Like David Einhorn, Horseman Global had a very ugly month, in fact its 6.9% drop in June which dragged YTD performance back into the red (-2.83% YTD), was the worst month for Horseman going back to the end of 2016.
However, unlike Einhorn, who lost 8% in June bringing his YTD performance to -19% and whose woes can be mostly attributed to the relentless rise of the tech names that make up his “short basket”, Horseman was hit due to something else entirely: its aggressive short dollar bet. Like so many other funds who turned bearish on the greenback at the start of the year only to suffer a violent short squeeze, Horseman was caught in the trade war tug of war, in which China – for one reason or another – saw the Yuan depreciate last month by the most on record surpassing even the August 2015 devaluation. Subsequent dovish language from both the ECB and BOJ did not help as Horseman CIO Russel Clark explains:
it seems the larger consensus position in the market is to be short US dollar. More dovish than expected messages from the European Central Bank (ECB) and Bank of Japan (BOJ) led to a surge in the value of the dollar against all currencies. As the fund strategy has been built around flows into the US reversing and creating a weak dollar, our long book suffered without commensurate gain from a short book.
Due to the violent whiplash in the dollar, technicals also promptly reversed, making the long dollar trade the biggest pain trade for the hedge fund community:
Short dollar and long commodity trades had attracted a great deal of trend following money, and Commodity Futures Trading Comission (CFTC) data and broker estimates now show that CTA and trend following funds have reversed their short dollar position, and are now long dollars, while long positioning in commodities have been largely cleared out.
The concurrent collapse in emerging markets, one of Horseman’s preferred trades for the past year, did not help performance.
Which brings us to Horseman’s key point in his latest letter to investors, as well as a major question: what is prompting the yuan devaluation? Is it merely China’s stealthy, if petulant, response to the Trump’s escalating trade salvos, is it a reaction to China’s weakening economy, or is something else going on. To Clark, the answer is “something else.”
The big question which remains unanswered is why have the Chinese become willing to let their currency fall after a period of keeping it strong? Where is there self interest in letting their currency weaken when there was little need for it, and it potentially destabilises the economy?
And the response:
The most reasonable answer to my mind is that they have tired of the endless currency devaluation policies of the BOJ, and possibly the ECB.
The reason for this is due to a structural change in the Chinese economy, which “now runs trade deficits with both Japan and Europe, so why should they allow the Euro and Yen to continue to devalue against the CNY?”
Why indeed, but if that interpretation is accurate, and if China’s latest Yuan deval is the product of trade concerns and not a simplistic response to Trump, Clark believes that this has two profound implications, one for traders the other for the economies of Europe and Japan:
- Firstly, that CNY weakness is a not sign of economic weakness at all, which is shown by the underlying data. Hence investors positioning for further Chinese and emerging market weakness could be very disappointed. Especially as dollar weakness still looks a structurally sound trade in my mind.
- Secondly, if CNY is managed now to prevent either the Euro or the Yen to weakening against it, while the dollar is likely to fall against all three currencies, this has negative connotations for European and Japanese exporters, who look to be hemmed in by a trade war with the US and a new Chinese currency policy. Combined with Chinese policy of keeping commodity prices high, the environment for Japanese corporate cashflow is turning negative. As Japan cashflow weakens, less of this money is likely to find its way to the US corporate bond market, likely causing corporate bond spreads to widen. We are seeing that Japanese have become the dominant buyers of US corporate debt and leveraged loans.
And yet, in his synthesis of these trends, instead of seeing the return of some virtuous leveraging cycle, Clark comes up with a conclusion which is especially bearish for the market, as he sees the recent shift in Chinese currency policy, and the current yuan weakness, as the potential catalyst that precipitates the collapse of several “unsustainable” trends, to wit:
For a long time, I have considered the BOJ quantitive easing policy, the US corporate bond market and volatility selling markets as unsustainable, but with little idea of what the catalyst would be for these markets to unwind. This change in Chinese currency policy could be a catalyst for change.
Well, as we have said for the past 3 years, it is the world’s most bearish fund for a reason, and not just before of its gross and net short exposure of -135.5 and -44.3%, respectively.
Clark’s latest full letter is below:
Your fund lost 6.87% last month. Losses came from the long book and currency book.
I had thought the big consensus trade in the market was short bonds, and I had moved the fund to be largely neutral with respect to bond yields. To offset our short REIT and Pharma positions which do well with lower yields, I had taken a long bond position and short financial position (financials tend to do badly when bond yields fall). However, it seems the larger consensus position in the market is to be short US dollar. More dovish than expected messages from the European Central Bank (ECB) and Bank of Japan (BOJ) led to a surge in the value of the dollar against all currencies. As the fund strategy has been built around flows into the US reversing and creating a weak dollar, our long book suffered without commensurate gain from a short book.
With the dollar rally, markets have taken to punishing emerging market assets. Emerging markets certainly were weak during the 2013 taper tantrum, and the Chinese devaluation of 2015, so selling these assets during a dollar rally is perfectly logical. However, the differences between 2013, 2015 and today are profound, particularly for the mining sector. June saw new cycle highs for thermal coal and dry bulk shipping prices. We have also seen Chinese steel output rise to new all-time highs, at the same time Chinese domestic iron ore output has been reduced, which has led to rising imports. Major miners continue to cut capex and repay debt. Indian commodity demand continues to rise. Indian billionaire, Anil Agarwal, has looked to buy minorities out of his listed mining company, and try a buy the assets of Anglo American, as market valuations are very cheap despite an improving outlook.
Short dollar and long commodity trades had attracted a great deal of trend following money, and Commodity Futures Trading Comission (CFTC) data and broker estimates now show that CTA and trend following funds have reversed their short dollar position, and are now long dollars, while long positioning in commodities have been largely cleared out.
The big question which remains unanswered is why have the Chinese become willing to let their currency fall after a period of keeping it strong? Where is there self interest in letting their currency weaken when there was little need for it, and it potentially destabilises the economy? The most reasonable answer to my mind is that they have tired of the endless currency devaluation policies of the BOJ, and possibly the ECB. China now runs trade deficits with both Japan and Europe, so why should they allow the Euro and Yen to continue to devalue against the CNY? This seems perfectly reasonable to me and has two profound implications.
Firstly, that CNY weakness is a not sign of economic weakness at all, which is shown by the underlying data. Hence investors positioning for further Chinese and emerging market weakness could be very disappointed. Especially as dollar weakness still looks a structurally sound trade in my mind.
Secondly, if CNY is managed now to prevent either the Euro or the Yen to weakening against it, while the dollar is likely to fall against all three currencies, this has negative connotations for European and Japanese exporters, who look to be hemmed in by a trade war with the US and a new Chinese currency policy. Combined with Chinese policy of keeping commodity prices high, the environment for Japanese corporate cashflow is turning negative. As Japan cashflow weakens, less of this money is likely to find its way to the US corporate bond market, likely causing corporate bond spreads to widen. We are seeing that Japanese have become the dominant buyers of US corporate debt and leveraged loans.
For a long time, I have considered the BOJ quantitive easing policy, the US corporate bond market and volatility selling markets as unsustainable, but with little idea of what the catalyst would be for these markets to unwind. This change in Chinese currency policy could be a catalyst for change. Your fund is long commodities, short developed markets.
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