Several years ago, we first described Horseman Capital’s Global Fund, as “the world’s most bearish hedge fund” for a simple reason: of all existing asset managers, Horseman may be the one with the biggest and longest net short in history (during the longest bull market in history). Indeed, as shown in the chart below, after last going net short in 2011, Horseman has gone over 7 years being net bearish the market, with its latest net exposure a whopping -88.14%, and a gross short position an unprecedented 160%.
And while for Horseman, and its CIO Russell Clark, this chronic bearish position was hardly a curse, with the fund outperforming the S&P not only in 2018 but for most years in the 2011-2017 period, 2019 – with its near record bear market rally – has been less forgiving, and after plunging 7.9% in January, the fund tumbled by the same amount in February as stocks continued their relentless rally higher to start 2019. As a result, Horseman has started the year with its worst 2-month performance on record, tumbling 15.1% in just the past two months.
So with stocks soaring, and Horseman betting the farm against further upside (while fighting central banks in the process), CIO Russell Clark says that what investors wanted to know is two things: 1) why I have I remained so bearish into such a long bull market; and 2) why don’t I really think it matters that the Federal Reserve seems to be moving dovish again.
His answer is below:
I originally planned to write a newsletter laying out all the details of how the interplay of semiconductors and autocallables was driving market volatility lower, and markets higher, but looked like it was about to end. I also was going to add details on exactly how that was unwinding, even as markets rally. And if you want those details, email me and I will provide them to you
But what people really want to know is why I have I remained so bearish into such a long bull market? And why don’t I really think it matters that the Federal Reserve seems to be moving dovish again.
I have always held the view that QE does not really do anything. It can boost an up cycle, and slow a down cycle, but ultimately it makes no difference to economic cycles. Believers in QE will point to the US economy, with a record-breaking rally in the S&P 500 and lowest unemployment since the 1960s and tell me I am wrong. I can point to Japan and say they have had forms of QE for over 20 years, with no obvious benefit. So the bigger question is to ask why has the US done so well, if QE has not played a part?
I believe there are three things have driven markets since 2011.
- First, the shale revolution has seen the US go from producing 5m barrels of oil a day to 12m barrels a day. This is hugely positive for growth. This has also had the added benefit of lowering the cost of energy. But data here is starting to weaken, and profitability and share price performance of shale companies is beginning to lag traditional oil drillers. This driver is looking to be coming to an end.
- Secondly, for the global economy, China has become a huge consumer. Its auto market has grown to be the world’s largest, and overseas tourism has grown substantially. This has been a huge tailwind for many industrial and consumer discretionary companies. Recent data is showing that this is beginning to get saturated, with both auto and smartphone markets showing falling volumes.
- Finally, and I would suggest the least understood driver has been the falling cost of equity insurance. For more than 10 years, from 2000 to 2011, equity investors suffered large equity drawdowns in global markets. And it is no coincidence that over this period there was huge growth of the hedge fund industry. When markets continually sell off, and bad things keep happening to your equity portfolio, you are going to want to have some money in a “hedge of some sort. In fact, by 2011, all sorts of tail risk and Black Swan funds had appeared. All these funds bought equity insurance and pushed its price up.
However, low interest rates eventually forced both institutional and retail investors to find other ways to get a higher yield and selling equity insurance has become a very popular way to achieve this. And the reason I continually talk about autocallables, is that this is the method by which it is sold to retail investors. The funny thing is that the conditions that were in place in 2011, a high cost of equity insurance, the growth in Chinese consumption, and strong growth in US energy production are all behind us. So fundamentally, I am very bearish.
But regardless of my views, I am always conscious of what other people are doing, which drives my reputation as a contrarian. When my views strongly diverge from market views, then I tend to get more aggressive, mainly because the risk reward tends to be so strongly in your favour.
The consensus view is that new stimulus from central banks will keep the party going. Investors have continued to move money from active managers like myself to passive, private equity and quant strategies. Hedge funds are shadows of their former selves, and finally, autocallables globally have created a very predictable fuse by which markets will blow up. Even more excitingly, I don’t have to wait for macro data to turn my way, that has already happened.
A criticism that I do have to accept is that fund is more volatile lately. And this is true. But from what I see, people have greatly overvalued and gone very long strategies that hide their inherent volatility, such as autocallables, private equity, ETFs and trend following funds, and I want to be the other side of the trade.
Finally, for those wondering where…
… and what the fund is most short…
… the answer is: the US, with a blank short across financials and semiconductors (and for the reason why, read “Beige Book Shocker: “Semiconductor Orders From China Plunged The Most Since The Collapse Of Lehman“”.