After a painful stretch of five consecutive down months, September couldn't come fast enough for Horseman Global, which we previously dubbed "the world's most bearish hedge fund", due to its exposure which, while fluctuating, has been bearish for the past 6 years even as it generated significant alpha, and most recently had a net short position of -47.33%, even more bearish than its -43.5% net last month.
In September, the fund finally rebounded, rising 1.8% - its first up month since March - bringing its YTD return to -8.79%, with "gains coming from the long book and the short book. The currency book lost money" according to CIO Russell Clark's latest monthly letter.
So after what is setting up to be Horseman's most painful year since 2016 in which the fund lost 24%, is Clark ready to throw in the bearish towel, stop "fighting the Fed", and join the countless ranks of momentum chasers?
Not at all. One month after Clark wrote in his September letter to clients that he is confident the time for the next big short has come, the Horseman CIO says in the latest letter to clients to "make no mistake, this fund is run to make a positive return for investors. You might think with the fund being net short I am trying to position it as a hedge, or that I am super cautious, but this could not be further from the truth. Why not just buy the market, or buy momentum then? Well, my personal experience of "buying assets that are going up" has been decidedly mixed. What I have found really works for me is doing detailed analysis of an industry, working out what has to happen from basic business and economic logic and having positions in these areas, ready to take advantage of the outcome."
Unwilling to join the bullish crowd, Clark then explains his preferred strategy as follows:
The idea is, while we are waiting for a downturn which I see as inevitable, these different assets will trade independently of each other, but hopefully produce a small upward bias to the fund. Then when the inevitable occurs, these previously uncorrelated assets become correlated and the fund has a huge move. It's an odd strategy I know, but it does allow the fund to run net short for prolonged periods of time.
This bearish strategy worked remarkably well for 4 years - from 2012 to early 2016 - when even as global stock markets continued to rise, the fund which was running extremely net short, and made positive returns year after year (see table above). According to Clark, this alpha "was the culmination of work done in 2010 and 2011 as we worked out what was going on in the Chinese steel industry and how its inevitable problems would affect miners, Latin America, currencies and bonds."
And after what the CIO says was "a lot of hard work in 2017 and 2018" he finally feels that he has "found the combination of assets both long and short that offer the return profile that we want."
So what is Horseman seeing?
In a word: oil. In 5 words: oil prices going much higher.
As Clark wrote in his most recent Market View letter, data from the EIA, price action of stocks, and comments and capital market activity "are all pointing to the oil industry beginning to move away from US onshore. Not in a huge way, but a bit," he adds. Looking at the "brutal and unrelenting economics of US shale oil drilling", Clark predicts that US oil production will slow and quite possibly contract.
This is made even more likely in my view by the consolidation of large shale drillers, who may well feel that it is in their self-interest to slow oil production and help to push up WTI oil prices. Betting on self-interest, particularly when it comes to Americans, has historically been a good bet.
What happens next could be a replay of the oil price shock observed in the days just before the global financial crisis struck in mid 2008.
WTI prices have already risen from 30 USD at the low in 2016 to 74 USD today. The last time US oil production slowed, the discount to WTI disappeared, and if that happened today it would move to 85 USD. Given the current issues with Iran, in anything but a recession, it's hard to see oil prices falling.
Should this thesis pan out, Clark predicts that the sudden jump in oil prices would cause US auto demand to weaken, a sector that is already falling and suffering from slowing demand in China and rising commodity prices. Next, falling auto demand would impact a semiconductor market that is already seeing inventory builds and rising competition from China.
Aside from specific sectors, a slowdown in US oil production and a rise in oil prices, would also have broader economic implictions and cause a sharp slowdown in US growth.
And given that the US fiscal deficit is already at 4% of GDP, "even a minor slowdown would cause this to widen dramatically, likely leading to the US dollar falling, either due to changes in the expectation of Fed tightening, or concerns about the fiscal stability of the US." And as the spread in oil prices closes, this also reduces a huge competitive advantage for the US.
A falling US dollar would feed into our very short USD currency book and would aid our large short positions in European and Japanese auto manufacturers and suppliers.
But what has Clark most excited about this sequence of bearish events is that "all these different trades feed off of each other, and they are beginning to correlate. Much like in the period from 2011 to 2016, as one area begins to work, we can move the fund to other areas as weakness in one area bleeds into another."
As usual, Clark's letter ends with his net positioning, which "remains short developed markets and long commodity related companies", and nowhere is the fund more short than tech...
... which is a net -50% of the fund's entire book.
We conclude with the parting words from his September letter, which we suggest being read in conjunction with his latest one:
2011 and 2018 are playing out very similarly for me. Easy momentum trades of the past year are breaking down, and investors are herded from one area to another. While all the talk is of an emerging market crisis, the biggest emerging markets are all engaging in reform, while the developed markets are still overly reliant on easy money. In 2011, selling the then outperforming emerging markets, and buying Irish debt was the right trade. And in 2018, shorting developed markets and buying emerging markets looks the right trade now.