Morgan Creek Capital Management letter to investors for the fourth quarter ended December 31, 2015.
Morgan Creek Capital Management – Fourth Quarter Review
We opened this section of the letter last quarter with a comparison of Q3 equity market activity to a roller coaster ride and wrote “summertime is often a time for heading to the Amusement Park to spend some time eating great American foods like hot dogs and cotton candy, playing carnival games and riding the rides. Q3 was the embodiment of the proverbial roller coaster ride for global equity investors as fears about Greek Debt and Capital Controls, the PBOC’s (People’s Bank of China) decision to weaken the RMB and the Fed’s inability to communicate a cogent plan for beginning to raise the Fed Funds rate in the U5. caused significant volatility in global equity markets.” Perhaps it was the impact of El Nino that kept summertime temps around a little longer, or maybe it was the inability of any of the Central Banks to effectively communicate solutions to the issues mentioned above, or perhaps the equity markets were just finally getting the message from weakening credit markets and beginning to anticipate a global slowdown; whatever the reason, the roller coaster ride continued in Q4 and the Beach Boys Endless Summer soundtrack became the theme music for global investors. The Sell in May and Go Away challenges are supposed to end by Labor Day and, actually, it did appear as we penned the last letter that things were looking up for equity investors, as a ferocious October rally was leading to lots of talk about the impending Santa Claus rally and getting back to new all-time highs. However, the carnival ride was not quite over and the last three months have been more Anti-Claus than Santa Claus. After a flat November followed by a slightly negative (highly unusual) December, the New Year ushered in the worst first week in U.S. equity market history and the 9th worst January of all time in the (interestingly tied with 2000 – more on that later).
Morgan Creek Capital Management – The Global Equity Roller Coasters
Let’s take a quick tour of the global equity roller coasters over the past three months. In the U.S., the S&P 500 started off on 10/31 at 2,079 and had a quick series of whoop-de-dos, rising 1.5% to 2,110, falling (4.1%) to 2,023, gliding back up 3.9% to 2,102 and falling (4.6%) to 2,005 on 12/18 (two days after Ms. Yellen finally went full Lucy and raised rates). The markets reacted with an inverse “Sell the Rumor, Buy the News” reaction and pushed the coaster up the last hill of the year to peak at 2,078 on the 12/29 before the fun really began. The real thrill ride started the next day and the S&P careened almost straight down for three weeks, falling (12.8%) to an intra-day low on 1/20 of 1,812 when, out of nowhere, some able-bodied Carnie pulled an emergency brake and the coaster surged back upwards 2.5% to close the day at 1,859 and then rose another 4.4% (inclusive of a short squeeze induced up 2.5% on 1/29) to finish the month at 1,940 (to complete the ride down only (6.7%) over the three months). Perhaps someone knew that Super Mario Draghi would (once again) say he would “do something” on 1/22 and extend the ECB QE Program beyond 2016, or perhaps it was Pierre Andurand switching from Bearish to Bullish on Oil the day before (allowing oil to find a temporary bottom at $26.55 and surge 26% over the next week), but clearly something changed and the panic subsided (at least temporarily). The Euro Coaster was even a little scarier as the Euro Stoxx 50 started the ride at 3,418 and climbed a small 2.6% to 3,506 on 11/30 before plunging (10.5%) to 3,139 by 12/14, jumped smartly after the Fed decision, rising 5.6% through year-end on 12/29 before careening back down (13%) to 2,883 by 1/20 and has since jumped 5.6% back to 3,045 (including the final day rise of 2.2%, still down (10.9%)). With two double digit drops and a double digit decline over the three months, something doesn’t seem right on the European track. The Samurai coaster was even more extreme as the Nikkei began at 19,083 and crept up 4.9% to 20,012 by 12/1 before dropping (7.2%) over the next two weeks to 18,566 on 12/ 15, then quietly rose 4.3% over two days before careening down a truly motion sickening (17.2%) to 16,017 on 1/21. On roller coasters, bigger drops mean bigger rises and the Japanese ride followed the pattern surging 9.4% over the last few days of the month (including an up 2.8% last day) to finish at 17,518 (still down (8.2%) from three months ago). Nearly as scary as Japan was the Emerging Markets ride where EEM ended October at 34.4, rose a slight 3.3% to 35.5 to 11/3 and started a very bumpy downward ride, dropping (7%) to 33 on 11/ 13, a short ride back up 4.7% to 11/20 and then zipped down a big hill falling (10.2%) on 12/11, surged 6.6% back to 33.1 over two weeks to 12/23 before being the first market to begin the big drop, zooming down (14.7%) to trough along with everyone else on 1/20 at 28.3, before jumping 8.2% (up 3.2% on the last day) to finish the month at 30.6 (an uninspiring (10.8%) lower than where the ride started on Halloween). However, the award for scariest coaster goes to China this time, as it has been a wild ride indeed over the past few months. Sentiment about China has shifted at an incredible rate as concerns about the risks of an RMB devaluation overwhelmed slight improvements in economic data. The Shanghai Composite Index (“SHCOMP”) started off at 3,383 and was the calmest ride around for most of Q4 as the index rose 7.8% to 3,648 on 11/25 before a sharp two day drop of (5.8%) to 3,436 and then resumed the calm ascent back up 6.3% to 3,652 on 12/22. Just when things were looking good for Shanghai riders, the PBOC suddenly moved the RMB peg ever so slightly (only about 1%), but investors panicked and the coaster swooped downward a truly frightening (27.3%) over the next five weeks to trough at 2,656 on 1/28. The SHCOMP did actually participate in the 1/29 global melt-up and rose 3.1% back to 2,738, but the Index finished January down (19.1%) over the past three months.
The continual ups and downs of the equity markets over the past year might give one a sense of deja vu and when looking at the ride of the equity markets above, that sense grows very strong (and is actually quite appropriate) given how 2015 has been extremely similar to 2011. We wrote about the similarity between the two years in our last letter when discussing how Super Mario had come to the rescue last fall (just as he had done four years ago). We described the fragility of markets after the August collapse and said “things were looking a little precarious. Then in a very deja vu moment harkening back to 2011 (it has actually felt like 2011 all year with Greek Crisis 2.0), Mario “Whatever it Takes” Draghi threw the Bulls a lifeline and said that the ECB would increase their QE program within the next six months.” It was quite interesting to watch the full spectrum of sentiment in real time during September, as investors celebrated the ECB commitment to keep the liquidity spigot turned on (markets surged) and then panicked when QEeen Ianet decided not to raise rates later in the month (markets dropped). In an almost schizophrenic crescendo, global equity investors then abruptly (and collectively) changed their mind and we described the shift (and the eerie similarity to 2011) as follows; “Investors then began to decide that the Fed not raising rates was actually a good thing (meant multiples could expand a little more since sales and EPS keep falling) and equity markets around the world went up nearly every day in October, pushing gains to the best month in since, you guessed it, October 2011. The similarities with 2011 are amazing, in both years the market peaked in May, had an initial trough in August and then had the final bottom 5 days apart, September 28’h this year and October 3rd in 2011. In 2011, the S&P 500 rallied 14.5% from the October bottom and so far in 2015 the Index has rallied 11.5% of the bottom.” The balance of the years in 2011 and 2015 were very similar for the S&P 500 with both years having another downturn and a final rally to finish the year essentially flat. 2011 was precisely flat, (up 2.1% with dividends), while 2015 was down (0.7%), (up 1.4% with dividends). The similarities didn’t stop with the S&P. The Russell 2000 was nearly identical, falling (4.2%) in 2011 and (4.4%) in 2015. International equities lagged the US. (although not as badly in 2015) with EAFE down (12.1%) in 2011 and only (0.8%) in 2015 and it was a very similarly challenging year for Emerging Markets with the EM Index down (18.4%) in 2011 and (14.9%) in 2015. There were two notable differences, however, NASDAQ was down (1.8%) in 2011, but FANG (FB, AMZN, NFLX and GOOGL) held the Index up in 2015, rising 7% and (most notably) the bond market returns were vastly different as the Barclay’s Aggregate Index was up a very strong 7.8% in 2011 and only managed a scant 0.6% gain in 2015. Mark Twain famously quipped that “History doesn’t repeat, but it rhymes” and 2015 was clearly singing out of the 2011 capital markets hymnal.
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