We have followed Hugh Hendry, the outspoken and bold CIO of Eclectica Asset Management, and one of the few profitable absolute return hedgies during the last 12 to 18 months, as he built his high conviction case for deflation, and invested as such, in long dated government bonds, Gilts and 30-year US treasury bonds. Last year, it was Hendry who pointed out that 10-year US treasury bonds were signalling deflation, and that in a sea of risky assets, they were the only asset that was up, and up by 15%, while stocks declined in value by 20% or more, the first half of 2008. Falling interest rates, a flattening yield curve, which came as a result of investors flight from risk in equities and commodities, paid off, with Hendry ending the year up some 40% in his flagship Eclectica hedge fund.
In the months since the beginning of March, however, his thesis has been challenged by the market's renewed embrace of inflation risk, and stocks recovered off brutal lows, as a result of the deemed "risk" trade. By April, Hendry, who is not known for being a buy and hold investor, despite his standing beliefs, reduced his positions in long duration government bonds, treasurys and gilts in the short term, challenged by yields returning to last year's levels as the economic "green shoots" teased.
We recently posted Hendry's June 2009 letter to investors in which he re-iterates his view on inflation/deflation, and explains in fair detail that rough waters lie ahead for stocks and commodities as a result of the markets' over-anticipation of the effects of the whirring central banks' printing presses. He has avoided investing in stocks for most of the last year, making almost all of his fund's returns from owning long duration government securities.
Hendry, an avid market historian, believes it possible that we have already experienced the very inflation and hyperinflation the market fears, during the 2002-2007 period where creditor nations (BRIC) amassed enormous forex reserves in the trillions, while gold broke out of a 27-year trend and oil skyrocketed to $147 per barrel. In yesterday's interview, he also points out that during in the last 7 years the US dollar lost 40% of its value, an occurrence which is often overlooked or underplayed, but that he calls unprecedented. He explains this view in yesterday's CNBC interview. As usual Hendry's clarity on the matter is enlightening, as he has a mastery of the complexity of currency effects arising from carry trades and currency crosses.
One year ago, Hendry warned the Hungarian finance minister that the Hungarian economy, and others like it in Eastern Europe, which were financing their growth with Yen and Swiss Franc crosses and/or carry trades, would be unable to keep up with the spectre of cyclical currency fluctuations which could rapidly destroy the monetary liquidity they were awash in during the "strong Euro" era.
Click play to watch the June 29, 2009 interview:
CNBC: Fears about inflation and hyperinflation could create another economic downturn, bigger than the one the world went through, Hugh Hendry, chief investment officer at hedge fund Eclectica, told CNBC Tuesday.
The stock markets are due for a correction after having risen dramatically this year, but this is not likely to come in the summer and another rally is possible, Hendry, who said he was remaining risk-adverse this year, told "Squawk Box Europe."
"We have a huge intellectual conviction… that this is a more profound downturn that we're experiencing and markets will be under pressure," Hendry said.
"People get more get more concerned about government debt… and it sows the seeds of its own destruction," Hendry said. "We're actually tightening the screw, we make monetary policy tighter and tighter."
Long-term yields on government bonds have been rising, as investors fear central banks, especially in the US and the UK, will have to absorb excess liquidity from the system and raise interest rates to fend off inflation once an economic recovery takes hold.
"I think this paranoia today that inflation is happening today I think it puts in place a motion for a decline in the economy," Hendry said. "I think they're not printing enough money… with regards to the wealth destruction that has been happening over the past 18 months."
"We raised interest rates and actually we killed the golden goose," he added.
Stock Market Correction
A correction in the stock market is likely, but it will not come over the summer, and the S&P 500 index may even hit 1,000 before the downturn, according to Hendry, who admitted he is not stepping in to catch the tail of the rally.
"It's kind of fun watching it from the sidelines, I must say I'm not participating," he said. "My flower opens in the winter, not in the summer."
There is a tight correlation between the oil price and the Chinese currency, the yuan, with oil prices rising as the yuan was strengthening, Hendry said. This is because Chinese speculators had borrowed in dollars as the yuan firmed, and all that liquidity was thrown into the oil market last year.
"The one non-confirmation in the world is that, since July, the Chinese currency has done nothing, it was flat vis-à-vis the dollar," he added.
Hendry said he still prefers conventional government bonds, and admitted they were the cause his fund was 3 to 4 percent down on the year. But, he added, government bonds were down 20 percent – although he doesn't think they will end the year like this.
China and other countries with a current account surplus are not as safe as they seem at first glance, because their economies are still hugely dependent on exports to the US, which is still "down on its luck," he said.
"If that's the case, the last place you want to be is the surplus countries," Hendry said.
Source: CNBC, June 29, 2009
http://www.cnbc.com/id/15840232/?video=1167997692&play=1
