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Being bearish with your portfolio will prove to be “very painful”, warns Hugh Hendry

04 November 2015

The former permabear star manager explains why panicking and holding a defensive portfolio in the current environment is likely to be the completely wrong strategy.

By Alex Paget,

News editor, FE Trustnet

The widespread pessimistic views on the state of the global economy and market have been massively overblown, according to Eclectica’s Hugh Hendry, as the former ‘permabear’ has firmly pinned his colours to the bullish mast by describing cautious positioning in the current environment as a “very painful” strategy.

The amount of bearish commentary on the state of global markets has increased drastically over recent months as fears of an economic meltdown in China and a recession in the West have been on the rise.

Certainly, after a sustained rally in risk assets following the global financial crisis (which many believe has only been driven by policies such as ultra-low rates and quantitative easing), equities have endured a very volatile time of it since April 2015.

Performance of indices since April 2015

 

Source: FE Analytics

On top of that, uncertainty remains rife regarding the future of the Chinese economy, weakness in emerging markets and tentative signs of a slowdown in the US.

In his most recent update, however, Hendry’s main point is that investors need to ignore this market noise. While he is largely renowned for his previously bearish views on the market (he was once dubbed as one of the many ‘Dr Dooms’) he says taking such a cautious view now will only hurt a long-term investor.

“Angst is perhaps the true disease of the 21st century. Cancer and diabetes will most likely be cured in time but anxiety seems more deeply rooted in the human psyche,” Hendry said.

“In markets, of course, it can be useful, especially if you become anxious before others; I have some good form here. Indeed, it is ironic that I am perhaps best known for advising ‘that you panic’. However, if you are anxious at the wrong time it can prove very painful.”

He added: “Today, I would advise that you don’t panic!”

As mentioned earlier, Hendry used to be among a small group of high profile fund managers who were very vocal critics of the market and its apparent distortions – and this mantra served his investors well during the most severe index falls.  

His hedge fund famously made more than 30 per cent in 2008, for example.

Hendry drastically changed his stance in November 2013, though, when he moved his CF Eclectica Absolute Macro fund into a far more aggressive position as he didn’t want to continually bet against the rallying market.

The trade, and the fact he relaxed his absolute return fund’s risk parameters, didn’t work well for him over the first year as equities struggled and fixed income flourished. However, as the graph below shows, his fund has more than doubled the MSCI AC World index since the sell-off in autumn 2014.

Performance of fund versus sector and index over 2yrs

 

Source: FE Analytics


 

Despite his fund’s recent falls though, he says investors shouldn’t buy into the bearish argument (which is championed by star managers such as Bruce Stout, Iain Stewart and Sebastian Lyon) about the state of the current market.

In an article last year, FE Alpha Manager Iain Stewart told FE Trustnet that very easy monetary policies meant the market was hugely distorted and that some of the biggest bubbles in history were being created.

“Basically, [central banks] are tackling huge amounts of debt with more money. This will inevitably create a bubble. The problem is; there isn’t a ‘plan B’. If all this QE doesn’t work, they will just have another bout of it,” Stewart said.

“These guys actually believe that these policies can work and unless they junk these, basically, religious beliefs about QE, it is going to continue.” 

Hendry, on the other hand, believes this is a very naïve way of thinking about the market and the wider economy.

“Today’s grumpy bears allege that our central banks have been adding funny stuff to the world’s money supply via QE and have polluted the sanctity of the market pricing mechanism. As a result we have (too) high asset prices despite low growth and no inflation.”

Performance of indices since the global financial crisis

 

Source: FE Analytics

“In this pessimistic interpretation of the global economy the biggest complaint is the incapacity of central banks to raise interest rates; they have now been kept unchanged in the US for longer than during the Great Depression,” Hendry said.

“If only those dastardly public officials had not averted a 1930’s style policy of mutually assured destruction, when the world’s monetary authorities stuck rigidly to the mantra of ‘hard-money’ to the profound detriment of the real economy.”

“Then, so they reason, we could have had the cathartic effects of a depression and by now, seven years later, a recovery would be in full swing, signs of inflation would be emerging and we could start raising interest rates … we would be saved!”

Nevertheless, Hendry points out many macroeconomic presentations continue to paint a very gloomy picture with the manager likening them to “the pages of religious pamphlets and science fiction novels which overwhelmingly present a future that is mainly worse than the present”.


 

For example, thanks to the recent price swings, signs of weakening economic growth and widening of credit spreads which have occurred during recent months, certain managers warn that the current market is looking increasingly similar to backdrop presented to investors in 2007.

Performance of indices between Jan 2007 and March 2009

 

Source: FE Analytics

Columbia Threadneedle’s Mark Burgess said last month: “Depending on one’s starting point, we are now some seven or eight years on from the start of the global financial crisis.”

“For what it’s worth, my reference point is the HSBC profit warning in February 2007 when it cut its profit forecasts. Even if the crisis didn’t really start with a vengeance until 2008, history would suggest we are closer to the start of the next downturn than we are to the end of the last one.”

However, Hendry says there is one major reason why market chaos is not on the cards.

“For markets do not crash when we are collectively so worried,” he said.

“In my mind it is as though QE and the zero lower bound of policy rates have replaced the capital markets’ airbag with a dagger protruding from the steering column. Market participants are hugely uncomfortable with today’s elevated prices and the lack of an obvious orthodox policy response should the global economy weaken further.”

“Unsurprisingly there is little appetite to drive fast and the brakes are applied at the merest hint of danger.”

Therefore the manager – who has more than tripled the returns of his peer group composite since the turn of the century – says he will continue to run a more aggressive portfolio which is skewed towards equities.

“The market’s fear of crashing has seen it thrash around looking for the merest hint of danger. First it was Europe, then the high yield credit space with the vulnerabilities of the shale oil issuers, and then it was back to Greece and then the mother of them all, China, with its falling property and stock prices seemingly knocking economic growth and making a sizeable devaluation inevitable.”

“And yet nada… the weeping prophets have failed to force a crisis after one hell of a go.”

 

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