In Crispin Odey’s latest letter to investors, the billionaire hedge fund manager laments “how quickly everything has changed”, notes that “without the reflation fireworks, equity markets feel vulnerable”, and concludes that while a year ago it was easy to be bearish – China was slowing, world trade was creaking, Europe was not recovering and the oil price was hitting new lows – “a year later to be bearish feels lonely, despite the fact that the reflationary story of the past year looks difficult to sustain and auto loan lending has joined a long list of risks along with Trump and Brexit.”
And yet, unlike Horseman, he is not throwing in the towel just yet: “Money creation alone has taken markets to all-time highs but what strong arms take, strong arms must defend. Valuations demand that they do.”
And while Odey’s trenchant appeal that “when we look back at this madness, some people will feel ashamed” is accurate however, considering his YTD P&L of -4.9%, following a 1 year drop of 33.7% (and more than half over the past 3 years), Odey may not be among those looking back.
Full letter below:
Look how quickly everything has changed. Trump, defeated over the Obama Healthcare reform has, as it were, retreated into an aggressive foreign policy which is almost the opposite to the Monroe doctrine which he was adopting earlier. Bannon is on the back foot. In the absence of a corporate tax cut or any kind of VAT tax reform, the US economy is succumbing to an overvalued dollar and a growing crisis in subprime lending, centred on the second hand car market. The government bonds have already guessed Yellen’s mind. No more rate rises. We are now just waiting for the Fed to set up a lending business, loaning 5 year old cars to people who can neither drive nor borrow. That is what they need to do to stop the subprime losses ballooning.
Last year what bailed everyone out after the bad first quarter was China and the oil price. Despite China pumping in 40% of GNP in new lending, the statistics are revealing. The economy grew nominally 7½%. Consumption of steel grew by 2%, despite steel prices rising 60%, and the auto market started to weaken (by 2.5%) in the new year after being driven up by the size of the support exercise. For this year, it is going to be difficult for China to even continue its recovery. The chances have to be high that we have just witnessed a giant rally in a bear market for commodities. Where is Trump’s massive infrastructure boom?
Without the fireworks, equity markets feel vulnerable. The Great Reflation was responsible for a re-rating of stock markets. If all we have left is the Central Bank’s bond bubbles, that may not generate enough growth to support prices.
Whilst undoubtedly bonds were in bubble territory last year as evidenced by the fact that the only way a buyer could possibly make money was by selling the loss making asset to a bigger fool, the equity market did become compliant in the game. Companies learnt to pay out dividends with borrowed money and became very adept at using shares as dividends – so called scrip. Very popular with corporates.
Several of our favourite shorts have shown a tremendous appetite for scrip. Intu Properties, the largest shopping mall owners in the UK are valued at £8bn EV, not surprisingly when they received £447m in net rent and £408m in EBITDA in 2016. They paid out £240m on interest and hedging costs (year end LTV of 44%), needed to spend £121m in capex to keep the tenants happy and so shareholders got £183 million in dividend of which £29m was in scrip (£73m in scrip the year before). The problem with scrip is people are starting to find that it is not worth the paper it is written on. Intu this year say they will spend not £121m but £297m to keep tenants happy. In a world where scrip is no longer being appreciated that leaves a £300m shortfall after £230m interest payable, capex and dividend. Whoops!
With the subprime problem emerging in the used car market, remember that this is nothing but a can (car) kicked down the track some years ago. In 2012, with the compliance of the Fed, leases on cars were extended from 3 years to 5 years with a residual value of 20% of the new at the end of the 5 years seeming reasonable given that cars last 10 years. The result was a 30% increase in demand for new cars on the back of a 30% decline in cash costs. Five years later, with subprime in the USA some 2.3x larger than it was in 2008/9, these second hand cars are not attracting bids at or above the residual prices built into the leases. At present, prices are just 7½% below the expected price. Dangerous but not critical. What frightens everyone is who is going to buy so many second hand cars for cash over the next few years? A change to the new leasing price now needs to be made. Just when sales have already been weakening.
Another inadvertent child of QE has been the rise of disruptive technologies – Amazon, Uber, Tesla, Artificial Intelligence, ViaSat. All promise to undermine incumbents and most importantly the current assets employed by the incumbents, lent against by the banks and the corporate bond market. Paradoxically it is also the reason that productivity is falling – losing income earners are not easily found, equally well paid jobs. It is putting pressure on property prices in much the same way as it is hitting second hand car prices.
Unless we are happy to see the Fed and other central banks extend their remits drastically these new developments must have repercussions in the capital markets. The unwillingness of investors to discount this, has made stock markets both so resilient and so difficult to read.
The Bank of England, under Carney, have taken this further than most, presiding over personal savings rates falling from 12% in 2008 to 3.5%. At a time of uncertainty of trade terms, the UK is reliant on credit equal to 5% of GNP. With inflation rising thanks to the fall in ster-ling towards 4% and short rates at 0.25% and 10 year bonds yielding 1%, prices are not that tempting. No wonder that foreign investors have been selling down their gilts. The optimist will tell you that sterling is 25% too cheap ‘on the Big Mac Index’ and is due a bounce. But a bounce presupposes that individuals will start to save again. With all interest rates negative they seem intent on borrowing and spending. When we look back at this madness, some people will feel ashamed. Twisted facts and twisted logic may be met in the quiet of the night by reality.
A year ago it was easy to be bearish. China was slowing, world trade was creaking, Europe was not recovering and the oil price was hitting new lows. A year later to be bearish feels lonely, despite the fact that the reflationary story of the past year looks difficult to sustain and auto loan lending has joined a long list of risks along with Trump and Brexit. Money creation alone has taken markets to all-time highs but what strong arms take, strong arms must defend. Valuations demand that they do.
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Finally, as per his position breakdown, we may have identified one of the biggest cable shorts. In light of recent events, it appears that Odey’s losses are set to continue.
Finally, here are his top 10 holdings: