market folly

Today we present you the latest market commentary and current outlook from Crispin Odey, founding partner and portfolio manager at Odey Asset Management, one of the premier and widely regarded UK based hedge funds. Odey currently manages around $5 billion for institutions, endowments, private banks and individuals. Crispin founded the firm in 1991 with a focus on preserving capital and generating superior returns.

In terms of recent results, we saw in our May hedge fund performance update that Odey was down 10.96% in the month of May alone. Crispin addresses this and other topics in his most recent commentary:

"May was ugly. Markets did exactly the opposite of what I was expecting them to do. Government bonds rose by 8%, equities fell by 8%. In my hedge fund I was 100% short the bonds and 100% long these equities. Risk controls cut in and ensured that we lost only 1.5% on the bond book, but we also lost money on the currencies. We took the net equity book down to 40% at one stage and we reduced the bond short book to less than twenty percent. This was not one's finest moment.

However, do all those price moves change much? Are there lessons to be learnt? What are markets predicting?

Questions, questions, questions. Sure the ECB handled Greece badly. They should have investigated bankruptcy. Sure the Spanish Caixas need recapitalizing and some honesty needs to be brought to bear in property loans in evaluating Spain, but should this blow off course the natural reflationary policies being pursued by the authorities. The price action of May for all asset classes was only explicable on the grounds that Europe and indeed the world is going to follow Japan into deflation.

The line of argument goes. Firstly, credit cannot expand because there is a standoff between those who have the equity to buy assets and those selling the assets; over price. The equity participants are asking for a discount on the assets. The sellers, thanks to low interest rates, do not have to sell and are holding out. This presents an uneasy truce but it does not permit credit gains.

Secondly, governments are only too aware that this crisis has left government finances in an untenable position long-term. Tax revenue has rarely managed to get about 40% of GNP. Government expenditure is now universally running in excess of 50% of GNP. In Osborne's case, the need to bring expenditures into line with revenues is compounded by the fact that if he does not announce cuts immediately, he cannot blame the outgoing government.

Markets are worrying in many ways rightly, that with the corporate sitting on cash, a fall in government expenditure is not going to be met by a rise in private sector spending and employment. Thus the market in May is pricing in a double dip.

This has been compounded by the weakness in the corporate bond market of late. With the one year ECB repo of ?400 billion coming due on 1st July, every bank is nervous that the ECB may not renew it or will only renew it only quarterly. Here I remain more positive. For me the lucky thing for Europe is that Germany may have the strongest economy in Europe, but they also have the weakest banking system and that is some claim when you look at the competition in Europe. This means the 1st July is likely to bring news that the repo loan is extended and most likely for one year. Thus fear of deflation provokes further reflationary policies.

This brings me on to the future. It is highly unusual for a new bear market in equities to begin even as profit estimates are being upgraded as they are now. Equities are cheap against all other assets, pricing in a 30%-40% fall in profits.* They are also under-owned. That makes them vulnerable to changes in sentiment. That makes them volatile, but it also makes them attractive as investments.

As some stage the re-flation will result in inflation and all of these fire practices will help the fund to do well. But in the meantime it looks like returns will be allied to volatility. *Even in 2009, with the banks going bankrupt in the UK, profits only fell by 8%. Written the 28th of May 2010."

Certainly intriguing commentary from the Odey manager and for more from this hedge fund we've previously covered Odey's European Fund commentary from earlier in the year. Additionally, we often cover fund manager Hugh Hendry on the site and keep in mind that before founding his firm Eclectica, Hendry was previously a partner at Odey. As such, we recommend you also view Hendry's recent thoughts where we learned he has constructed an Asian bear portfolio.

For more market commentary from top investment managers, head to our compilation of various hedge fund investor letters.