The "World's Most Bearish Hedge Fund" Has A "Stunning" Theory What Happens Next To The Dollar

After a rollercoaster year, the clients of Horseman Global, which in 2016 we dubbed  the world's most bearish hedge fund when its net exposure hit over -100%...


... finally got some good news when in his December letter, CIO Russell Clark announced that after returning 5.54% for December, the month emerged back in the green for the full year, up a modest 2.27%.


However, what caught our attention was not the fund's performance, which after a -24% 2016 barely closed in the green in 2017 (and suffered a dramatic plunge in AUM as a result), but Russell Clark's comments on the plunging USD, a topic which seemingly everyone has an opinion on.

Specifically, we found his comments notable because if he is right, the dollar slide will only accelerate, and will have profound consequences not only for assets, but for the US and global economy in the not too distant future.

Here is Clark's "fascinating" - as he puts it - theory about the source of dollar weakness, and more troubling, why what is about to happen next will make the recent collapse in the USD seem like a walk in the park.

Since the financial crisis, I have tried to apply the Japanese Quantitative Easing (‘QE’) model to the world as more and more central banks moved to zero or negative interest rates and asset purchase programs. In Japan the practical effect of QE has been for Japan to export capital, and this creates credit bubbles in the recipient countries. The country receiving the capital then has to deal with the credit bubble by devaluing and exporting deflation back to Japan. In my view, Japanese QE was the cause of the Asian Financial Crisis, and played a role in the Global Financial Crisis and the Eurocrisis. In Japan QE has meant my strategy has been to always be bullish JGBs, and short Japanese equities whenever they attempt to exit QE, and short the currencies of countries that had accepted QE capital flows. From 2013 to 2016, shorting various emerging markets, and being long developed market bonds was a winning strategy for the Fund.

However, in 2016 Chinese policy changes seemed able to reverse this trend, mainly through government mandated capacity cuts. I have seen many fund managers and economists hold on to investment and economic ideas long after they have been proven wrong, so given this break in the model, I thought it wise to question many of my investment ideas, particularly on bonds.

It is very easy to get bearish on bonds. With Chinese growth improving, and commodity prices rising, inflationary pressure is building. Furthermore, Chinese bonds currently offer 4%, substantially higher than developed market bonds. In addition, in a break with the Japanese experience of QE, the Federal Reserve has managed 5 interest rate increases, rather than only the one or two that Japan has been able to achieve since the bursting of the bubble. The refrain that I have heard these days is that QE works, and the US will be able to easily exit QE policies, followed by the ECB and the BOJ, and that bonds are a sell.

* * *

December tends to be quiet, so I have had time to reflect on market views on QE. Looking at how the US dollar has traded, and the performance of bonds, I am beginning to think that the model is not broken, but needs to be adjusted for the fact that QE is now undertaken by various central banks simultaneously, rather than just by Japan. The big increase in QE from the ECB and the BOJ that we saw in 2016, has seen capital move from Japan and Europe to the US. This has meant that even as the US has raised rates, credit conditions have remained very favourable. This combined with a recovery in China has created an extremely favourable market for all assets in 2017. But what does it mean for 2018?

Well, if the QE model still holds, then the capital flows from Europe and Japan to the US are beginning to slow and even reverse. The implications of this is that the strategy is to be bearish US dollars and bearish on US corporate credit. It also implies being bearish on European and Japanese banks, and buying of bunds and JGBs, however this remains to be seen.

Intriguingly, all these assets are already beginning to move this way. The full implications of thinking this way are fascinating.

And here is the conclusion, where - if Clark is right - better hold on to your hats, because it's about to get very volatile:

The worst-case scenario would be profound dollar weakness forcing the Federal Reserve to increase interest rates much more quickly than expected. Dollar weakness would cause Japanese and European exporters to suffer, forcing money into JGBs and bunds. This would be like the capital flight market in the US we saw in the late ‘70s. For reference, Swiss bonds yielded only 2% in the late 1970s, even as US rates went to near 20%.

Naturally, it would be poetic justice if the payback for the world's biggest (and really only) globally coordinated episode of QE which injected some $15 trillion in QE in capital markets, was a just as rapid, and accelerating episode of rising interest rates, starting with the US, in the process crushing US stock first and then spreading like a tsunami around the globe.

Maybe mean reversion is not dead after all, maybe it's just waiting for the right reversal to remind the economist PhDs in the Marriner Eccles building that there is no such thing as a free lunch... or free all time highs in the stock market.

And incidentally, for those who are wondering, Horseman "remains long emerging markets, short developed markets."


mpnut Pinto Currency Thu, 01/18/2018 - 16:22 Permalink

While the USD has been bearish in 2017, the longer-term momentum is still suprisingly bullish.  This tells us that momentum still on the upside, and with short term positive divergence should suggest a rebound.  This rebound should tell us whether the momentum has stayed the course or has shifted.  Only then would I ever suggest such bearishness.  

In reply to by Pinto Currency

AldousHuxley mpnut Thu, 01/18/2018 - 16:32 Permalink

dollar is coming back to US in the form of corporate cash repatriation which will strengthen the dollar and lower interest rates. Perhaps this is the opportunity for Fed to increase interest rates which are offsetting.


SP500 up 5% YTD already. looks like this year it will get out of control on the up side since so many "experts" are bearish.

30% annual gain possible this year with 3-5% inflation. Trump juicing it up for midterms. 


burger joints in California can't hire flippers even with $15/min wage.





In reply to by mpnut

are we there yet stizazz Thu, 01/18/2018 - 17:31 Permalink

The problem is the Fed is not tied to anything fixed, not gold, not bit coin, etc. SO they can debase an exchange medium with impunity. As can other countries debase their currency. I propose a world currency based on the number of female citizens with 'D' cup and above breasts within its borders. Germany would do great, and China would have fewer, which they want anyway to have an exchange rate export advantage. I would volunteer to inspect for genuine D cup quality control. I would be thorough. We could even start a D-coin for those who like virtual D cups. Another advantage would be D cups could get free drinks at happy hour.

In reply to by stizazz

OverTheHedge zebra77a Thu, 01/18/2018 - 23:58 Permalink

It's all about dollar recycling: when the us ran a surplus, it sent its dollars out into the world, so that they could then be spent on us products (Marshall Plan). Once surplus turned to deficit, a new system was needed (Eurodollar). Volker's mad interest hike was to attract dollars back to the us, never mind the crushing recession worldwide. As per the article, if us treasuries pay 20%, and Swiss pays 2%, where do the funds flow to?

The Fed is more interested in dollar recycling than in the economy, and it's not as if much gets manufactured in the us anyway. There will always be good growth in the war business, which covers the important sector. So I see an early 80s recession with huge interest rates and starving ex workers in the pipeline.

In reply to by zebra77a

pitz AldousHuxley Thu, 01/18/2018 - 20:53 Permalink

"repatriation" is a complete lie.  The "money" is already invested in the United States, even when it is owned by offshore entities.  "repatriation" is only about settling the tax bill with the IRS, not about where the "money" is invested or not.  And if America is an inefficient place for investment (which it appears to be), why would these funds, with the tax bill settled up, be invested in the USA?  It makes no sense.


Of course, Trump and his ilk want you to believe that the "money" is just sitting overseas (literally) in some vault, and that when it returns to the USA, it will shower down in a fury of jobs and lower interest rates.  Nothing could be further from the truth.  In fact, the repatriation tax holiday will just encourage and accelerate offshoring, a validation of the strategy previously pursued that led to the accumulation of massive balances in "offshore" subsidiaries anyways.

In reply to by AldousHuxley

Singelguy AldousHuxley Fri, 01/19/2018 - 07:39 Permalink

It is difficult to predict how this will all wash out. There are a number of factors in play.

1. The Trump tax law will bring capital back to the USA, primarily from Europe which will put pressure on the European banks.

2. The tapering of QE by the ECB which will force bond rates higher in the EU.

3. National elections in Italy coming in March where the anti EU parties are expected to win the majority which should take the euro lower.

4. The repatriated cash will likely be used to buy back stocks, pushing the Dow even higher, and likely resulting in more capital inflows to the USA, and a stronger dollar. 

When you add this all up, I expect that the dollar will strengthen in the near term but given the other economic fundamentals, the long term outlook for the dollar is bearish.

In reply to by AldousHuxley

Arnold Fed-up with be… Fri, 01/19/2018 - 06:16 Permalink

Quite a bit of off shore is held in TSY.……

"The 50 top overseas cash holders in the S&P 500 have parked $925 billion of their cash and marketable securities outside the U.S...."

In reply to by Fed-up with be…

new game Stroke Thu, 01/18/2018 - 18:40 Permalink

this guy has waaaay overthought this. all these dollas created are coming to roost back where they originated. it is finally becoming inflationary. they are coming from many sources that they went to.. but what remains to be seen yet is what happens with that petro dolla thingy. and the ten around 2.6. and future treasure bid cover. not to mention treas holder reaction. seems as though something could trigger an avalanche. the black swan?

In reply to by Stroke

HRClinton BullyBearish Thu, 01/18/2018 - 17:00 Permalink

With all the distortions and bubbles in the fiat monetary system off of the klepto plutocrats, people will reallocate they're Street Money into other assets.

Enter cryptocurrencies. Where price Discovery and free-market Enterprise is at home.

That is where the smart people and genuine Libertarians will congregate.

In reply to by BullyBearish

earleflorida Meat Hammer Thu, 01/18/2018 - 19:00 Permalink

Ref:     (American Corp's digging in deep in China's business/manufacturing model for the long haul)


*first comment interesting on payment via bilateral parties 'Russia--MIR card' and 'China's--Union card'   caveat? all countries should demand VISA/MasterCard security (?collateral?). The MIR/Union Cards will eventually be offered to all countries if need be via BRI Initiative  

In reply to by Meat Hammer