The Capitulation of Hugh Hendry

Scottish-born, global-macro fund manager Hugh Hendry, renowned for his generally contrarian and bearish outlook, appears to have capitulated in the face of the seemingly endless central-bank-open-market-operations-fuelled global bull market in equities that emerged after the early 2009 bottom of the 2008 equities market crash.

Indeed, his about-face is so dramatic, that one cannot but think that in retrospect he will be famous for either top ticking the bull run and exploding, or for truly being able to live up to his 'plasticine man' moniker by bending himself into sync with a mad market and surviving through conscious adaptation.

Either way, its the death of Hugh the contrarian.  The question is how profitable Hugh the momentum junkie is, and whether he will retain this ability to sell at the top, if ever there comes another top before the current ledger is purged in the fires of war.

HH espouses his views in this Nov 2014 Moneyweek interview with Merryn Somerset, recently made available on youtube.

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[ On Capitulation ]

HH: And now the problem... the perception I have of the problem... is that that's when the moral curmudgeons step in and say, 'This is all crazy. I disagree with this.  I'm not playing.' [comically folds arms]

MSW:  So they make their disapproval a reason, a reason not to play the game.

HH:  It wouldn't work, and so they don't participate.  Equities are overvalued, and I'm going to tough out, I'm just not going to be in that market.

As I say, there was a time in my life when the sun only rose to humiliate me, where perhaps I shared that, and its bunk, its nonsense.  It may not work, but presently, the perception is that it will work, and those asset prices are trending, and you should participate.

[ On Distortions Created by Central Bank Intervention ]

If I make segue into that answer by challenging the notion, the popular notion, that quantitative easing has distorted and manipulated public markets.  Again, I think I user the term earlier, buttercup, absolute nonsense, absolute nonsense.

JGB (Japanese Government Bonds), if we take an example, are fairly valued.  The economy just fell 7% in the last quarter (on an annualised basis), there is no inflation.  They've had 25 years of no real GDP growth.  Where would you expect JGB bond yields to be for a fiat currency that can issue its own paper currency.

US treasury bonds, where should they be ? You know, you know, I struggle to see... and you know again, Dylan Grice was the great architect of the notion that you can define the upper bound to today's interest rates by trying to determine societies' capabilities to meet those interest rates at higher and higher levels, and what you find is that we can't.  We cannot live with a Paul Volker putting interet rates at 15% - it doesn't work.  There's so much debt that, if you repriced it, the economy slows down - and you saw that in 2012.  I think after the taper tantrum, when 10 year bond yields went over 3% - what happened next ? The economy slowed down.

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partial transcript:

Merryn Somerset-Webb: Hi, I’m Merryn Somerset-Webb and I’m here today with Hugh Hendry, manager of the Eclectica Fund. We are going to talk about everything from China to the US, to Europe, to Japan. But Hugh, I just want to start by asking you what you think makes a successful hedge-fund manager and whether you are, under that definition, a successful manager.

Hugh Hendry: I think I’ve always answered that question by relating back to the ability to conceive of a contentious posture. I think if I was to quote from Fight Club, I think there’s a famous saying “Would you rather…” my children would say ,”Would you rather upset God or have God just ignore you?” There’s a degree to which being a successful macro-manager is upsetting, not only God, but to the rest of the world, if you will. By being out there with the articulation of qualitatively intelligent argument, which just isn’t shared by the majority. But which can stand the test of time and come to actually define the future. That is what global macro is all about.

With regard to language the notion of “bullish” and “bearish”, I think, does an injustice to the complexity of the arguments that are necessary to construct a global macro hedge fund. I think if I had my time again, I would have been saying that we’re actually, perhaps, guilty of the misconstruing of a bull market in equities, for what is actually the ongoing degradation in the soundness of the fiat monetary system. I think that’s what I was trying to say.

Merryn: The interesting thing is that you have a reputation of being something of a perma-bear. People think of Hugh Hendry, they think of bearish. But what they’re really thinking about is your macro-economic ideas, not your investing ideas. So they’re remembering your views on deflation, which by the way you’ve been correct on, right?

They’re remembering your views on deflation and then they’re remembering your previous views on what might happen to markets as a result of that deflation. The change last year was to think about, not to change your views on the economic condition, but to change your views on how they would affect asset markets.

Hugh: Yeah. A very good point and I’m sure everyone’s aware that we, as a business, have experienced quite a substantial amount of redemptions from the fund. There was a degree to which there was that pigeonholing, and that of being a bearish diversifier, if you will, to an investors’ portfolio. After all, I was the guy who made 30% odd in 2008. That’s out there, and of course with the redemptions there was the notion that I turned into, rather than a diversifier, a concentrator.

Merryn: Well, there was also, slightly, the idea that you had somehow capitulated.

Hugh: Indeed.

Merryn: You had given in to a bull market that you had refused to accept previously.

Hugh: Such is my performance cabaret persona, I certainly would have alluded to that notion, and a degree of mea culpa. Again, what it is with me is, I’m weird.

I cannot truly engage, unless I get angry, I don’t think… and possibly it’s back to my Scottish roots and the weather. So if you cast your mind back, the last time I was really angry was late 2010-2011. Where the market, in its wisdom, had yet to configure the changing economic landscape, and it was perceiving that the economy in Europe and elsewhere was recovering. Therefore the fixed income markets were beginning to price in a very high probability that central banks would raise their overnight rates.

To make matters worse, of course the ECB when it was governed by Trichet, actually came to the fore and raised rates. I thought that was just insane, that we weren’t capturing the kind of deflationary zeitgeist that was approaching.

So with that anger, if you will, I really took on a lot of risk. I was long on fixed income and in the vernacular I was receiving interest rates. So essentially I had a large fixed income bet, which said these rate rises will have to be rescinded and the expectation that there would be further rises are just not going to happen. That proved to be correct, if you will, and that was my last moment, really. I have to say when I look back in the last three years it feels as if the sun only rose each day to humiliate me after that point.

Merryn: I doubt it was really quite that bad, was it, really?

Hugh: In my mind, at times, it’s felt bad. But the mea culpa, that I think is very necessary in that I found myself unable to forgive the Federal Reserve and the other central banks for, if you will, bailing out Wall Street from the excess of 2008.

I just couldn’t get over it. I luxuriated in the polemics of Marc Faber and James Grant and Nassim Taleb, in our own country, Albert Edwards, et al. I luxuriated as they ranted and it was fine for them to rant. But I am charged with the responsibility of making money and not being some moral guardian and certainly not a moral curmudgeon. I had to get over that. So again, back to my infamous letter of last year.

That was cathartic for me to say “You know what? I get it.” I think if we’re going to try and explain the qualitative arguments behind why we are more receptive to the notion of not only left tails where markets can fall, but the right-hand tail of the expression, where markets can actually continue to rise if not to accelerate.

Merryn: But the key point from talking about Marc Faber and Albert Edwards, etc is that you don’t disagree with these people on the fundamental economic condition of deflation. You just disagree with them on the effect on the markets of Central Bank behaviour and on the longevity of that behaviour.

Hugh: Increasingly, I have to say I just disagree with them. I literally and with the utmost respect, I’ve turned the volume down to zero. Previously they were like sheet music. When I read it, I could see the trades appear in front of me, and I just don’t hear the sound of music today. That’s my difficulty. So I really feel very, very isolated from their view of the world. Arguably, we’re talking about the here and now and the future’s a long time. But in the future, I’m sure our paths can converge once more.

Merryn: OK. Well, let’s talk about your view of the world now. Last year there was the infamous letter, the great bullish letter, as something you’d be interested in and your clients said, “No, not really.” Can we make mention of it now? Is there something you can say to your clients now that would re-interest them in this concept of the great bull?

Hugh: Well, let’s have a go. Because there are two things unfolding. Hedge funds and within the broad tranche of hedge funds, macro hedge funds are struggling to make money, and there is a dissatisfaction with that. I’m not the only manager to have suffered withdrawals.

Merryn: Why do you think that this sector as whole is failing to make money? What’s going on there?

Hugh: Well, I can’t be a spokesman for other and far better managers.

Merryn: But I’m sure you can allow yourself to comment on them.

Hugh: But I can reflect on my own difficulties, if you will. What I’ve found is that macro is distinguished, I believe, by superior risk control. It’s almost analogous to a disaster insurance programme. In 2008, all the good macro managers, they made you money. That’s what you pay them for. The world became profoundly unsettling and you cashed in your insurance policy.

Today, I question the relevancy of that disaster insurance. In a world where the central banks seem to have your back, seem to be underwriting risks and global asset prices, do you require that intense scrutiny of risk?

So when I look at my fund, my fund’s not dissimilar to others. We go out of our way to avoid traumatic periods of losing money. For us, typically, that would be defined as losing 5% or more in one month. Such, I think, is our capability that we have 12 years, in running this fund. So 144 monthly observations. Out of that we have had the indignity of suffering nine such months. Not that many when you consider the tremendous amount of either bull market or bear markets that have gone on.

But it forces you, that disaster scheme if you will, or prevention scheme, it forces you to reduce risk. Which is to say to sell the things you like when they go down in price. Notably this year, I had constructed this argument that I wanted to be bullish, yes, and yet, with risk control, I found myself a seller at lower and lower prices. Lo and behold, it became impossible to fulfil my mandate and to make money. I think that is a problem that I shared with many others.

Now I have, again I’m introvert, and I look and I examine my own behaviour. I have concluded that my risk tolerances were too taut and it was creating too much of my own intervention, in the portfolio, and it was damaging to the client’s performance. So I’ve pulled back or I’ve widened the tolerance of the portfolio.

Merryn: So your basic point here is that if the central banks have your back, there’s no need to have the same kind of risk controls that you used to have.

Hugh: There is less need. Less need. I tell you, I was at a conference with some of the great and the good global macro managers in September in New York and I asked them all the question, “If the S&P is down 12% what do you do? Are you selling more or are you buying?” Guess what? They’re all buying. So the central banks have created a behavioural tic which is becoming self-reinforcing and I believe we saw another manifestation of that behaviour in October.

So when I look at the year, I started the year hugely bullish on Japan. Hugely bullish, let me say, not qualitatively. I’m not an advocate of the three arrows and the resuscitation to the great heights of whatever Japan represented in the 1980s.

I am saying that I can see persistent failure to achieve such honourable ambitions, which leaves no recourse but to intervene again and again and again. Therefore I see the Yen being a weak currency.

The other side of that, the stock market, being higher and higher and higher. But I think four months of the year the Japanese market had fallen 16% from its high, and I had to swallow my pride and I had to reduce position.

I had to sell at lower prices, and yet, such is the foreboding presence or shadow cast by the Bank of Japan, that not even if we mentioned the recent intervention, without that intervention the Nikkei had gone back to its previous highs. So I was wrong in selling.

Again, over the summer the European stock markets had a similar decline, even greater if you look at the banks’ index, I think it was down over 20% and what happened? The ECB responded and took its rates negative and it committed to re-engaging, re-utilising its balance sheet to acquire European risk assets. Prices rapidly rallied from the middle of August into September. Why did I sell?

So thankfully, you only make those mistakes a few times, if you’re wise. So when we came into October, I got it. I got it. That, as a discipline, meant we stayed invested in the month of October and then we were able to buy more equity risk towards the middle of the month. Which is to say, we made money in October. We made money in September and we made money in August.

So if you will, it’s not just the narrative, it’s the risk engagement and giving trade expressions the room to breathe, such that they may prosper.

Merryn: So the simple message here, is in a market like this never sell anything and you’ll be fine.

Hugh: You can say that, but I cannot.


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wikipedia on HH:

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Hugh Hendry is the founding partner and, at various times, the chief investment officer, chief executive officer and chief portfolio manager of Eclectica Asset Management. He began to attract attention when his fund achieved a 31.2 per cent positive return in 2008 in the depths of the financial crisis, earning him a reputation as a contrarian investor, but his claim on wider public notice was based in a series of outspoken media appearances. Hendry has been referred to as "the most high-profile Scot" in the hedge fund sector.

Hendry once said to an interviewer: "To my mind, the three most important principles when it comes to investing are Albert Camus's principles of ethics: God is dead, life is absurd and there are no rules." He suggested that a great fund manager was defined by "an ability to establish a contentious premise outside the existing belief system, and have it go on and be adopted by the rest of the financial community".
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