast the US oil spicket and saturate the market. Keep prices capped. Crazy times. 

Blano's picture

Did you read the article?

Hugh tapped out as a short in 2010 and went long. So did a bunch of others.

The market has done quite well since then.

BarkingCat's picture

Why are people down voting this comment.

It is 100% accurate.

The one he is responding too is mostly accurate.

Certainly the overall condition and what can happen.

It is actually very much in line with Martin Armstrong's long term outlook.

LePereMersenne's picture

If you are playing poker and can't spot the patsy among the other players at the table, You Are The Patsy.

HRClinton's picture

FYI, you are misapplying Carlin's quote. 

"The BIG Club" refers to the Labor Unions, regardless of whether Carlin knew that or meant that.

"The LITTLE* Club" is for the 1% or, more truthfully, the 0.01%.

   * Aka Elite, Privileged, Chosen...

Now that we have that cleared up... I'm pretty sure you referred to the latter (the Elite), not the former (the Unions).

Ace Ventura's picture

LOL...interesting take, but I think what Carlin meant by 'big club' had not so much to do with the number of members....but rather the size of their wealth and influence. Meaning....this numerically small group of oligarchs wields BIG POWER....and you (we) ain't invited to do likewise by admittance into their group.

knukles's picture

Actually, good time to bail.
Got enough bucks to enjoy that Greecian island he bought 5 years ago.

38BWD22's picture

 

 

Was it Island No. 16?

Wonder what his secret formula is...

peddling-fiction's picture

A Greek island, Turkey plus WW3, will be an interesting forward observing spot to see the shells and missiles.

mkkby's picture

Greek islands have 100k angry muzzies swimming ashore per month. Only way to enjoy it is with an electric fence and a private navy patrolling the shores.

Jimbeau's picture

but how in the heck would he keep those pesky 'refugees' from continuing to overrun his little paradise?

BarkingCat's picture

A squad of mercenaries...hhhmm, I mean, private security and few machine gun nests.

Thoresen's picture

I always liked Hendry. His timing, like that of so many others, has been thrown by QE etc. His original thinking will be proved correct, but 10 years later than he thought.

Blacksunday3's picture

i'm sure the guy is a complete genius and i totally understand the bear arguments. but investors want returns. does it go up or down? 

NotApplicable's picture

It goes "Japanese."

This was an interesting read, but a whole lot of words just to explain why his approach could no longer work.

Could've said the whole story with a single graph of central bank balance sheets over his career.

LittleMaestro's picture

Amen. One chart was all that was needed. I found the letter to be slightly incoherent. 

LittleMaestro's picture

Amen. One chart was all that was needed. I found the letter to be slightly incoherent. 

consider me gone's picture

Unfortunately he was reading the ZH. He could have put it all in an S&P ETF, charged 15 basis points, and fished, dived and surfed the Bahamas with nary a worry. But then, I guess he couldn't have known that. He was trying to be rational instead of lucky.