market folly

Crispin Odey, founder of hedge fund firm Odey Asset Management, is out with his latest market commentary and outlook. Back in September, he noted that equities were attractively priced but unloved. Since then, equities have rallied furiously. So, what's his latest take? See below for his outlook penned on the 30th of November.

"Crispin Odey
Founding Partner | Portfolio Manager
Current Outlook

Easy money takes the pain out of hard knocks. In May, in August and again in November, markets have attempted to dissolve the Euro – to fracture it. Insolvency in Greece came about because their governments could not collect taxes. Insolvency in Spain and Ireland relates to banks lending against mortgages on margins of only 20 basis points over Libor whilst borrowing at 100-200 basis points above Libor.

These issues need addressing. Keynes wrote in the thirties that: “…the absolutists of contracts are the parents of revolution.”

Banks need to be allowed to reset lending margins; they need to be profitable. Who cares if this demands legislation to take effect?

It is odd that Merkel has been the instigator of the Euro wobbles. She is of course worried that German banks will need to be bailed out if these countries go down. She is right to be worried that German bankers might be foolish lenders: look at the history. Recently German banks’ net interest margins should have soared because in Germany there were no tracker mortgages, no teaser rates. Borrowers borrowed for 10-15 years at nominal rates. Two years ago those borrowers were borrowing at 4% and the bank was making nothing, today they are borrowing at 4% and the bank could be making 300 basis points of margin. Instead, by matching the duration risk and having to borrow at 100 basis points over Libor, German banks still make little money out of mortgage lending.

Throughout these crises I have remained bullish and I still remain more optimistic for stock markets than for a long time.

Why? Because the markets are too cautious about the strength of the economic cycle. In previous quarterly calls I have outlined how the USA is now successfully encouraging economic growth and inflationary pressures to grow in the emerging market economies. But what is not understood is that Germany in this regard looks exactly like an emerging market. Thanks to the problems of the Euro, German exporters are not only enjoying a massive boom, they are also enjoying a currency advantage of around 30% over their Japanese competitors. Couple this with a tax rate which, since the last boom in 89-90, has fallen from 52% to 30%, and shareholders – for the first time – will almost certainly enjoy an unheralded boom.

In a country where individuals spend more on cut flowers than equities, these profits will come to us – yes to the foreigners. This is not going to be popular in Germany, and quite quickly I expect profits to be commuted into wage increases, but this will do something which is not expected. It will mean that from next year the boom in consumption in Germany will help to lift all of these bankrupt southern economies out of recession. The Euro will work as it was intended. German inflation will be higher than others, German competitiveness will suffer and yes we will stop having Euro crises. Of course Germany will not enjoy this boom and if it was down to their authorities, interest rates would rise and their currency would strengthen but they are going to find their feet being unable to reach the pedals as Ireland et al found this year.

Bernanke, who I think is much maligned, wrote this recently in ‘Rebalancing the World Economy?’

As currently constituted, the international monetary system has a structural flaw: its lacks a mechanism, market based or otherwise, to induce needed adjustments by surplus countries, which can result in persistent imbalances. This problem is not new. In particular, for large, systemically important countries with persistent current account surpluses, the pursuit of export-led growth cannot ultimately succeed if the implications of that strategy for global growth and stability are not taken into account.’

So like Simeon, are we about to say; ‘today this prophecy is fulfilled’? Could there have been a more perfect Christmas tale than this? Yes, in a way.

Bernanke is wrong. The mechanism is starting to work. It will shower profits upon those fortunate enough to see the opportunity. It may well start the beginning of the bear market in government bonds but it will also lead to a much more balanced global economy – balanced but inflation prone and inflation bound."

The key takeaway here is that he is constructive on the markets and remains bullish and optimistic, flying right in the face of caution and pessimism. Odey thinks there could potentially be a bear market in government bonds and we've highlighted that numerous other hedge fund managers agree with him. Odey sees inflation in the world's future as well and if you concur, here are the best investments during inflation.

It's been a while since we last covered this hedge fund as back in October we noted their new short position in Provident Financial (LON: PFG). You can also read Odey's previous market commentary here.