The following is from Hugh Hendry’s January letter to investors, a copy of which was obtained by ValueWalk. Hugh Hendry is bullish on equities as he sees Central Bank easing not going anyway anytime soon. The flagship global macro fund started the year off with a 7.3% return – thanks to some of his blue pills.
See Hugh Hendry’s full letter below.
Hugh Hendry The Triple Play
Last year’s resurgence in the Fund’s performance continued, if not accelerated, in January with a return of +7.3%. Our P&L pivot can be traced back to the unshackling of the US dollar last August as the Fed prepared to discontinue its QE program. We reasoned that in the absence of the Fed’s policy intervention, the global deflationary impulse would make dollars scarcer once more and hence more valuable relative to other currencies and that tighter US monetary policy could tilt incremental global GDP growth in favour of the rest of the world. Equities, especially in Germany, could catch up with their American counterparts and relatively high US nominal interest rates could participate in the global convergence to very low yields. This triple-play of long dollars (+ 2.4% for the month), long European, Japanese and Chinese stocks (+2.5% for the month), and long US Treasuries (+1.6% for the month) has proved very rewarding.
Doubts, derision and further uncertainty will not disappear overnight. The current worry knots of a macro manager consist of determining the scale of any financial reverberations should Greece be cast aside from the Euro or should the Fed follow through with what we would view as a questionable rate hike in June. However, such fears are widely known and for now do not seem to be interfering with the fortunes of the triple-play.
seeking capital; thankfully I have always been adaptable and of late I have found myself favouring equities as my principal source of risk capital once more.
I haven’t jettisoned government securities. Former Fed Chairman Bernanke was right: the risk of inflation from central banks expanding their balance sheets to buy sovereign bonds has borne little practical difference from their conventional open market operations which have never been subject to the same inflation paranoia. I think I got this call correct; we have persistently sought to profit from the disinflationary trend evident in fixed income markets. But today it is not our sole risk exposure.
Global Rate Convergence
When analysing interest rate markets, I take issue with the idea that QE compromised the market’s primacy in setting bond prices. Central bank bond purchases have certainly smoothed, one might argue distorted, the flight path of interest rates, but they haven’t changed the destination. Bond yields are where they are today owing to the stifling levels ofdebt-to-GDP in secure political economies like the UK, Europe, the US and Japan and the persistent decline in the marginal productivity of incremental credit which has left GDP growth struggling as entrepreneurs have lacked a sufficiently large profit outlet for their endeavours.
Where are today’s equivalents of the 19th century canals and railroad boom, the productivity revolution in America in the 1920s or the 21st century’s spectacle of China’s race to urbanise? Such investment projects promised initially very high returns on capital; nothing comparable seems imminent today. And in the absence of the next big thing, the demand for credit has sagged and nominal GDP growth rates have trailed historical precedents everywhere.
That’s why I believe we are in the midst of a global rates convergence to very low nominal yields. Remember when Japan’s JGBs were regarded as a grotesque aberration? Today they act as a magnet as other sovereign bond prices have converged in the absence of an abundance of high returns from private endeavours. In fact, amongst developed markets the 2% yield available in 10 year US Treasuries looks to be oddly generous when JGBs and Bunds yield less than 50bps, especially when priced in an appreciating US dollar. And that is why we have retained an exposure to fixed income within our portfolios.
The Bright Side of Slower Chinese Growth
However, we continue to see opportunities in asset classes other than Treasuries. In a break with previous crises, the middle classes in developed nations have struggled immensely. A meaningful swathe of this constituency, historically insulated from the forces of globalisation, have found themselves at the sharp end of wage competition and the threat of offshoring as the acceleration in the power of the connectivity of the internet as well as further advances in automation and robotics have made in-roads into previously untouched areas, even supposedly high-end services like the law and banking.
But perhaps of greater significance is the experience of the globally set prices of non-discretionary household items, notably food and energy, which until only very recently had not declined in proportion to the diminution of households’ income prospects. This was due to China’s immense stimulus in 2009 and the greater competition it encouraged from emerging economies for these basic goods. For the first time, western consumers were no longer the price setters and a recession no longer ensured that the prices of staples would reset downwards to protect real incomes.
A successful investor five years ago had to recognise just how close to a global depression we were in 2009. If anything, the expansionist central bankers in the US and Britain lacked sufficient vigour as evidenced by the relative, in historic terms, weakness of their ensuing recoveries; they arguably did too little rather than too much. Instead, one had to acknowledge that a depressionary crisis in 2009 was averted not just because of QE in the US and UK but also owing to the sheer scale of China’s fiscal stimulus. Despite making up just 7% of global GDP in 2007, China accounted for 35% of global GDP growth over the period 2009 to 2012. Today, it is most unlikely that the Chinese can repeat such a feat; they are no longer so isolated from the global system and their room for such aggressive co-ordinatedfiscal and monetary splurge is far less now that they are so indebted. Monetary policy loosening as per the rest of the world now seems a more likely response.
The good news however is that as emerging market growth has slowed, the competition for basic goods has abated and western consumers are now, at last, enjoying falling prices for
non-discretionary goods and their real incomes are expanding. This is a clear blessing for those economies that were first to boost their monetary policies and where employment levels have recovered sharply. And whilst challenges still remain for the heavily indebted developed economies who were slow to implement QE and now have to deal with the spectre of unanticipated deflation, I don’t think the risk is too great right now as their policy-makers are vigorously recanting their previous errors.
Iacta alea est (“The die is cast”)
Julius Caesar, as reported in Suetonius, Vita Divi Iuli
And that’s why January was such an epic month: global central banks rewired their monetary policy programs with the ECB finally crossing the Rubicon into QE land and with what seemed like rate cuts everywhere else as well as further negative rate experimentation on the European continent. With the lone, and pitiful, exception of Switzerland, the world’s monetary authorities swung decisively towards addressing the problem of global indebtedness; such bold policy actions at last improve the prospects for society’s risk takers. For the first time in what seems an age, it can be alleged that global monetary policy now “gets it” and with no prospect of rate hikes in the foreseeable future outside the US, equities appear the most obvious asset class for savers.
And lest any grumpy sadomonetarist from either the SNB or the community of discretionary global macro bloggers need reminding, Denmark’s central banking chief added for good percentile bands since 1988.
“There is no limit to how low rates can go and how large foreign currency reserves can grow…The message is that if it’s not enough, we will do even more…Either we can expand our balance sheet or we can go deeper into negative territory with the interest rates…We can go on forever”.
Forever? This is truly an astonishing time for macro investing…
As I see it, global monetary policy will now push all known boundaries in an attempt to generate the levels of inflation we witnessed in the west following WWII. However, success is not assured. I think it will require more and more accommodation; like the Danes, I think their room for intervention is underestimated by capital markets and that’s why equities are our largest risk component.
We have to remember that owing to previous inflationary calamities our societies have erected huge obstacles to prevent public officials debasing their coinage. They are going to have to huff and puff before they blow down society’s immense barriers for public policy induced inflation.
Thirty years ago our political economies began sanctioning 2% inflation targets for their central banks, and these arbitrary fixed mandates may well have been responsible for the previous tight monetary regime that has resulted in a world set adrift with disinflation. Arguably they held back the size of QE programs allowing considerable spare capacity to build. One only has to think back to the hysteria of 2010-11 when the Bank of England governor had to grovel for forgiveness from the British Treasury as reported inflation repeatedly exceeded the mandate. Under the highly unusual circumstances described above, commodity prices rose despite the severe recession in the west. Governor King was one of the few to recognise that the pricing anomaly arose from China’s $15trn credit pump and not incipient inflationary pressures within the British economy; his fortitude in not tightening prematurely is poorly recognised by commentators.
The task for public officials to generate inflation is also not helped by the sheer scale of public bond markets versus GDP. Hawkish investors have periodically seized the upper hand in the pricing of interest rates, tightening policy more quickly and effectively than any procrastinating central bank – the rapid surge in Treasury yields back in 2013 or since January this year being obvious examples which again make it harder for central bankers to pursue a policy of higher prices.
For this reason I would argue that the rational policy is for central banks to take inflation risks by maintaining policy rates at the zero lower bound. Why tighten prematurely like the Fed did in 1937 and be permanently cast in history as a wrongdoer when the markets will tighten policy for you? If I were a policy maker I would let the markets take the blame or glory: I simply see no reason why central bankers have to make the first move under such a regime. Time will tell.