This article was originally published on Valuewalk.com by Mark Melin. For additional behind the scenes insight, see additional commentary provided at the end of this post.
One of the world’s most bearish hedge fund managers, Crispen Odey, had yet another dismal month in April, a letter to investors reviewed by ValueWalk shows. The OIE MAC strategy, with $852.7 million under management, was down -5.4% (USD class) and -8.5% (GBP B class) on the month. But perhaps what is most notable is a timing mistake Odey makes in the letter, highlighting just how difficult a crash prediction is to make and remain committed.
The Germans stopped their advance on Moscow on December 5, 1941
Odey’s April 2017 missive that seems longer than it actually is. Perhaps this is because he sounds a familiar theme: the world is going to come crashing down, and when it does, Odey investors will profit.
With year to date performance at -9.9% and three-year performance at -55.5%, the basic message of the investment thesis hasn’t changed much, only the way in which the mounting losses are described to immensely patient investors seems to adjust.
To describe his position, and explain why he remains “stubbornly bearish,” Odey harkens back to one of history’s greatest military defeats: Germany’s failed attempt to take the Russian capital of Moscow in 1941:
In 1942 when Hitler’s Germany was at the gates of Kiev as well as Moscow, and Britain was on its own just surviving, Todt, Hitler’s Minister of Supply, startled Hitler by saying that the German war effort would stall. For his prescience he disappeared a week later when his plane fell to earth unexpectedly. But what he could see was that the lines of supply were at breaking point. Success was the necessary ingredient of failure.
Not to quibble, but Odey has his timing a little off.
Kiev was taken months before the attempt to move on Moscow and German troops were not simultaneously “at the gates,” they were already in Kiev in 1942. What’s more, t was not 1942, but the end of 1941, that the Germans stopped advancing on Moscow. German general Heinz Guderian, leading the charge, wrote in his journal “the offensive on Moscow failed … We underestimated the enemy’s strength, as well as his size and climate. Fortunately, I stopped my troops on 5 December, otherwise the catastrophe would be unavoidable.”
The Soviets then launched a major counteroffensive and the retreat started, with the Japanese attack on Pearl Harbor two days later bringing the US into the war. With the Germans in retreat, Fritz Todt, in charge of all armaments that failed during the cold of December 1941, met with Hitler in February of 1942. After that meeting, his plane crashed, with suspicions of sabotage being voiced. Albert Speer was later named head of German arms production.
Such a slight timing error may seem like nitpicking, but there is an important Odey investment strategy point to consider.
Odey has a logical investment thesis, it is the timing that is so difficult
Odey’s primarily investment thesis isn’t that illogical. It rests on several premises, but there is one component, timing, that he seldom addresses but should. In fact, the slight mistake made in providing a history lesson is endemic of a major issue with such market crash predictions.
The first leg of the thesis is that the current economy is built on debt to a degree never before witnessed in history. “What got the developed world into its crisis in 2008 was ‘large widespread borrowing by individuals who could not repay their debts’ and now what has got us out of our crisis, is luckily, ‘large widespread borrowing by individuals who could not repay their debts.’”
He looks at the current subprime lending crisis as an example:
Subprime lending both facilitates and is driven by employment. Lend the man the loan for his car and the demand induced gives him the job that keeps the payments current. When that goes into reverse, and from a position of full employment it can only go one way, the consequences are easy to see.
There has been a valid debate about the role debt plays in artificially pulling demand from the future forward. The thesis on this concept is not in question as much as the timing, a point he doesn’t so much address.
The correct assessment of timing comes into play regarding other pillars of the Odey thesis. Odey looks at China, which recently received a downgrade from Moody’s that the market is ignoring, and sees trouble in an interconnected world:
Whilst the Chinese have been enjoying 10.6% consumer spending growth and 7.6% economic growth, it came because they pushed 40% of GNP in new credit into the economy last year. An attempt to rein in this misallocated credit since March has immediately impacted economic growth and spending by 1% of GNP, to say nothing of the 20% falls in Chinese involved commodity prices. All of these instances of slowdown since March are threatening the reflation trade which has driven stock markets up and bond markets lower. What if we are not in a normalising cycle? What if last year was a rally in a bear market? What if China can no longer be the font of growth?
It is not just a Chinese demand bubble that has kept the world economy afloat that has him worried. Like George Soros, who recently increased his bearish positions, he sees significant political risk as the winds out of Washington DC might point to a constitutional crisis. This could be particularly interesting as a September spending bill is required to be passed to keep the government running – a point that could be occurring with a resistant US President under siege or potentially in the throes of an impeachment process. Odey didn’t address this logical angle, but he gets the point about the political risk the market is currently ignoring.
So far political worries have made no dent upon markets. Nothing has. But QE is now due to end over the next two years,” he writes, pointing to a nation devoid of free markets. “Venezuela signifies all that I think about today’s markets. The country is rightly enveloped in riots and misery.
There will come a point where the markets will reach a point of disaster. “We have to watch for ‘the Minsky moment,’” he warns. In part, Minsky argued that long periods of prosperity fueled by debt and speculation could end in a sudden major market collapse, similar to a flash crash. “Minsky argued that periods of low volatility, presaged crises because they encouraged excessive risk taking. Well, we are into the risk taking.”
Odey is not calling for the world to end for his investment thesis to recover the 55.5% he has lost over three years. If the last market correction is any measure, his investors just might close break even assuming a decline near 40% or 50%. If things get worse, which they could, investors from three years ago might actually see a profit. “This fund truly does not demand that the end of the world comes tomorrow,” he says. The destruction of the world is not required for Odey investors to profit, is the message.
What he didn’t address, however, is the most important point and the most difficult to get right in determining a collapse: the timing. Jeffery Gundlach has said that a debt crisis takes much longer to materialize in a market price re-adjustment, but when it does, the movements will be quick and destructive.
Insight / Analysis / Opinion:
Crispin seems a little disorientated in this letter. I have yet to see him address the relationship between attempting to predict a market crash and the accuracy on getting that timing correct.