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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