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This article was originally published on ValueWalk.com by Mark Melin. For additional behind the scenes insight, see commentary provided at the end of this article.

Is Crispin Odey’s “golden cross” about to occur? The golden cross is known in certain algorithmic trading circles as the point at which price momentum in one direction tends to trigger additional force in the direction of the trend. It often occurs when a shorter-term price moving average crosses another longer term price moving average, the historical basis for the trend following execution trigger. In Odey’s case, the golden cross, if it were to occur, would hypothetically indicate a sell signal, but the cross is not a technical indicator in this case for several reasons, most specifically because it does not represent two different time horizons tracking the same asset but rather the cross of the OIE Mac fund’s returns performance with that of its self-selected stock market benchmark. In his June, 2017 letter to investors, one of the world’s most bearish investors who experienced dramatic profits in the wake of the 2008 financial crisis, gave up much of those profits and is now watching a golden cross in his performance profile occur relative to a slow and steady equity market benchmark.

Crispen Odey’s Golden Cross approaches. Yikes!

Odey’s returns performance is about to make a golden cross formation with the fund’s equity benchmark

 

Coming into the global financial crisis, Odey correctly positioned his hedge fund for what appears in hindsight to be an obvious oversight – failing to recognize that banks relaxing credit standards to absurd levels would result in defaults. This is market theory 101 that PhD economists missed… again. Odey’s analysis and preparedness were “Big Short” worthy, as the Fund’s net asset value from up near 400% in roughly 13 years to up near 1,500% in relatively quick succession.

 

Such large and quick returns in a short period of time are often questioned in an algorithmic portfolio management approach. The concept is to recognize the “repeatability” of a returns stream. Odey’s performance from his inception in 1994 to just prior to the 2008 market crash was slow and steady. The fund created a returns profile that was generally close to market beta, he was up near 400% during that period. The point of algorithmic consideration is that in a relatively short historical lookback period – starting near 2007 and ending in 2014 – is where the significant returns were generated. The returns profile during the dramatic 2008 win, on a yearly basis, was really significantly out of sample size performance.

 

An algorithmic mind might have looked at what is categorized in some portfolio management schools as a fat tail risk hedge strategy is also known to have a low win percentage and a high win size. Looking at Odey’s dramatic fall from grace – going from nearly 1,500% profits since inception back down 500% in the relative blink of an eye – this give-back should not be that surprising. To emphasize the point of investor loss since 2014, Odey’s returns performance is about to cross the fund’s self-selected benchmark, the MSCI Total Returns Europe stock index. While this is not a technical indicator to take any action, it is rather interesting how the hedge fund’s returns pattern is consistent with a certain strategy.

 

The returns pattern has the modeling profile of a fat tail strategy that benefits from a market crash. Those in algorithmic portfolio management circles know that a low win percentage can erode profits and that the play is for a significantly high win size. Further, significant price deviation from a mean over a short term period that is not consistent with historic patterns is often considered a yellow flag investment signal. Odey’s success in the OIE Mac fund is dependent to various degrees on accurately predicting a market crash, a feat seldom if ever accomplished on a consistent basis.
But could Odey’s current ghoulish outlook on the markets be correct and it’s just a matter of time before the next market crash? His June OEI Mac investment letter provides insight.

Both Soros and Odey questioned central bank omnipotence, as Odey sees inflation ahead

Breaking down Odey’s market outlook into a pattern of behavior, there is a consistent he maintains with many of the great hedge fund trades in history. Just like George Soros and numerous others, they understand that eventually the gravity of market balance eventually comes into play.  In the famous Soros / Stan Druckenmiller bet against the mighty Bank of England, at its core the trade recognized that central banks are subject to the same rules as us mere mortals, regardless of a certain central banker’s claims to being “magic people.”

 

Odey isn’t that different in his core analysis of central bank manipulation of interest rates than other major hedge funds, but his execution point is a little different. While Bridgewater’s Ray Dalio is skeptical of central bankers and previously predicted an end to the debt super cycle – he knows trade timing on a market crash can be difficult. He recommends to continue dancing and pretty much says there will be signs of the crack before the dam breaks. Odey sees the cracks in the dam forming and has been moving to higher ground to protect from the coming flood. The difference is trade execution time horizon and the all coveted consistent noncorrelated returns stream.

 

“Incentive is everything. Our current Governor will return to Canada and so his interest in the ultimate outcome for the UK is decidedly less involved. Interest rates averaging 0.25% and ten-year bond yields driven down by Bank buying to around 1%, do not encourage the country to save,” Odey writes, pointing to a traditional economic point being ignored. “Instead we are dependent upon foreign investors to lend us money knowing that at present they are losing 2% in real terms thanks to inflation.”

 

Historic negative interest rates have skewed incentives and Odey sees a more liberal policy regarding relaxing pay raises for UK government workers and labor shortages in the US generating significant inflation. In other words, the general population feeling the same societal benefits as stockholders is going to create too much wealth, and the breaks will be applied either by central banks or inflation that will force their hand.
“With around 400,000 unemployed and employment growth annualising at around 200,000 per month, suddenly the Fed can no longer just keep the credit cycle moving with QE but must take account of the looming leeward coastline, which will stop growth anyway,” Odey writes. Markets have begun to lose fundamental mooring, is one message, and when this happens good things seldom follow. “In every previous such down cycle for the last ten years, central banks have responded by printing money. But this time they are doing the reverse, which must, one thinks, exacerbate this trend.”
Odey might be correct about his negative outlook. But as he implores his readers to “enjoy the hot summer,” one wonders how much heat Odey investors will take before they give up on his fat tail strategy, or will they stick with him well after his golden cross has passed?

 

Insight / Analysis / Opinion: 
Crispin Odey may very well be a genius. He predicted the 2008 crisis and successfully invested during that period. If he predicts the next crisis — considered an obvious prediction in some circles — the real issue will be his timing on the trade.