One month ago, when we updated on the performance of Horseman Global, what until recently was the world's most bearish hedge fund with a record net short exposure of -98%...
... at least until Icahn Enterprises emerged with its even more gargantuan -149% net short...
... we cited fund CIO Russell Clark who observed the fund's dramatic -9.6% drop in the month of March, and made it clear that he wasn't going anywhere because he was confident that the move was nothing but a short squeeze, which - if anything - made Clark even more bearish.
I can hear you say, how do you know this is just a short squeeze, and not the beginning of something much more substantial? While equities are trying to send a bullish tune, the 200 day moving average is now trending down for S&P, Dax and the Nikkei. This is not bullish. Furthermore, yield curves in the US, Japan and Europe have flattened. This is not bullish. Yen is rallying. This is not bullish. We have seen substantial covering by the market. This is not bullish.
To my mind, if you want to be short, this looks about as good as it gets.
One month later and not everything is working out according to plan because after last month's nearly 10% drop, the losses continued and Horseman lost another 4.3% in April and -5.1% YTD after being up as much as 10% in the first two months of the year.
What happened? Well, as Clark puts it ever so well, "I think something has changed."
Your fund fell 4.29% net last month.
To lose 4.29% last month was a bit of a surprise to me, as most of the technical indicators I use indicated that the short squeeze was largely over at the end of March, and yet it continued into April.
The question to be answered after a drawdown is always the same, “Has something changed?”. In this case, I think something has changed. The overwhelming theme of the market for the past 18 months or so has been that of a strong dollar. European and Japanese markets had performed well as their currencies weakened versus the dollar, and commodity prices were generally weaker. Furthermore the strong dollar put pressure on the renminbi and encouraged thoughts of a Chinese financial crisis.
I was aware of the consensus in the market and put hedges in place to offset a weak dollar. I have had since last year long euro and long yen positions in the currency book, while having short Japanese and European exporters in the short book since last year. These hedges have performed very well, and have been the main reason that despite the drawdown, the fund has managed to hold on to most of the gains from last year.
The message that I am getting from the market, the “something” that has changed is that the US dollar is no longer a strong currency. Typically the US dollar falls when its economic cycle begins to roll over. Many of the indicators that I look at show the US is either in or heading for recession. These indicators include; the US trade deficit ex petroleum products which is back to 2006 levels; US capacity utilisation peaking in late 2014 and declining rapidly ever since; and US high yield have generally been widening since 2014.
Historically, a weak US dollar is good for commodity prices, and it is also good for emerging markets. This has played out this year, where we have suffered pain on emerging markets and commodity shorts, but have gained on Japanese and European shorts. Given that the US dollar could potentially fall significantly from here, it seems to me that we should take what have been hedges to our portfolio (that is long euro and yen, short Japanese and European equities), and make this the core of the portfolio, while our emerging market and commodity related shorts should become the hedges.
Having realised this late in the month, we have already made substantial progress to making this change in the portfolio. We have increased our long euro position to 50% of the fund, and long yen to 30% of the fund. We have closed a number of emerging market financial shorts, and opened European financial shorts. We are now net short European financials. We have closed a number of US listed oil shorts and replaced them with shorted euro denominated oil stocks.
It is possible that the US dollar could be so weak, that the US equity bull markets can continue, but it would probably lead to depression and crisis in Europe and Japan. At the beginning of the year, an investor asked me to sum up current central bank policy. I described it as a circular firing squad, where at best perhaps one economy could escape, but most likely everyone dies. The gun that they hold is competitive devaluation. We know now who is most likely to live and who is most likely to die, and are making the appropriate changes.
Your fund remains short equities and long bonds.
And so it does, because after realizing that the "strong dollar" thesis is no longer dominant case, did Horseman cover any shorts? Not at all, and in fact quite the contrary: as of April, the hedge fund is for the first time in its history more than 100% net short, something Carl Icahn would surely appreciate.