Submitted by Dominique Dassault via Global Slant.com blog,
Headline:
Hendry’s Convoluted Doctrine Boils Down To…If You Can’t Beat ‘Em…Join” ‘Em…NOT!
I do not personally know, high profile hedge fund manger, Hugh Hendry but his recent investor letter is both fascinating and troubling. His letter examines the contemporary investment conundrum confronted by all long/short money mangers. Take a gander thanks to the folks at Zero Hedge:
http://www.zerohedge.com/news/2014-12-31/hugh-hendry-embraces-central-planning-matrix-i-am-taking-blue-pills-now
Hendry, generally, believes that global central banks’ money printing policies are doomed to fail and the worldwide economy will pay a steep price in the future. AGREED. He also suggests that the timing of the grand, negative economic impact is impossible to precisely predict. AGREED. Therefore, in the meantime, as long as central banks keep printing money and suppressing interest rates [the strategy that Hendry assigns for his gloomy long term economic outlook] he is long the equity markets- DISAGREE BIG TIME – based on, in my opinion, Hendry’s core belief = The Theory of “Greater Fools”. This is a wildly dangerous [yet nothing new], and controversial, market belief…and, therefore, worth examining.
What is the Theory of “Greater Fools”?
The current premise is that global equities markets will rise regardless of economic fundamentals. Money must flow into equities [perceived as the only asset class capable of producing “acceptable” returns] because the alternatives offer virtually no return…with interest rates pinned near zero in most western economies. Just buy any equity [akin to dart throwing] and a “greater fool than you” will buy after your purchase, at a higher price, ad infinitum…thus ever increasing the asset’s value This is such an obviously flawed argument on so many levels…albeit, like almost any strategy, is surprisingly effective from time to time. Still…it is, ultimately, a long term losing strategy because nothing moves up forever [whether it be a balloon or equity prices]…especially when wholly relying on the “fools” behind you.
Complicating matters further is that this strategy is being employed, contrary to popular belief and a centrally banked driven six year suppression of volatility, toward the riskiest asset class [aka equities] at all time price peaks. Investors have shifted to a “risk on” profile…as the global central bankers [the new breed of investment advisors] desire. Investors [aka “The Herd”] are following the directive and “doing what they are told to do”.
And somewhat understandably so as fixed income returns of close to zero just do not “cut it” for most investors as they seek any decent return on their money [despite the historic risks associated with equities]. But equities are not a true substitute for bonds. Never have been and never will be. The historic risks of owning equities tower over the risks typically experienced by owning high quality fixed income. It’s like replacing your morning glass of orange juice with a tall glass of scotch and expecting the same biological effect. Still, it might feel good initially but later in the day you are sure to regret it.
Amazingly, and paradoxically, this riskiest of investments [equities] has, recently, not displayed any quantitative elements of risk…further raising these already dangerous stakes. The “happy potion” [applied by global central bankers] poured over global equities has virtually extinguished most investors’ mere thought of “perceived risk”.
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Consider the Following Price Data of the Past 31 Trading Months:
1. The S&P 500 has advanced for 25/31 months.
2. The largest peak/trough capital draw-down is 9.8% while total returns = 56.05%.
3. Sharpe Ratio of S&P 500: Measure of Risk Adjusted Returns > 2.0.
These are historically staggering statistics…especially for the riskiest of asset classes. The “topper” is that all of this data “stands on the shoulders” of a 96.51% gain in the immediately prior 3+ years. And, of course, the gains are primarily a function of central bankers flooding the global economy with freshly printed money [aka “liquidity”].
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Back to Mr. Hendry and his cleverly titled investor letter inversely referencing Theo’s [“The Matrix” protagonist portrayed by Keanu Reeves] preference to embrace the pain [the red pill] of reality/truth rather than to continue to live in a veiled world of fantasy/lies [the blue pill].
And how does Hendry rationalize his intake of the blue pill? I cut and paste from Hendry’s letter: So I have come to embrace the French philosopher Baudrillard’s insight. “Truth is what we should rid ourselves of as fast as possible and pass it on to somebody else,” he wrote. “As with illness, it’s the only way to be cured of it. He who hangs on to truth has lost.”
I am not certain is if this is more demoralizing or more defeatist. At the very least this relic-ed quote is surely shaking Ayn Rand’s grave site. Anyway…think about it. Is Baudrillard correct…or not? Do you really want to know the truth…or not? Can you handle the truth…or not? And then…what is the truth?
Do you prefer Theo’s red pill or Hendry’s blue pill? Most people, I believe, prefer a third option. A green pill that earns them money irrespective of market dogma. Sadly, that pill does not currently exist. The only choice is red or blue.
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So is Hendry’s current hypothesis the new paradigm to investment success in the world of long/short money management? That the truth does not matter…that following fools is really the best investment strategy…that the best solution to cure the debt laden balance sheets of most western economies is to have their own central banks simply print money to buy-back, and perhaps eventually retire/forgive, their own debt?
How absurd has all of this become that, even after six years of a stabilizing/moderately improving U.S. economy, bad news is still perceived as good news because it perpetuates the massively ineffective money printing tactics of global central bankers?
Or, conversely, is this the “invisible hand” of the market tempting Hugh Hendry with the forbidden fruit of short term profits after entirely harvesting/removing Hendry’s risk considerations over the past six years? And, no doubt, he has bitten deeply into this apple for all of us to see.
That somebody as shrewd and intelligent as Hendry has finally capitulated [after years of skepticism] to the money printing side of the investment equation speaks loudly to the pressures of long/short money management in this unadulterated bull run.
Because, to this point, being short/hedged/risk averse has been nothing “short” [no pun intended] of sheer agony and pain. The only thing worse than that pain is shedding your beliefs just before your hypothesis actually “plays out”…and you miss the downside “price action” you’ve patiently sought for years. That is the risk to Hendry’s strategy of which I’m almost certain he’d admit to.
Finally, I must say, it is difficult not to admire Hendry’s courage to publicly state his provocative strategy. He definitely has some “sack” and has surely selected the right business for himself but, in this case, I reluctantly do not wish him good luck.
