October was not a good month for the “world’s most bearish hedge fund” Horseman Global Management, which suffered another steep drop, losing 5% in the month, and down 5.5% YTD. Absent a rebound in the last two months of the year, Horseman is set to have its worst year since 2009. Alas, with Horseman’s net exposure a whopping -84% (if fractionally more bullish than the -100% recorded in early 2016) as a result of an equity short and a bond long, November does not appear overly promising for the fund’s investors. Unless, of course, the market swoons as both yields and the dollar continue surging (as DB warned), and Horseman does have the final laugh.
That, however, would be surprising considering that some of the most prominent billionaire mega-bears, such as Carl Icahn and Stanley Druckenmiller, both quikcly flopped to bullish in the aftermath of Trump’s election, on just one catalyst: more debt resulting in more stimulus, and (hope) for more growth.
Yet Horseman refuses to change its thesis. Why? Instead of guessing, here is the answer straight from the “Horse’s mouth” – the following excerpt from the latest letter to investors by CIO Russell Clark lays out what the gloomy hedge fund believes will be the outcome from a Trump presidency.
Your fund fell 4.96% last month. Losses came from the bond book, the forex book and the short book. The long book made money.
First Brexit and now the Trump triumph has left many supporters of open liberal economies despairing. They feel that the world is turning in on itself and that perhaps a darker less safe world is emerging. And perhaps they are right.
But in many ways, the great western democracies of the world, the UK and the US are working as they should. It is plainly obvious that large parts of the population in both the UK and the US feel that the system has not worked for them, and they have voted for change. And those voters have had their voices heard and change is on the way.
Undemocratic regimes in the rest of the world look on in either horror or bemusement at the changes in the UK and US and congratulate themselves that their system is so safe and stable. And yet, the reality is that if the political system cannot provide the change that people seek, then eventually and inevitably, revolution becomes the only option for change. And revolution always extracts a very high price on those that have been in power.
When thinking about a possible Trump victory, I perceived that the USD could be very weak, and that this weakness would lead to treasuries also being weak as foreign investors dumped their holdings. What has happened is that domestic US investors have reappraised their views of US domestic growth upwards, and have dumped treasuries to buy equities, and the US dollar has been very strong.
While the stated aims of the Trump administration are very pro-growth, to me the actual effects seem likely to disappoint. Plans to allow more drilling will be dependent on a much higher oil and gas price. Scrapping car emission standards whilst good for SUV makers, will unlikely reverse the falling demand for cars due to high levels of auto debt. Lower taxes and more infrastructure spending may well be bullish for growth, but need to be balanced against the sell-off in the long end of bonds, which will have a negative effect on housing and with DR Horton reporting weak numbers makes, I feel growth will disappoint in the short term.
The more apparent of the negative aspects is that higher bond yields are starting to cause some financial pressure in Hong Kong and Chinese interest rates. If a trade war, becomes more likely, then a large Chinese devaluation also becomes more likely. Furthermore, the Trump win makes the break up of the Eurozone far more likely in my mind.
After Brexit, being short equities and long bonds was a fantastic trade for a week or two, but then reversed quickly after, causing severe pain for those that had reacted to the market quickly. I think the Trump win has seen many investors sell defensive positions and buy cyclical positions. I suspect they will come to regret that. Your fund remains long bonds and short equities.
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Steepping away from Trump, here is Clark’s asset allocation and sector breakdown, and what appears to be a wager that Trump is about to end the record wave of industry consolidation in a move straight out of Teddy Roosevelt’s playbook:
This month losses in the short portfolio, in particular from the European and Japanese banks and the automobile sectors, were partially offset by gains in the banks and oil sectors in Brazil and the defence contractors in the long portfolio.
In the US the value of announced mergers and acquisitions (M&A) reached $337 billion in October, making it the biggest deal-making month ever. 2015 was the biggest M&A year ever globally with total deals of about $4.3 trillion dollars (source: Bloomberg). High M&A activity may give the impression that the economy is robust, but in our opinion it merely reflects a sluggish economic environment as companies struggling to grow their revenues and profit margins organically, and turn to mergers and acquisitions instead.
QE monetary policies have supported M&A activity by allowing ample availability of funding, as investors searching for yield are eager to buy corporate debt and drive credit margins lower.
M&A activity causes a decrease in the number of firms and an increase of their respective market shares. This can result in significantly reduced competition between firms. In economic theory, when a few large firms dominate a market there is the potential to engage in collusive behaviours such as deliberately joining together in cartels in order to increase prices. In extreme cases a company that becomes too dominant develops the power to influence market price, run competition out of business or not allow competitors to emerge. Once enough other companies are bankrupt or bought off, the remaining company can stop improving its product, lower the quality and raise prices as much as it wishes, because consumers have no choice.
It has been argued that some companies with large market shares can employ what game theorists call a “trigger strategy,” whereby they signal to their competitors that if they lower their prices, they will start a vicious retail war. If a rogue player refuses to play the game, it becomes the target of an aquisition, not because it makes great products, but because owning it allows an oligopolist to raise prices.
Another detrimental effect of low competition to the consumer was illustrated by an article in The New York Times entitled ‘Arbitration Everywhere, Stacking the Deck of Justice’, about the rise of private arbitration clauses in consumer services contracts, which allow large companies to avoid the court system and prevent consumers from joining together in class-action lawsuits.
The Herfindahl-Hirschman index (“HHI”) measures market concentration by industry and is used by regulators when reviewing mergers, values between 1,500 and 2,500 are defined as “moderately concentrated,” while values above 2,500 are defined as “highly concentrated”.
The US beer market has a high HHI of 2696, it is dominated by one large producer, whose current market share is 46%. The company recently made a large acquisition, but subsequently was forced by the Department of Justice to sell part of the acquired business as the combined market share of 70% would have resulted in almost monopolistic conditions.
At the turn of the 20th century, Teddy Roosevelt became president. He realised that for capitalism to maintain popular support, the monopolists and oligopolists of his time had to be taken on, and his presidency was driven by Trust busting. This set of policies looks set to re-appear.
The fund maintains short positions in airlines, banks, and certain consumer staples, primarily because we think that margins will remain under pressure due to the macro-economic environment and specific sectoral issues (please refer to Russell Clark’s Market views). These are not monopolistic sectors, however they are concentrated, should competition increase at some point, stock prices could de-rate even further.
Finally, here are Horseman’s Top 10 long positions as of this moment. Alas, the far more useful, top 10 shorts, are not public.
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