Hugh Hendry, CIO, Eclec­tica Asset Man­age­ment, has recently pub­lished his invest­ment out­look for August 2009. Since the Sum­mer of 2008, Hendry has been a strong pro­po­nent of defla­tion, and con­tin­ues so, even though his the­sis has been get­ting a thrash­ing lately. Hendry has dis­cussed invest­ing in long bonds fer­vently in the past, but had no choice in Late March to recon­sider his posi­tions and sell them off, as yields on long term gov­ern­ment paper started to climb sharply and the recov­ery rally of the last 5 months began to take shape. Hendry's flag­ship fund was up 40% for the cal­en­dar year in 2008, and most of that came from his bets in long term gov­ern­ment bonds.

We would note that Hendry is the first to pull the plug when he is wrong in the short term, as he did in March-April. He is no buy and hold investor, nor does he wish for the econ­omy to enter a depres­sion, but he does feel that it is inevitable given the debt defla­tion that he believes is ahead. One of Hendry's main asser­tions is that it will take many years for the devel­oped world to cor­rect its over-indebtedness.

Hav­ing said that, here are the first 4 para­graphs from his letter:

Good peo­ple are becom­ing des­per­ate. I know a man who is plan­ning to capit­u­late and buy stocks. He can­not com­pre­hend what is hap­pen­ing today. He is, to employ Churchill, a fanatic; he won't change his mind and he can't change the sub­ject. But, fear­ing the loss of his fran­chise, he will change his port­fo­lio. He laments that it is as though last year's events never hap­pened. Rhetor­i­cally, he asks whether we have all been sent through time to invest in equi­ties at the end of the 1970s when stocks were cheap and soci­ety had thor­oughly delever­aged (the oppo­site of today). "Why do other investors not con­tem­plate the prospect of fur­ther house­hold delever­ag­ing when build­ing their profit fore­casts?" he fumes. "Can they not see that the pri­vate sector's delever­ag­ing is more than off­set­ting the pub­lic sector's expan­sion?" Despite such rant­ing my Min­skian friend remains a most enter­tain­ing and charm­ing individual.

Now I know I have not cov­ered myself in glory these last few months. Stock mar­kets have gained 50% from their lows and the Fund has lit­tle to show for it except a mod­est rever­sal and no wild swings in our monthly NAV. Nev­er­the­less, I would con­tend that this game of play­ing "chicken" with the mar­ket is not for us. Our ambi­tion has been mod­est. To sur­vive the onslaught of a pos­i­tive change in social mood with­out being forced to capit­u­late in the face of a frenzy of opti­mism; so far so good, I think?

In this regard we have been helped immensely by a quote from Robert Prechter in early April. Hav­ing cor­rectly called for a counter-trend rally in stock prices in late Feb­ru­ary, he then described the most likely nature of the advance, "...regard­less of its extent, it should gen­er­ate sub­stan­tial feel­ings of opti­mism. At its peak, the President's pop­u­lar­ity will be higher, the gov­ern­ment will be tak­ing credit for suc­cess­fully bail­ing out the econ­omy, the Fed will appear to have saved the bank­ing sys­tem, and investors will be con­vinced that the bear mar­ket is behind us."

So far his prophecy reads well. It is rem­i­nis­cent of Warburg's line that the busi­ness cycle is "a sub­ject for psy­chol­o­gists" rather than econ­o­mists. Bernanke is already being com­pared favourably with Vol­cker. Con­ti­nen­tal Europe has appar­ently "escaped" from reces­sion. Pos­i­tive eco­nomic growth across the world for the remain­der of the year seems cer­tain. And yet Prechter went on, "Be pre­pared for this envi­ron­ment: it will be hard for most investors to resist. But beware... [the next move] will be the most intense col­lapse in stock prices"

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