Hugh Hendry is a bear of others’ views on inflation
Interview by Simon Kerr
Hugh Hendry has enjoyed the label of asset management maverick for some years. He has trenchant views which are often at a kilter to mainstream thinking, and he revels in that difference. He has an entertaining delivery style: putting his points across with aphorisms, obscure but supportive facts, and a broad sweep of knowledge brought to bear to his audience’s pleasure. He can illustrate his talks at conferences with the cover of a Beatles album and a graphic of money supply growth going back to Napoleonic times. It is all so entertaining.
However the piquancy of the bon mot should not detract from the seriousness of his messages. Or the analysis and consideration which goes into his views. It may come across that he is a gadfly of facts and sources – a little here and a little from there on a peripatetic basis, but that is to ignore the ability he has to extract value from the enormous range of information he devours to feed his hunger for input. He is able to order it in his head and recognise the classic cognitive dissonance between the world’s view that is priced into assets and his own take on the same. He has spent years refining his inputs so that he continues to take those that add value, or at least are engaging and thoughtful. There are no end to strategists thoughts, opinions from investment newsletter writers, and economic viewpoints, but putting them into coherent shape to challenge or agree with is a skill that Hendry has refined over time.
At the moment the great conjecture is about inflation, or more correctly whether we should be more afraid of the likelihood of inflation or deflation in the years ahead. Almost inevitably Hendry’s take is not in the mainstream of current thinking. He is not always contrarian, but he is unafraid to be so when his world view does not align with the consensus. So it is now: Hendry says “Markets continue to swing from the binary outcomes of inflation and deflation. At this point last year inflation was in the ascendancy. Backwards, forwards, since July of last year the same investors had to adjust to profound deflationary forces as all risk asset classes fell precipitously.”
As ever, Hendry has marshalled his facts: “My greatest angst is reserved for the four-fold rise in private sector, non-financial, leverage in America. In just 60 years, the private sector increased its debt from 43pc of GDP to 175pc. To put this into perspective, the UK is on the verge of having its formidable tax raising franchise downgraded because its debt may reach 100pc in two years time. And yet, until last year, there was little hand-wringing about the private sector having borrowed more than 4x the public sector’s then debt.”
Hendry’s second concern relates to the willingness of governments to use their own leverage as a remedy for asset deflation. “Policy makers seem to believe that the only way to reverse the tide in asset prices is to issue vast sums of ‘money-like pieces of paper’, aka government bonds,” he asserts. According to Hendry, governments are mimicking the previous decade when investment banks were able to boost the housing market by issuing trillions of dollars of mortgage-backed paper. “You can also compare it to the 1990s when it was new internet share issuance which drove the TMT bubble, or further back to John Law and his endless printing of Banque Générale certificates which financed the Mississippi stock bubble,” says the historian in Hendry.
In his analysis there is a glaring flaw in this process. “Government debt is very visible; certainly more so than the paper previously issued by investment banks,” Hendry notes. “Increase the issuance of mortgage backed securities, from $0.5trn in 1996 to $3.2trn in 2003, and no one bats an eyelid; house prices boom. Suggest issuing a corresponding amount of Treasuries and the bond market quickly fears inflation and frets over who will possibly buy all these bonds. Today bond prices are falling and there is the possibility that economic activity may be subdued by the rising cost of money. US mortgages are now dearer than at the end of last year.”
The hedge fund manager notes that prices are falling on the high street, total nominal wages are in retreat and yet the sovereign debt markets are in open revolt on the premise that “inflation is always and everywhere a monetary phenomenon”. And money growth is up sharply….so global macro strategists can insist that the US will definitely have hyper-inflation, and many market participants are convinced that inflation is the future. Hendry is not one of them.
“I asked a strategist who had been on the road to clients what the clients’ biggest concern was. He said “inflation, inflation, inflation.” Everyone mentioned it in every meeting,” relates Hendry. Real bond yields reflect that fear.
Where does that leave Hendry? Poised. Poised because bonds are still in a sell-off. Hendry is expecting more to come to create a better opportunity for him to add to his tiny positioning on the bet/view. And he is considering scenarios way beyond the usual.
“I keep thinking that it would be ironic if history were to show that US policy makers were right to fear the prospects of a $54 trillion debt deflation and that they should have been more ambitious in their monetary expansion. The bond vigilantes believe that the double dip deflation of the 1930s will ensure that the Fed will be slow to raise interest rates this time around. But what if the economy stalls because the credit markets are premature in tightening monetary policy for them?”
This conundrum for the markets is of the moment. The Bank of England yesterday announced a holding of interest rates at the record levels of the last four months. No surprise there. However the BoE also said that they want to reduce Quantitative Easing until they see the effects of that they have undertaken to this point. There is the inflation fear captured in the Central Bank policy change. If the Fed and Bank of England turn off the spigots too soon it won’t be inflation that will be the threat, but the markets will fear the lack of demand in the real economy and incipient DEFLATION… and Hugh Hendry will be up 14x on his current position in bonds.
However the piquancy of the bon mot should not detract from the seriousness of his messages. Or the analysis and consideration which goes into his views. It may come across that he is a gadfly of facts and sources – a little here and a little from there on a peripatetic basis, but that is to ignore the ability he has to extract value from the enormous range of information he devours to feed his hunger for input. He is able to order it in his head and recognise the classic cognitive dissonance between the world’s view that is priced into assets and his own take on the same. He has spent years refining his inputs so that he continues to take those that add value, or at least are engaging and thoughtful. There are no end to strategists thoughts, opinions from investment newsletter writers, and economic viewpoints, but putting them into coherent shape to challenge or agree with is a skill that Hendry has refined over time.
At the moment the great conjecture is about inflation, or more correctly whether we should be more afraid of the likelihood of inflation or deflation in the years ahead. Almost inevitably Hendry’s take is not in the mainstream of current thinking. He is not always contrarian, but he is unafraid to be so when his world view does not align with the consensus. So it is now: Hendry says “Markets continue to swing from the binary outcomes of inflation and deflation. At this point last year inflation was in the ascendancy. Backwards, forwards, since July of last year the same investors had to adjust to profound deflationary forces as all risk asset classes fell precipitously.”
As ever, Hendry has marshalled his facts: “My greatest angst is reserved for the four-fold rise in private sector, non-financial, leverage in America. In just 60 years, the private sector increased its debt from 43pc of GDP to 175pc. To put this into perspective, the UK is on the verge of having its formidable tax raising franchise downgraded because its debt may reach 100pc in two years time. And yet, until last year, there was little hand-wringing about the private sector having borrowed more than 4x the public sector’s then debt.”
Hendry’s second concern relates to the willingness of governments to use their own leverage as a remedy for asset deflation. “Policy makers seem to believe that the only way to reverse the tide in asset prices is to issue vast sums of ‘money-like pieces of paper’, aka government bonds,” he asserts. According to Hendry, governments are mimicking the previous decade when investment banks were able to boost the housing market by issuing trillions of dollars of mortgage-backed paper. “You can also compare it to the 1990s when it was new internet share issuance which drove the TMT bubble, or further back to John Law and his endless printing of Banque Générale certificates which financed the Mississippi stock bubble,” says the historian in Hendry.
In his analysis there is a glaring flaw in this process. “Government debt is very visible; certainly more so than the paper previously issued by investment banks,” Hendry notes. “Increase the issuance of mortgage backed securities, from $0.5trn in 1996 to $3.2trn in 2003, and no one bats an eyelid; house prices boom. Suggest issuing a corresponding amount of Treasuries and the bond market quickly fears inflation and frets over who will possibly buy all these bonds. Today bond prices are falling and there is the possibility that economic activity may be subdued by the rising cost of money. US mortgages are now dearer than at the end of last year.”
The hedge fund manager notes that prices are falling on the high street, total nominal wages are in retreat and yet the sovereign debt markets are in open revolt on the premise that “inflation is always and everywhere a monetary phenomenon”. And money growth is up sharply….so global macro strategists can insist that the US will definitely have hyper-inflation, and many market participants are convinced that inflation is the future. Hendry is not one of them.
“I asked a strategist who had been on the road to clients what the clients’ biggest concern was. He said “inflation, inflation, inflation.” Everyone mentioned it in every meeting,” relates Hendry. Real bond yields reflect that fear.
Where does that leave Hendry? Poised. Poised because bonds are still in a sell-off. Hendry is expecting more to come to create a better opportunity for him to add to his tiny positioning on the bet/view. And he is considering scenarios way beyond the usual.
“I keep thinking that it would be ironic if history were to show that US policy makers were right to fear the prospects of a $54 trillion debt deflation and that they should have been more ambitious in their monetary expansion. The bond vigilantes believe that the double dip deflation of the 1930s will ensure that the Fed will be slow to raise interest rates this time around. But what if the economy stalls because the credit markets are premature in tightening monetary policy for them?”
This conundrum for the markets is of the moment. The Bank of England yesterday announced a holding of interest rates at the record levels of the last four months. No surprise there. However the BoE also said that they want to reduce Quantitative Easing until they see the effects of that they have undertaken to this point. There is the inflation fear captured in the Central Bank policy change. If the Fed and Bank of England turn off the spigots too soon it won’t be inflation that will be the threat, but the markets will fear the lack of demand in the real economy and incipient DEFLATION… and Hugh Hendry will be up 14x on his current position in bonds.
