For some people, such as the Horseman Global hedge fund which has been net short since 2012, fighting the Fed can be profitable (even if March was a different story). For others, it is become a nightmare. One such person is Crispin Odey who has - so far - had a truly terrible year.
Recall it was Odey who last February predicted that the "shorting opportunity is as great as 2007-2009", when he said that "we used all our monetary firepower to avoid the first downturn in 2007-09, so we are really at a dangerous point to try to counter the effects of a slowing China, falling commodities and EM incomes, and the ultimate First World effects. This is the heart of the message. If economic activity far from picks up, but falters, then there will be a painful round of debt default."
He continued:
We have seen though some strange things, with economics 101 turned on its head. We’ve seen that falling prices produce more supply, as the biggest producers see that they can take market share and use the opportunity by reducing average costs through excess production. We’ve seen that in the oil, minerals and iron ore industries. We have also seen in the last couple of years that as bond yields fall, governments are able to issue more debt.
But this time round the problem we have as well is that politics will start to rear its head and we are left to deal with politicians who are increasingly critical of the capitalist system’s ability to allocate capital and provide for society. For me the shorting opportunity looks as great as it was in 07/09, if only because people are still looking at what is happening and believe that each event is an individual, isolated event. Whether it’s the oil price fall or the Swiss franc move, they’re seen as exceptions.
His bearish strategy worked in 2015... in 2016 not so much.
One month ago, we updated on his performance when we noted something startling: after starting off the year with a P&L bang, things quickly turned sour and Odey by mid-March Odey was suffering daily AUM swings of more than 5%. The billionaire was stunned, and used the famous line that "this was no longer an investment market but a battlefield."
Markets need equilibrium to prosper. When the authorities have a problem, markets have a problem. We have been hurt by this rally in China-related companies, and indeed we reduced the gross and net positioning of the fund significantly in mid-March, to help reduce the short term volatility of the fund, but we remain convinced that China is in many ways in an even greater bind over policy than the developed world. By mid-March the fund was rising and falling by over 5% per day. At which point this was no longer an investment market but a battlefield. On the day that Draghi came out with his massive market support operation, the stock markets rose 2.5% and then closed down 1.5% on their lows. Imagine how painful it was to see the markets bounce the next day and celebrate his success. At that point I reduced the short book by a third and the long book by 10%.
It was not enough, and as the FT reports today, what until now was merely a terrible start to the year has turned absolutely brutal for Odey's European fund, which is now down nearly a third, or 31%, in the first four months of the year, wiping out almost half a decade of trading profits in his flagship hedge fund in less than four months. His more popular EOC MAC Macro Fund did not do much better, and plunged a whopping 24.4% in the month, one of its worst monthly performances in history, pushing the YTD total to -26.8% which is shaping up to be the worst year for Odey since its inception year of 1994.
According to the FT, the value of the €729m Odey European Fund has now fallen 31.1 per cent to the middle of April, dragging it back to its lowest level since January 2012. His large bets against currencies and equities have gone awry, making his stockpicking fund one of the worst performers among large vehicles this year.
Odey's story is well known to Zero Hedge regulars. "Mr Odey, who has been among the most prominent British financiers to back the country voting to leave the EU, has held strongly bearish views on emerging markets and China for more than a year." And following the massive coordinated reflation attempt by not just the Fed but all central banks, Odey has learned the hard way what it means to fight not just the Fed but all central banks.
What, however, makes the loss especially painful is that as Odey's latest March letter (below) explains, he is spot on. The only problem as noted previously, is that he picked the absolutely worst time to fight not one but all central banks.
Then again, he remains optimistic and as he concludes his letter, he believes that he will have the last laugh over the rotting carcases of central banks:
Losses in the banking sector at this point in the cycle are really bad news because banks are already suffering from weakening margins. They need rights issues to deal with these losses, but why should anyone subscribe to a rights issue when zero interest rates promise no let up to a fall in profits? The only way that banks could become attractive to underwriters of the shares are if profits are rising and the only way that profits can rise is if their loan book gets repriced. Yes, only higher interest rates would make banks attractive, but higher interest rates would bring on the recession that has been kept at bay by QE and zero interest rates. Less QE and more QED.
QE does however have an important effect. It drives all savings to embrace higher yielding assets globally. Life insurance companies and pension funds push more money into faraway places. However if the credit transmission is not there to support increased activity, QE is merely encouraging misdirected investment. Recovery rates from EM destinations are more in the teens that the twenty percents. Is this good signalling by central banks? Remember it was Keynes, the architect of their think-ing, who said, “It is good for people to travel, goods to travel but not for savings to travel.” The disconnect between travelling and arriving may be coming home to roost. It will make the retreat from Moscow appear painless.
Good luck!
* * *
From his manager's report.
QE came out of Fisher’s work on business cycles in 1935. For him what created the depression was the cycle of over-indebtedness allied to overcapacity, which ensured that when prices declined, loans could only be repaid by assets being sold off. The debt paid back made the debt still owing that much more expensive, because in a deflationary age, zero interest rates still meant that money remained too costly.
QE involved lowering interest rates from nearly 5% to almost zero very quickly, taking over the weaker financial intermediaries – AIG, Washington Mutual in the USA and, in the UK, Northern Rock, Lloyds and RBS – so that assets did not have to be sold and the debt deflationary cycle did not have its pernicious way. Central banks in a world of QE have become obsessive of where they perceive the ‘risk premium’ to be too high. Where interest rates payable by industries or by banks are seen as too high, central banks intervene and buy the bonds and in the process grow their own balance sheets.
The idea behind all of this is that by keeping interest rates low, slowly the economies of the world can recover and that hopefully this recovery would not be led, as it had for the 20 years before 2008, by debt that grew faster than incomes.
Newspapers are still full of central bank promises that interest rates can go negative and that if the worst comes to the worst, money could be helicoptered into the economy; a method that would involve increased government expenditure financed by the printing press. Quite apart from the practicality of charging individuals negative rates on their positive balances, there is a growing body of people believing that QE and zero interest rates have already done as much as they can.
For, by the nature of QE and zero rates, central banks put themselves in competition with the clearing banks. They are eating the same food. Banks make their money in two ways. Maturity transformation and credit spread. However in a world of per-sistent low rates, assets (loans) will reprice downwards following liabilities (deposits) that reprice more quickly. Net interest margins will fall and in the absence of costs falling, so do profits. Secondly, central banks buy sovereign bonds and then later corporate bonds, driving down yields and again driving down the profitability of investing in these assets by banks.
In a world of QE and low interest rates, banks become increasingly unprofitable which may lead them to become that much more reckless in pursuit of higher yields to expand into subprime, auto loans, leveraged loans and credit cards. It certainly does not encourage them to lend naturally. Without lending and credit however, economies will find it, as Japan has shown since 1996, difficult to grow. They can only grow as fast as productivity will allow. Factor outputs rising faster than factor inputs.
However a side effect of zero interest rates is that companies that would have gone to the wall, remain and help to keep compe-tition intense. Profit margins suffer. Equally, in the USA, low interest rates have served to encourage quoted corporate Ameri-ca to buy back shares with debt rather than invest. Why invest when competition is driving down prices, when buying back shares helps management to realise profits on their share options? So now zero rates are leading to weak investment spending.
For the first time, productivity globally has fallen either to zero or even below that. This tells a story of misallocated capital – again very likely in a world of zero rates – but more tellingly it reflects that now, where there has been overinvestment, and here China is the worst culprit, that overcapacity is leading industries – oil, iron ore, steel, coal, shipping – to sell their goods and services at prices below cost. These losses have to be financed in some way and in the end these bad debts end up with the banks.
However losses in the banking sector at this point in the cycle are really bad news because banks are already suffering from weakening margins. They need rights issues to deal with these losses, but why should anyone subscribe to a rights issue when zero interest rates promise no let up to a fall in profits? The only way that banks could become attractive to underwriters of the shares are if profits are rising and the only way that profits can rise is if their loan book gets repriced. Yes, only higher interest rates would make banks attractive, but higher interest rates would bring on the recession that has been kept at bay by QE and zero interest rates. Less QE and more QED.
QE does however have an important effect. It drives all savings to embrace higher yielding assets globally. Life insurance companies and pension funds push more money into faraway places. However if the credit transmission is not there to support increased activity, QE is merely encouraging misdirected investment. Recovery rates from EM destinations are more in the teens that the twenty percents. Is this good signalling by central banks? Remember it was Keynes, the architect of their think-ing, who said, “It is good for people to travel, goods to travel but not for savings to travel.” The disconnect between travelling and arriving may be coming home to roost. It will make the retreat from Moscow appear painless.
* * *
Finally, here is what Odey disclosed are his top 10 holdings in OEI Mac.