Horseman European Select Fund letter for the month ended March 31, 2016.
The Amazon rainforest is certainly an ecological wonder of the world. During a brief visit, I experienced first-hand what it had to offer. We were armed with the strongest mosquito repellent, ice-cold drinking water, raincoats and the recommended footwear but nothing could have prepared us for such a harsh environment. Despite having all the protection against its many different elements, the power of this natural habitat made spending even a very short time there a feat of endurance. Even with our best efforts, the mosquito bites, the thick mud ingrained in our clothes and near 100% suffocating humidity proved that this ecosystem was simply more powerful than us mere mortals and impossible to overcome.
Concerted and extremely proactive actions by central banks to generate inflation can be likened to my experience in the Amazon Rainforest. Your Fund has been trying to monetise central banks’ ability across the world to boost asset prices and generate inflation. These actions are now clearly not working and this quarter’s Fund performance is proof of this. As with attempts to protect oneself against the elements in the rainforest it is now clear to me that current policies being used by central banks to fight against this period of deflation have become counterproductive and the deflationary forces are simply too powerful to overcome.
In March, your Horseman European Select Fund failed to monetise the most recent action by the European Central Bank (“ECB”) and could not hold onto its strong gains early in March. All central bank interventions are now being greeted by failed moves in currency markets and a more deflationary outlook by bond markets. I believe we are close to a period in time when central banks in Europe and Japan are starting to recognise that their policies, intended to generate inflation, are now destroying the very fabric of capitalism. For capitalism to truly work central banks will most likely have to concede defeat and stand back from printing money and allow capital to be destroyed and for capacity to be finally taken out of industries. Once this is done, only then will inflation be allowed to reenter the financial system. Given this more structural ingrained deflation backdrop, your Horseman European Select Fund is now liquidating its long exposure and will now most likely move to a net short equity position. We will direct our resources into industries that are experiencing the most deflationary forces and will use the forthcoming earnings releases to scale the trade.
Horseman European Select Fund – Consolidation in the Italian banking system
The latest round of consolidation in the Italian banking system has also raised our concerns about the credibility of the Asset Quality Review (“AQR”) test results. These “thorough” tests effectively drew a line under the amount of capital banks would be required to hold against their nonperforming loans. For the recent merger of Banco Popolare and Banca Popolare Milano to be given approval by the ECB they requested (we believe in the middle of March), that Banco Popolare raise an additional Euro 1 billion of equity. The ECB is now effectively signalling to the market that they now want Italian banks to sell their non-performing loans at a more rapid rate and so take bigger losses. This to me removes all the credibility of the AQR test and creates many new question marks over the ECB’s future intentions around all non-performing loans in Europe. In our minds the unintended consequences of these actions will only cause European banks to de-risk their balance sheets further and so slow down future economic growth. The current policies of the ECB and the evolving political landscape in Europe are making investing in its banks and its recovery much more unpredictable.
The last quarter has been the most difficult period that I have ever had to manage capital. There has been so much dispersion of performance across different sectors of the stock market, along with conflicting global economic data points. This dispersion and increased volatility, seems to me indicative of a bear market in equities and is one we will now look to optimise and monetise. Shifting the exposure in the portfolio is always a difficult time but we feel our actions are now warranted. Bond markets are firmly pointing to deflationary forces remaining in the financial system for a prolonged period of time. New themes will be developed to take advantage of these trends.
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