Last March, after the worst year in Horseman Capital’s history when the fund lost -24% of its AUM, on par with its performance in 2009, fund CIO Russell Clark capitulated on what until then was the world’s most bearish portfolio, sending its net exposure from -100% to just -12%. Clark also revealed that instead of being outright short equities, as he mostly had been for years, he would split his bullish exposure by shifting long into Emerging Markets, while staying short Developed markets.
What I find interesting, is that US markets have moved up on the promise of reform, even though they look fully valued in my view. China and India we have already had reform take place, and the stocks are not priced for these benefits. Plainly the choice is obvious for me. Long emerging markets, short developed markets is the strategy for the fund.
The decision to rotate into EMs, which at the time was certainly contrarian, may have helped Horseman Global, – which back then was struggling with an avalanche of redemptions – survive, because while it failed to generate spectacular gains, it still managed to turn around the 2016 rout and return 2.3%. The fund’s winning ways continued in 2018, when after the first 4 months, the fund – which we previously dubbed “the world’s most bearish hedge fund” due to its chronic net short bias – was up just over 5%, even as Clark maintained his unprecedented net short book into its 6th year.
Fast forward to today, when after several bland monthly letters to investors in which as Russel Clark himself admitted he “refrained from talking about the market in detail”, the widely followed contrarian is out with a new missive which may presage another key inflection point in the market.
According to Clark, recent developments in China may have finally revealed the key that “unlocks” the QE trap, which would then permit the gradual rise in rates without catastrophic consequences, however this combination of slightly higher short-term interest rates and higher commodity prices “seems to be slowing growth.” This, combined with the general long equities and short bond position of the investing community, strikes Clark as dangerous.
So, one year after dramatically uprooting and overhauling his entire portfolio, Clark is making another major change to his book once again, and as he explains, in the past two months, he has “reduced shorts that work well with higher interest rates, such as staples, REITs, and telecom stocks.” Instead, Horseman has shifted bearishly into the economic cycle-sensitive short book, “namely semiconductor stocks and financials.”
So what about his net exposure? Here Clark says that while he is “tempted” to cut the long book, he has instead “maintained this exposure because, if growth heads south, the chance of central bank intervention in either China or the US rises.” Indeed it does as April 17 showed, when the PBOC unexpectedly cut RRR rates, launching the current surge in both the US Dollar and Treasury yields.
So with the threat of central bank intervention in minds, Clark writes that “Chinese intervention may well be to be cut more capacity and raise commodity prices higher” while the US may back away from further rate increases, with both moves “bullish for commodities.” As a result, the Horseman “long book is really a hedge against central bank policy supporting the economic and market cycle.“
Curiously, anticipating that LPs and investors in the fund may be “fickle” as Clark begins another major portfolio rotation, he writes that he is closing the fund to new investors from June 1, and says there are several reasons for the move: “I understand my style of investing better. I have a natural tendency to attack consensus positions. And, by definition, when I do well, everyone else does badly, and vice versa. The best investors for me are those who understand this, and therefore, by definition, these are the investors that are in the fund now after a period of average returns.”
Which brings us to the punchline: on the (roughly) one year anniversary of his last major portfolio rotation, this is what the Horseman Global CIO will be doing now:
For the last year or so I have characterised the fund as long emerging markets and short developed markets. This is not correct anymore. We are short three of the four largest emerging market stocks. We have also started to buy bonds again: 30-year Japanese Government Bonds a couple of months ago, and 10-year treasuries at the beginning of May.
Considering the recent plunge in EMs, Clark may have timed his rotation perfectly
And since this latest portfolio shift brings Horseman back to its original, bearish posture, Clark’s poetic conclusion is spot ont:
Markets are much like life, if you keep going long enough you end up back in the same spot. Coming back a full circle, your fund is once again long bonds (and commodities), short equities.
Clarke’s full letter to investors is below:
Your fund lost 2% last month, all from the currency book. Losses in the short book balanced gains in the long book.
The last two newsletters have largely refrained from talking about the market in detail. I believe quantitative easing (“QE”) is a disastrous policy, and the example from Japan of it being an extremely hard policy to escape still seems true to me. However, the Chinese policy of forcing capacity cuts and raising interest rates, seemed to offer a way out of the QE trap. Certainly, since China enacted its policy change, the Federal Reserve has managed to reverse far more of its QE policies than the Japanese ever managed. So, I have been conflicted. Maybe the Chinese,
with their unusual hybrid economy, can unlock us from the QE trap that we have fallen into?Sadly, April saw Chinese government bond yields start to fall significantly. Even as interest rate increases have become more expected, 30-year bonds have stayed becalmed, and in some cases are starting to move lower. The combination of slightly higher short-term interest rates and higher commodity prices seems to be slowing growth. This, combined with the general long equities and short bond position of the investing community, strikes me as dangerous.
So, April and early May have seen me reduce shorts that work well with higher interest rates, such as staples, REITs, and telecom stocks. We have used the space created to increase our economic cycle sensitive short book, namely semiconductor stocks and financials. The gross short book has shrunk, but when beta adjusted it is probably flat. I am tempted to cut the long book, but have maintained this exposure because, if growth heads south, the chance of central bank intervention in either China or the US rises. Chinese intervention may well be to be cut more capacity and raise commodity prices higher. The US may back away from further rate increases. Both seem bullish for commodities. The long book is really a hedge against central bank policy supporting the economic and market cycle.
I have recommended to the fund Directors that they close the fund to new investors from June 1. From that point on, we will only accept investments from new investors that began their due diligence before June 1.
I suspect that many readers of the newsletter will wonder why I want to close the fund to new investors. Whilst returns have improved, and we have seen some inflows, neither has been extreme. There are several reasons. I understand my style of investing better. I have a natural tendency to attack consensus positions. And, by definition, when I do well, everyone else does badly, and vice versa.
The best investors for me are those who understand this, and therefore, by definition, these are the investors that are in the fund now after a period of average returns. I obviously struggle at inflection points, so by not having the distraction of new prospects I would hope to manage inflection points better.
For the last year or so I have characterized the fund as long emerging markets and short developed markets. This is not correct anymore. We are short three of the four largest emerging market stocks. We have also started to buy bonds again: 30-year Japanese Government Bonds a couple of months ago, and 10-year treasuries at the beginning of May. Markets are much like life, if you keep going long enough you end up back in the same spot. Coming back a full circle, your fund is once again long bonds (and commodities), short equities.
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