Hugh Hendry’s long dark night of the soul

Fascinating presentation from Eclectica’s Hugh Hendry on why he lost $1 billion assets under management.

Houses and Holes
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  1. To me, that was sadly the presentation of a brilliant mind that will be dead in a year’s time. The confusion that Hugh seems to be expressing is an amalgam of ‘what he believed’ and ‘what has happened’ to produce ‘what will be’. If he lives, he might eventually return to his beliefs of 2007; the ones that were so clear and so obvious to him, and realise that what he thought back then was always correct. I wish him well and will be as interested as any of us as to what happens to him from here.

    • Wow. Who is Janet? How eloquent a comment. Brilliant and in 100% agreement.
      Hendry was my hero post crisis, no longer after watching this video. How ironic. A lot of economists love the soap box and their voices and so profoundly wrong or not, they must be heard and they stay the course, visavi central bankers today. Hendry called their absurdity and got nailed in the markets (his 8% being redemption only due to his size and having to survive by catching the tail of large FI movements) like my self who didn’t believe the central bankers would be so absurd as to undertake the policies that they did which now are showing signs of decay and will eventuate into complete failure, not to say I think we will go into depression but we will get asset price correction and a return to risk adjusted pricing with some readjustment pain. Hendry is then no different to the central bankers in having to come and sing a song of survival on the soap box similar to the economists, pundits that think they got it right post crisis with the retarted policies of the last 8 years. Perhaps in his desire for self preservation as a fund manager, he has come about face because the ultimate demise of the policies and actions of the last eight years will take ten to twenty years do be concluded as failure. They may fail earlier but the complex will not conclude failure for a long time coming. So self preservation (who doesn’t want to be boss and I assume he lives a lavish existence) and what seems to be the obvious love of hearing his own voice (thus the news letters) he has turned about face. Unfortunately as Janet points out, his clarity in thought post GFC in the miss allocation of capital in China and the failed policies of the central bankers will play out just as he envisioned many years back but the manifestation of the failures will be profoundly different to that which he thought thus his conclusion on incomes being saving grace and what he then believes will all be OK.

      Now my turn on the soap box. He is mistaken and confused. The Internet (broadly the revolution in automation tech) is at its infancy and as it matures, it will continue to compound deflationary forces so incomes will not rise. China’s manufacturing strength will revert as the intellect property producers bring manufacturing closer to input supply (ironically Australia may becoming a manufacturing power house in future) meaning China either produces IP and not cheap labour or they will slip back to where they were 20 years ago. This will cause a significant global correction but not depression thanks to their decades long trade surplus (their banking system will obviously fail and have to be rebuilt). USD debt exposures will be traded with what ever remaining foreign capital they have. This is worst case scenario which assumes they won’t produce IP. Like the Japanese they are copying the world, are undertaking automation builds them selves and so will compete and so the outcome will rather be a mix of what I proposed a few sentences ago. Regardless of how you model it, if the advent of automation tech. continues – deflation is here to stay. Fewer jobs and lower incomes is the new new new normal for the entire globe as we go through the automation revolution and all the debt created in the last eight years will be non performing which is why he will have been right with his views post GFC (although future private and soverign debt jubilees may mean the failures will be of no consequence except the repricing of assets down and creditors being rewarded for the return of allowing debtors to hold their devalued assets). Globalization regardless of Ariums failure and forceful purchase of Australian steel for govt projects will not be stopped nor will govt policies to slow automation tech in laws of driverless cars and the like, the debt burdens in the near term are going to paradoxically accelerate the tech. ( see Turnbull innovation agenda).
      Question is, how to you trade a broken market where their are no rules. This is Hendrys predicament and thus the new born optimist.

      • dissonanceMEMBER

        This sort of thought provoking article and discussion is what keeps me coming back to MB. Rarer these days amongst more group think responses, hyperbolic headlines and staunch adherence to a particular stance, seemingly required to justify/support a blog’s existence.

        Hugh Hendry’s struggle with ever changing macro overlays and their implications is evident in his cognitive dissonance at perceived implications vs actual outcomes. The talk was typically Hendry in showmanship and eloquence but sadly almost delusional with contradictions, justifications and excuses surrounding the reality of being a professional prognosticator. A reminder in the dangers of dogmatic beliefs and the brittleness of our convictions, especially where money is riding on them.

        If you will allow me the soap box please. My first observation is that if one is investing based on their macro opinions then the time frame and inherent volatility over time must be respected. Macro fundamentals are often a long run phenomena swamped by the interference of powerful central banks or politics, and made almost invisible by the noise of volatile markets and reflexivity. Even if Hendry comes around full circle to his 2007 beliefs was he right if it takes 10 years to be proven right? The rollercoaster ride and his cynical, almost bitter demeanour suggests not. Good strategies for the short term may be counter to the long, regardless if it grates against better sense.

        Still, macros are the most important foundation driving any long term investment philosophy IMO and one ignores such at their own peril. I cannot think of anything more important to preservation/growth of wealth and steering the net generation in making the right choices than understanding the fundamentals of our economic future. A rising tide of a new golden age with strong economic growth may lift all peoples into a better situation but I doubt it. More likely we are entering a period of ever increasing changes and challenges that will continue to widen the gap between the haves and have-nots, perhaps even bringing into question the very sustainability of our systems and beliefs.

        In contrast to Simpleton, who clearly is not, I don’t see manufacturing returning closer to inputs or the west without a renewed trade war and all that portends. Economics of manufacturing has some inviolable laws; including economies of scale. Economies of scale, together with socialist subsidies of land, rent, electricity, inputs to production, low green and red tape costs, and debt relief will keep China the powerhouse of the worlds production for a long time to come. The current account surplus it delivers is wielded by the middle kingdom as a weapon of influence. The jobs that subsidised production bring and the power it gains the country far outweighs lower living standards for the general population as it’s side effect. The population will never understand how such a system has robbed them of a higher standard of living and, so long as their standard of living keeps climbing, what they don’t know won’t hurt them. Stability of the one party state sits at the very top of policy goals, daylight second.

        Yes, deflation will probably continue to weigh upon the world with a surplus of means of production (abundant liquid capital printed by central banks, cheap debt, no respect for IP, instant information transfer, almost infinite labour at a time labour is being replaced by automation etc). Automation especially will cap wage rises despite the best efforts of government to legislate for such. The unfortunate unintended consequence will probably be raising unemployment and an overall drop in demand, quite the contrary to what Hendry suggests. IMO it will ultimately it will take a form of helicopter money under a revolutionary new social contract to dig us out of the demand deficit quick sand but that is a theory for another post.

        One of my concerns embracing China in the brave new globalised world is that it collapse of the western capitalist system that we have relied on for hundreds of years. I know that sounds alarmist but we are simply going where the west has never been before and our system has never been so fundamentally challenged before, much more than the cold war ever did.

        As seen early on with aluminium production and now with steel (of which China has zero natural advantages in) when a China intends to produce a product with heavy subsidies for zero profit using essentially non-repayable debt they will destroy the industry so far as western capitalism is concerned. Western capitalism is predicated on a profit, sufficient to both to encourage entrepreneurs to make investments in production and also to allow payment of interest and repayment of debt.

        If all industries that China becomes involved in tend towards zero profit ‘for the sake of employment and the state” then those industries are dead to western capitalism. Shareholders will not put up equity, banks will not lend except perhaps at exorbitant rates to cover the high risk of bankruptcy. Never before have companies had to compete with enormous, efficient and technologically advanced society for whom subsidies are endemic and debt need not be serviced or repaid. This is simply unprecedented!

        It started in $2 shop stuff, then heavy industrial such as aluminium and steel, low tech and everything Bunnings, it will now move inexorably into high tech. Phones will become profitless high volume products like desk tops and lap tops now are, ships, trains, cars, flat pack houses where does it stop? Like doped mice, the west would rather enjoy the easy fruits of cheap subsidised labour than start a trade war until it is too late, just like Hendry’s frog sitting in a pot of slowly heated water.

        China do not play by the same rules and therefore will continue to drive domestic employment with increasing automated production efficiency at the expense of foreign employment. We are seeing it play out now in the currency war raging across the globe. It is not at all clear to me that governments will start a trade war or subsidise/protect our own means of production until it is too late.

        Sure, China will lend us the money to borrow and buy these cheap goods and we will enjoy the fruits of their labour for a while. But what happens when the stock market falls slowly or quickly into depression like levels when profits keep falling across most/all companies due to competition and deflation? What about to the huge amount of debt backed into soon to be profitless companies like Arrium? The negative wealth effect of so much savings wiped out by falling markets, the inevitable loss of confidence, wealth and jobs driving and long winter of falling house prices? It will be ugly no doubt.

        But though I say these things like they are certain, they are not and may take decades to fully unravel. What does one do knowing the high risks of a final catastrophic outcome but having to deal with the here and now for indeterminable amount of time? Hiding under the desk in a foetal position sucking your thumb like a baby is not an option, at least not for long.

        To bring my rant full circle and to an end, the answer is surely to read blogs like MB and try to dodge the bullets best you can while playing this dangerous and broken game. Avoid investing in business’s that fall early to globalisation, don’t get sucked into unsustainable rally’s that counter the laws of physics, pick macro trends like falling commodities or the AUD early, use long-short strategies, manage risks. However, it is also a risk being too fearful that the end is nigh and therefore not invest at all, in the long run we are all dead.

        Like Hugh Hendry, most of us do not have the luxury of enough time and money to sit back and relax waiting for a long term outcome to arrive. We must keep re-evaluating, re-investing, re-positioning all the while managing our risk knowing that we will be wrong at times in our prognosis or timing. Just do not go crazy like poor Hugh from the pressure of the journey 

      • notsofastMEMBER

        “So strangely and uncomfortably I’m no longer profoundly bearish, I think we are going to be OK”

        I think this comment about sums up Hugh’s presentation. He never looked very comfortable at any stage.

  2. His theory on bonds v equities and the high level of debt makes a lot of sense to me.
    If the prevailing view on inflation from 1981 onwards was actually wrong. And in fact inflation was a low probability risk, inflation targeting wasn’t necessary and 1946 – 1981 was an anomaly. What should have happened? In real terms bond holders would have returned more than they expected to return when they initially lent money. This is exactly what has happened. Real ex-post interest rates have been far too high, creditors have been over-rewarded, debtors have been penalised so demand for bonds has been far too high. The job of the banks has been to find new borrowers (when underlying credit demand should be getting weaker) . Thus the explosion in debt. This seems counter-intuitive. low interest rates are supposed to be responsible for high levels of debt. But this isn’t correct. Debt is a two-sided transaction and creditors have the agency because they control the sellers of debt (banks). Debt has exploded because interest rates have been far too high.

    I think negative interest interest rates could be the turning point though.

    • There IS an anomaly 1946-1981, and it is an extremely large elephant in the room.

      Abundant automobile-based development gave urban areas low, flat urban land rent curves for decades and stable real property prices. The effect of this as a macro cyclical stabiliser is a massively important concept hardly recognised by 0.1 % of economists yet. Phillip J. Anderson, Fred Foldvary, Mason Gaffney and other Georgists “get it” about the stability but are dead from the neck upwards about the underlying cause. There are plenty of observers of the relationship between the modern-day “anti sprawl” urban planning and the return of urban property bubbles, but most of these don’t go on to observe the macro implications.

      We are committing economic suicide with almost nobody understanding the essential combined-factor reasons why, and almost nobody taking any notice of the voices in the wilderness who do see something.

      • It is extraordinary how important economists get insights like the below and don’t pursue the implications to the needed conclusion:

        Davis and Heathcote (2007) “The price and quantity of residential land in the United States”

        “…Although the goal of this paper is primarily to organize facts rather than to explain
        them, we have in mind a simple story than can perhaps account both for the decline in land
        prices between 1930 and 1950 and the upward trend since then. The interpretation of the
        decline is not new. As the cost of automobiles fell over the first half of the twentieth
        century car ownership surged, such that by 1950 there were almost as many cars as housing
        units in the United States: 40.3 million versus 46.1 million. As new roads were built, the
        quantity of land within reasonable commuting distance of city centers expanded rapidly.
        This increase in the supply of potential residential land has been put forward as a likely
        explanation for the decline in land prices over this period (see, for example, Grebler et al.,
        1956, p. 364). Since the widespread adoption of the automobile there have been no further
        significant technological innovations in passenger transportation. Over time, more and
        more cities have either developed most of the land within reasonable commuting distance
        of the city center, or have implemented policies to slow further development. Thus growth
        in the supply of desirable residential land has not been sufficient to accommodate growth
        in demand for housing, and land and house prices have risen. This explanation for the
        u-shape in the value of land over the past century awaits a more formal evaluation in the
        context of an explicit quantitative theoretical model…”

        Then there is Ed Glaeser in “Nation of Gamblers” (2013):

        “..The post-World War II era demonstrated exactly what textbook economics predicts should happen when robust demand meets relatively elastic supply. Quantities rose and prices stayed relatively flat. The relatively elastic supply owed much to the rise of automobile-based living on the urban fringe, which can be seen as either a shift in housing supply or a change in supply elasticity. For example, in an open-city formulation of the Alonso-Muth-Mills model, with supply costs that increase with density, lower transportation costs will increase supply but not change supply elasticity. Yet it is possible that the automobile made supply more elastic as well. On the urban fringe, lower cost, low density housing can be built in massive quantities, essentially using a constant returns-to-scale technology…

        “…The missing post-war price boom is not a problem for conventional economics, but it does present a challenge to those who seek to explain bubbles as the outcomes of a stable process where readily observable exogenous variables translate into the presence of a bubble. The 1950s had easier credit for homeowners than the 1920s and economic conditions were at least as good. Any model that suggests that there is a stable relationship between either of those variables and price bubbles has difficulties with this epoch…”