"The "bailout culture" often coincides with sustained weak growth because, among other consequences, successful companies have to compete with companies who are alive only because of cheap credit. Overcapacity and inefficient production are engendered by such policies, causing price and profit declines. Failure is an essential element of capitalism, and if failure is politically denied, the most effective, efficient and innovative solutions cannot "win" over the "living dead" who clutter markets and consumer baskets."
"It is ironic that we are perhaps best known for advising “that you panic”. However, if you are anxious at the wrong time it can prove very painful. Today, we would advise that you don’t panic!
... by withdrawing the “Greenspan put” and using their asset purchase schemes to eviscerate any notion of value, the authorities have paradoxically created a safer yet more paranoid market."
- Hugh Hendry
Central banks are fearful and unwilling to normalize but artificially high valuations across asset classes cannot be sustained indefinitely absent fundamental global growth. Central banks are in a prison of their own design and we are trapped with them. The next great crash will occur when we collectively realize that the institutions that we trusted to remove risk are actually the source of it. The truth is that global central banks cannot remove extraordinary monetary accommodation without risking a complete collapse of the system, but the longer they wait the more they risk their own credibility, and the worse that inevitable collapse will be. In the Prisoner’s Dilemma, global central banks have set up the greatest volatility trade in history.
June was a bad month for most hedge funds. With China crashing, oil prices resuming their slide, volatility returning, and even momo favorite biotechs no longer rising at their conservative 10% monthly clip, few looked forward to writing their monthly investor letters, and nowhere was the carnage more indicative than in our favorite named hedge fund, the Tulip Trend Fund, which after soaring earlier in the year tumbled 15% in June and is now down almost 20% for the year.
It is unknowable how much more pronounced these excesses can become, especially in light of extremely loose monetary policy around the world. Things could easily become quite dicey as soon as tomorrow, but it is just as easily possible that valuations will continue to expand for some time yet. However, these data do indicate one thing: risk has increased enormously, and it will keep increasing the longer the bubble persists. Frankly, the situation also scares us a bit, because we expect that governments and their agencies (such as central banks) will find it extremely difficult to deal with the next crisis. They have become quite overstretched as a result of the last one. After having gone “all in” last time around, what are they supposed to do for an encore? The only options that come to mind are repressive measures such as capital controls, confiscation of private wealth, and a host of other unpleasantries.
Considering that Chinese equities are the best performing market in USD terms (second only, oddly enough, to Russia) in 2015, one can see why after a disappointing 2012 and 2013, and modest 2014, Hendry has hit 2015 out of the park with a bang, generating a 10.6% return in the first two monthes of the year. So is Hendry still bullish on China's stock market prospects? Why yes, and then some. But is he is contrarian just for the sake of being contrarian? Does he see something in China that nobody else does? Or is he simply right... or wrong, as the case may be? We will let readers decide.
The current premise is that global equities markets will rise regardless of economic fundamentals. Money must flow into equities [perceived as the only asset class capable of producing “acceptable” returns] because the alternatives offer virtually no return…with interest rates pinned near zero in most western economies. Just buy any equity [akin to dart throwing] and a “greater fool than you” will buy after your purchase, at a higher price, ad infinitum... thus ever increasing the asset’s value This is such an obviously flawed argument on so many levels... albeit, like almost any strategy, is surprisingly effective from time to time.
The problem is inherent in the knowing “that it will end badly” and yet turning a blind eye and making money anyway. For that’s what a good Wall Street aficionado does after all, right? I mean, who cares about arguing about real economics or fundamentals. Who cares – I’m up 8%!! As if that’s all that now matters. For if that’s all that matters why don’t we embrace crony capitalism, embrace stagnant wages, embrace the 99% vs the 1% as that’s the best it’ll ever be. Who cares, as long as we’re getting ours. This disgusting bloated behemoth of an adulterated Central Bank infused market is now getting downright scarier.
We will readily admit that one cannot know with certainty whether the bubble in risk assets will become bigger. However, it seems to us that avoiding a big drawdown may actually be more important than gunning for whatever gains remain. We don’t think it is a good idea to simply “take the blue pill” and rely on the idea that the effects of the money illusion will last a lot longer. It is possible, but it becomes less and less likely the higher asset prices go and the more money supply growth slows down. If no-one can say when, then the “blue pill” strategy has a major weakness. It means that things could just as easily go haywire next week as next year.
Hugh Hendry's Eclectica Fund has had a great Q4 (up 3.3%, 4.0%, and 5.0% in the last 3 months) despite portfolio risk being quadruple his 'old normal'. How did he achieve this? He begins... "There are times when an investor has no choice but to behave as though he believes in things that don't necessarily exist. For us, that means being willing to be long risk assets in the full knowledge of two things: that those assets may have no qualitative support; and second, that this is all going to end painfully. The good news is that mankind clearly has the ability to suspend rational judgment long and often... He who hangs on to truth has lost. The economic truth of today no longer offers me much solace; I am taking the blue pills now."
In some respects we’re in danger of running out of appropriate descriptive superlatives for the current bout of “irrational exuberance” (we’re open for suggestions). The current asset bubble is in many respects reminiscent of the late 1990s tech bubble, but it also differs from it in a number of ways. One of the major differences is that the exuberance recorded in the data is largely confined to professional investors, while the broader public is still licking its wounds from the demise of the previous two asset bubbles and remains largely disengaged (although this has actually changed a bit this year). Monetary pumping merely redistributes existing real wealth (no additional wealth can be created by money printing) and falsifies economic calculation. This in turn distorts the economy’s production structure and leads to capital consumption, thus the foundation of real wealth that allows the policy to seemingly “work” is consistently undermined. At some point, the economy’s pool of real funding will be in grave trouble (in fact, there are a number of signs that this is already the case). Widespread recognition of such a development can lead to the demise of an asset bubble as well.
Looking for answers to both financial safety as well as financial freedom in the same light or viewpoint where it seems one only needs to “think like a billionaire” or “tweak” or “slightly modify” perceptions on how one approaches these financial markets today – will hurt more than it will help. The Wall Street everyone believes they are dealing with today is just in name and memory. What made sense just 6 years ago not only doesn’t but rather if you try to apply any sense that resembles “common sense” you might as well be asking the Cheshire cat for a more straight answer. "How exactly are you handling the stresses and strains having to basically push sound fundamental theories or market underpinnings aside and now trade and position money at risk based solely on what some Central Bank will do next?" This is the avenue I wish Tony had driven or sought.
In the final part of Hugh Hendry's 3-part (part 1 and part 2 here) interview with MoneyWeek's Merryn Somerset the Sanguine Scot, perhaps surprisingly to some given his previous negativity - though fitting with his world view of fiat currency destruction - believes "to bet against China or Chinese equities, or the Chinese currency is to bet against the omnipotence of central banks. One day that will be the right trade, just not ready or sure that that is the right trade today."
In the second of three interviews (part 1 here), Hugh Hendry tells MoneyWeek's Merryn Somerset Webb why central banks will go even further than anyone expects to keep the global economy afloat. Hendry notes, "there’s so much debt that if you reprice debt, the economy slows down. We saw that I think in 2012, after the taper tantrum and ten-year bond use went over 3%. What happened next? The economy slowed down. If anything I would be a buyer of U.S. Treasuries."
In the first of three interviews with Merryn Somerset Webb, Hugh Hendry, manager of the Eclectica Fund, talks about what it takes to be a good hedge fund manager – and how he learned to stop worrying and love central banks. As he notes, the world is "guilty of the misconstruing of a bull market in equities, for what is actually the ongoing degradation in the soundness of the fiat monetary system."