Russell Clark, investment fund manager at Horseman Global Fund, is testing numerous red lines. One of these tests is occurring regarding the fund’s second worst drawdown in history. As one of the more consistent market bears who voices a decidedly non-consensus viewpoint that, at times, points to impending doom. Clark, with US$1.9 billion under management, looks a black future in the face with an odd sense of humor. It is unknown if his British background growing up amid Monte Python might be cause for his holy quest: The search for a grail that is a stock market crash. In the Horseman Global Fund December letter to investors reviewed by ValueWalk, Clark, ending 2016 as the third worst performing investment on HSBC Hedge Weekly platform, explains his negative performance exposure by exposure. But in reality, just taking a look at the Long / Short ratio turned on its head and understand the gory picture.

Anecdotally, from looking at dozens of Q4 letters it appears most hedge funds made or break their year within just a few weeks at the end of 2016. Many long biased funds made the majority of their gains in Q4 and with short biased funds like Horseman  much of the downturn came towards the end of the year.

Horseman Global Fund
Horseman Global Fund

Horseman Global Fund is not emotional about his politics and it doesn’t impact his gloomy worldview

The visual on the top banner of the Horseman December letter says it all. A bull’s horns gouging the matador, with a left horn tip apparently on a trajectory to impale a rather personal body part. This describes Horseman’s year: down -24.03% for 2016, and 7.81% in December on Trump trend aftermath, Clark has been mutilated by a market bull that some fund managers are saying defies logic.

In the wake of the Trump rally that some managers bet with and some against the surprise victory. George Soros, for instance, proved that some fund managers have a high correlation between their political persuasion and performance. Violating a rule about emotion guiding trading decisions, Soros possibly let his attachment to a political cause apparently influence his market outlook. How could anyone think a Trump win would correlate to a market rally? He wasn’t alone among Democrats for being in shock and having a violent emotional reaction. Soros, like Carl Icahn and former associate Stanley Druckenmiller, all bet on the election. Soros lost nearly $1 billion, the other two profited.

Clark, however, isn’t a bear due to the election of Trump based on political ideology. Reading his analytical prose, he was expecting a market crash due to other issues. The Trump election, he says, has changed the market focus. The extensive short positioning protecting against a China crisis reversed in the election’s wake. Clark isn’t so much rooting for one side or another, but rather pointing to changing market trends and how this caused the fund to drop in value so precipitously in December.

Clark expects China to have a currency or financial crisis, potentially with both occurring simultaneously, a logical correlation thought given the correlation among fundamental performance drivers. In the wake of the crisis, Clark molds his somewhat apolitical view into a trade. Clark is preparing for a Chinese crisis noting that he is closing shorts to make room for shorting more Chinese financials. Deflation will follow, with the commodity markets being particularly hard hit. Clark is using cause and effect-based modeling at and has logical if / then dots connected. The most significant input variable, however, is the trade timeframe. When will this loudly predicted China crisis occur? Therein lies the real strategic challenge.

Specifically, Clark states:

One of the reasons that I run the fund the way that I do is that I do believe that a Chinese financial or currency crisis (probably both at the same time) seems inevitable. The implications of this to me have been that commodities would do badly, deflation would become prevalent, and exporters to China would suffer. Given the unreliability of Chinese data, I feel it right to be bearish on China as long as its banks continue to trade sideways to down, as they have done since 2011.

Horseman Global Fund – Far from alone in sharing concerns over the world’s largest controlled society entering the “free world”

Horseman Global
Horseman Global

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Clark’s moment of insight came from looking at China. He believes a China crisis is coming, it’s just a matter of time. The trade concept is often the easiest for a strategist to nail. The thesis a China crisis is coming is based on both statistical and fundamental analysis. It’s the timing that is always problematic with predicting doom.

Clark isn’t alone in the camp of those questioning a country that combines free market and central planning as if the contrary concepts can exist together in harmony. Other fund managers look to both a social and statistical trends to bolster the China crisis thesis.

Documented talk among fund managers, through letters to investors and research, is that a free market yuan currency price adjustment is going to be interesting to watch as central planners have historically defended the yuan 7 in markets like the military now defends the East China Sea.

Furthering bolstering the China crisis conversation is a property bubble that can be documented to rival Manhattan in certain select Chinese locations. This comes as homeowners are outwardly looking for methods to take out money out of their homes after dramatically rising prices. They appear to have seen the 2008 US financial crisis and have learned capitalist lessons from it. Horsman’s REIT exposure is instructive in this regard. He predicts that high-flying Japanese REITS could be particularly hard hit, having to cut dividends as fund sell-downs are expected. Horseman falls in line with the likes of Julian Robertson, who has also warned on the investment product.

Specifically, Horseman Global Fund states:

Self-storage REITs outperformed other REITs last year. This segment is sometimes called ‘recession-resistant’, as people who lose their jobs and move into smaller apartments can be tempted to use self-storage facilities. Self-storage landlords have the upper hand when dealing with non-paying tenants, if the tenants don’t pay up, the landlords can auction them off. Most people have a natural tendency to hoard and are unwilling to discard the objects that they don’t use. Global urban population growth has helped, as people moving into apartments no longer have the luxury of a garage, attic or basement.
However, there has been a boom in construction in the US, which increased from about 240 units per annum in 2011 to more than 2,100 at the end of 2016 (source: US Census Bureau). As a result there are roughly 2.5 billion square feet of self-storage rentable space in the US, an area more than three times the size of Manhattan island. Almost 10% of American households already rent a unit. (source: Self-storage Association, 2015).
Since November last year rents started to slightly decline across the US. In Dallas, Boston and Denver they fell -4.6%, -2.6% and -4.3% respectively in December. (Source StorageSeeker.com).
We don’t see self-storage REITs as recession resistant assets. Strong growth in supply is likely to drive rents down, and investors should remember that without the ability to retain earnings REITs rely heavily on capital markets.
The Bloomberg Storage REIT Index fell by some 25% between March and November last year, it rallied after the US election but finished the year down 8.7% (5.7% including re-invested dividends). During the month we reduced some of our short REITs positions, but remain negative on the self-storage and commercial segments.

Fund managers might look at these interesting oddities and compare it to the statistical analysis, which documents price appreciation that moved well past historical averages and a flagging trend in lower monetary growth.

In part, this larger China crisis is what Clark was waiting for. It hasn’t come… yet. But Clark is quick to note that his specific strategy worked well leading into Brexit negativity, up 9.82% in June 2016. But the Brexit bounce that oddly occurred immediately following the sell-off led to the fund giving back nearly 70% of June’s bounty in two months.

From a stock standpoint, those who export to China would be most hard hit, which in part explains his portfolio exposure. The fund’s betting against the market, benefiting when stocks would go lower, subtracted 30% from the fund’s performance. The fund’s long and certain noncorrelated exposure was additive.

Clark likes to explain his performance based on idiosyncratic events. But looking at how the dial on the Long / Short ratio is set tells the story to a large degree: it is almost exactly reverse the traditional equity Long / Short ratio at 26.79% long and 119% short stock. For “diversification,” the fund had a gross long bond position of 53%. While Clark’s detailed account of portfolio positioning relative to the China crisis is interesting, looking at those high level statistics provides a quicker glimpse at performance causation.