It was another tough month for Horseman Global, which we previously dubbed “the world’s most bearish hedge fund”, due to its exposure which, while fluctuating, has been net short for the past 6 years and most recently had a net short position of -43.5%.
In August, the fund dropped another 5%, bringing its total return for 2018 to -10.40%, setting up for another painful year for Horseman LPs who have underperformed the market since 2015.
The fund’s underperformance was not lost on CIO Russell Clark, who writes that while he likes “big ideas, and I like trying to do something different. When it works, its great. But when it doesn’t, it’s average” admits that “lately, performance has been very average.” He attributed the reason for that to “US assets and the dollar which are drastically outperforming all other markets”, something we have discussed extensively in prior posts.
Clark’s lament is the same as that from Goldman Sachs, namely that running a large fiscal deficit with record low unemployment “makes little sense” – Goldman went so far as describing this state of affairs as only observed during war time – and with US oil production beginning to slow, he warns that “something is likely to break.“
Being bearish on the US dollar and US assets has hurt. I had a very similar problem, and similar lackluster performance from 2009 to 2011, when I thought Chinese monetary and fiscal policy was similarly deluded
Still Clark, and Horseman, continue undeterred, and as he writes in his latest letter to investors (who appear to be shrinking, with AUM under Horseman Global now down to $488MM), he has seen “lots of good short themes in the markets over the last year including Western corporates suffering from Chinese competition, higher commodity price and bond yield impacting the corporate bond market, an investment grade borrower getting downgraded and dislocating the high yield market, the collapse in crypto currencies and their negative impact on the semiconductor market and finally the destruction of the short volatility trade.”
Yet none of these were enough to get Clark truly excited, because as he further explains “all of these are ideas that hold water from a macro perspective, but they lacked one important factor: An industry that investors so believed in, they would continue to hold even as the sector began to break down.”
Now, with just 2 weeks left in the third quarter and with Horseman increasingly desperate for a Hail Mary trade, Clark writes that “finally, this month we think we found” what may be the next big short trade.
Here is his explanation of why the semiconductor space may be due to for a big drop in the coming months:
We had been looking at the semiconductor market for a while, but mainly looking at cutting edge semiconductor makers, and their exposure to cryptocurrency mining. However, one of our shorts, Applied Materials, stated in a conference call that the majority of its orderbook is for lagging technology, not leading as had been expected.
What is lagging semiconductor technology? To simplify massively, it tends to be sensors. Sensors take real world data and convert it to electronic data. When we looked closer, we found that investors had become enamored with this area for two reasons. One; the “internet of things” had convinced investors that demand would remain strong for the foreseeable future, and two; “the breakdown of Moore’s Law” had meant that supply was constrained.
We found that the number of lagging semiconductor fabs were forecast to increase after declining for years.
Finally, we had found the sector that investors believe in, even as fundamentals declined. We also know that the Chinese are entering this sector. All we needed was a market signal. And right on cue, a Japanese sensor producer, Renesas, warned on Q2 profits and then followed this up with a cash bid for US producer Integrated Device Technology at seven times sales! That’s what I call ringing the bell.
As we continued to look at the sensor industry, we began to see that the sector was seeing a slowdown in orders from the auto sector and particularly in China after a long period of growth. The auto sector is a big buyer of sensors. Higher commodity prices are starting to affect the profitability of auto firms globally, which have large amounts of debt. Ford has been downgraded to one notch above high yield and looks likely to become a fallen angel. General Motors could well follow.
With that in mind, here is Horseman’s latest portfolio allocation:
The short book is made up of sensor related stocks, autos and banks that will be affected by deterioration in the corporate debt market. The long book has seen us reduce or exit miners that produce commodities tied to the auto industry, such as copper, nickel and zinc. While the Chinese auto market is slowing, the effect on profitability is likely to impact foreign producers who dominate this market.
His parting thoughts underscore why Clark remains (painfully) bearish:
2011 and 2018 are playing out very similarly for me. Easy momentum trades of the past year are breaking down, and investors are herded from one area to another. While all the talk is of an emerging market crisis, the biggest emerging markets are all engaging in reform, while the developed markets are still overly reliant on easy money. In 2011, selling the then outperforming emerging markets, and buying Irish debt was the right trade. And in 2018, shorting developed markets and buying emerging markets looks the right trade now.