Capital Flows and Asset Markets

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The performance of listed franchisees and franchisors had attracted my interest some time ago. Can big listed franchisors continue to endlessly grow even as their franchisees are suffering financially? Surely pain for franchisees should eventually pass up the food chain.

Back in the free market era (circa pre 2016) autocallables (structured products in Europe) were guaranteed time bombs in financial markets. Essentially, they sold volatility to create yield products. In calm markets, they artificially reduced market volatility, but in crisis markets they amplified market volatility. Originally invented in Japan, they cost retail investors so much market, they eventually fell out of popularity. Korea is now the financial mecca of equity linked autocallables. If you want to know more - see the autocallable and volatility tab on my home page. I have had a few investors ask if there is any risk they blow up with this sell off. So I will present the most recent data I have on Korean autocallables, and allow you to make up your own mind.

Typically spikes in VIX coincides with a fall in autocallable issuance, as happened in 2015 (China devaluation fears) and 2020 (Covid). We saw a drop off in issuance as interest rates rose in 2022, but over the last year issuance has been relatively strong.

In February, the most popular equity linked products are below. Kospi 200, Eurostoxx 50 and S&P 500 are the most popular indices, with Samsung Electronics (#3), Nvidia and Tesla being the most popular single names.

Are we at risk of triggering a volatility spike with any of these popular names? On the KOSPI - we can see the dividend futures remain lacklustre - which is a neutral sign.

Kopsi Volatility does seem to want to break higher which would be negative for markets.

Kospi 200 has not hit a new high since 2021, which would imply there is large amount of volatility selling going on. The future direction of the Kospi market is largely determined by two stocks - Samsung Electronics and SK Hynix - both semiconductor plays. Of the two, SK Hynix (lower chart) has benefited from recent enthusiasm for AI plays.

I would say there is definitely some risk to the autocallable market from weakness in the Kospi 200. S&P 500 and Eurostoxx 50 both tagged new all time highs recently, which makes the risk of a blow up here less. But when I see 8mth generic VIX (UX8) turning higher, downside risk to the markets tends to be elevated.

On an individual stock basis, clearly there is risk in Tesla. Should it break 200, I would expect some problems in the autocallable markets. Typically autocallables are sold with a round number barrier 50% below spot where the banks can return risk to retail - so with Tesla trading around 400 early this year - 200 would be a likely barrier.

So there is a chance of an autocallable blow up, but with VIX already at 24, the risk reward of a long VIX trade is very tricky here.

What does look under-priced is corporate debt spreads. If you think autocallables are about to have an even, then corporate debt spreads looks far too tight.

In my view, I think it is correct to worry about market and corporate debt valuations - and maybe autocallables makes things worse, but will not be the trigger - they will act as an amplifier.

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At the heart of what I am trying to do is capture a shift away from the current economic and political system, that is a system that favours capital over labour. There are a lot of reasons for this, but the key trade at the heart of this view is a long gold/short treasury trade. Over the long term, we are still early to this trade, but in February, we saw a reversal to GLD/TLT, particularly at the end of the month.

The cause of this is not hard to find. Investors are seeing weakening US economic data, and are starting to price in interest rates cuts in the US. The 2 year treasury yield had a steep fall at the end of February. We also saw the cost of corporate debt fall, which is beneficial for US stocks, and hurts my short book.

It is very easy for me to see how investors can say that nothing has changed, and we are going back to the perfect days when the Federal Reserve cuts interest rates to protect markets, and US markets continue to soar. But for me February said to me the exact opposite - that the US led economic system is coming to an end.

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As I gear up for the fund launch, I am slowly but surely shaking off the apathy of being a personal investor and moving back to fund manager mode, and this is pushing me back to using my own trading rules. Personal investors in my experience are much more tolerant of losing positions. That is holding on to a mistake in the hope that it will “come good”. Certainly, I have been guilty of this in recent years. But now I am investing with a purpose - I am bringing back my trading rules.

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I have been asking my self two related questions. Can DOGE really cut enough spending to keep the US from a debt crisis, and secondly, should I move from a GLD/TLT strategy to a GLD/SPX strategy? If DOGE is a sign of reduced government spending, then this is deflationary, and should be good for bonds, and bad for equities.

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Nothing lasts forever. Sometimes when your entire investment career has only seen a bull market, then its hard to imagine change is even possible. But it does come. When you look at how far the S&P 500 has outperformed treasuries in recent years - not expecting change would seem to be the wrong attitude.

After a record amount of comments on the last post, and a huge volume of direct emails and even a few WhatsApp messages - I have settled on Brumby Capital. First of all, a brumby is the name of a wild untamed horse in Australia, which gives a rough association to both me and to Horseman capital. Australia’s most famous poem, “The Man From Snowy River” refers both to wild horses and horsemen, so that makes it feel welcoming, at least in my mind.

Even more apposite, is that Australia’s best provincial rugby team, the ACT Brumbies, is my team. For a long time at the Horseman offices, and now at my home, this signed jersey from the 2001 Championship team has hung proudly.

So Brumby Capital is the way to go. I may change the logo at some point to something more brumby, and less chess, but that is for when I have more time. Thank you everyone - and for the subscriber that suggested Brumby Capital, 6 month free access is coming to you.

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Naming a fund is a real chore, and I need your help. In my experience, fund management firms have two main different options for fund naming. They can name after themselves, or use some slightly esoteric words that describes their “values”. Examples of the first abound - Soros, Rokos, Balyasny are just a few. Of the second, we have LTCM, Citadel, Two Sigma, Renaissance Technologies, Global Asset Management are also just a few.

When I had been running the Horseman Global fund for a while, it always amused me to find investors thought the Horseman name was based on our “values” - ie the four Horsemen of the apocalypse. Of course, the firm was named after the founder John Horseman, but it still amused me. I suspect we have Zerohedge to thank for the association.

When I purchased the firm I did rename it to Russell Clark Investment Management. I toyed with names like Coast to Coast Asset Management - which reflects my love of basketball (Coast to Coast is getting a defensive rebound, and then taking the ball all the other way for a score - at least that’s what we called in in the 1990s. I liked this because I would often short companies I used to be long) - but all were either already taken, or had some negative connotations.

As I have being setting up a new fund, I have been asked if I really want to use Horsehead Capital as a name. The pros for me, is that when you get a call from Russell Clark of Horsehead Capital, you are going to know who that is. I also have this belief in the investment strategy is the business strategy - that is my investment philosophy “solves” problems for big allocators. In that way, I like to think that “I am making you an offer you can’t refuse”. Of course, some people think linking yourself to a mafia don is an unwise business move - for me, being associated with one of the greatest movies of all time is fine by me.

So dear readers, I am asking for your help. Please feel free to comment on the idea of Horsehead Capital as a name - either for or against, and even suggest alternative names. The best comment gets a free 6 month access to paid posts. Thanks in advance.

Russell

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Trump has done exactly what he said he was going to do, and negotiated with Russia directly to end the war in Ukraine. The Trump deal with Russia could be very bullish for Europe, as it could see Russian sanctions lifted, and oil and gas prices fall. This would be particularly bullish for Germany, as it has suffered from high energy prices. Although far less than in 2022, European energy prices are far higher than in the US or Russia.

Likewise, increased food supply from Ukraine and Russia could be bring down food prices - which would be bullish.

After decades of stagnation, Europe has broken out of its range, even as the Trump deal with Putin would seemingly be a negative.

It is easy to argue the opposite way. Generally speaking, when a dictator has succeeded in using force to increase their power and prestige, it is difficult for them to give up the gun, and the Baltics, like Ukraine used to be part of the Soviet Union. It is hard to find any equity weakness in this area. MSCI Baltics has ripped.

My best guess for all this bullishness would be the likelihood that the German government is going to abandon is fiscal austerity, and move to a more US style fiscal expansion - which should be good for equities and bad for bonds. That is Trump abandoning Ukraine has forced Germany to abandon austerity - and that is bullish.

The more interesting question is whether this is good for China or bad for China? On first blush, the market has decided it good. To be fair, for the Chinese tech sector we have also seen the emergence of DeepSeek and the rehabilitation of Jack Ma, and so the Hang Seng Tech index has doubled in 6 months.

On a more geo-political view, the implication is that President Trump is moving to a sphere of influence model - where Europe has to deal with Russia and its neighbours, while the US deals with its neighbours how it sees fit. The logic then is that China is free to deal with its neighbours how it sees fit too - and will not suffer consequences. In other words, China can harass and absorb Taiwan with impunity. For investors in Chinese assets this is bullish as you can now discount the risk of sanctions - which is what hurt foreign investors into Russia assets. Gazprom London listing is an example of this risk.

If Kissinger, who talked to Trump extensively during his first time, was still alive, then I would say this was unequivocally bad for China. “How so?” you might ask? Kissinger was instrumental in the ping pong diplomacy of the 1970s, that saw China and the US establish diplomatic relationships. For those you who learn history from popular culture (I learnt more about the royal family from “The Crown” that I ever learnt from any history class), Forrest Gump playing table tennis in China was basically seen as a way for the US to reach out to China. Kissinger was a prime mover in this. The driver of this détente was to isolate USSR- and from a economic point of view, betting on China versus Russia from this point of time made you a sure fire winner.

First of all there are two things to remember - China and Russia will always be important nations, by dint of the their population and land mass respectively. When they are aligned, they are very difficult to defeat, as we have seen in Ukraine, where Chinese technology has kept Russia in the game. But China and Russia are not natural allies - for most of their history they have faced off against each other. Hard to believe now, but the Soviet Union was not even that supportive of the Chinese Communist Party in its civil war for control of China, at least until the end of the Second World War. Prior to this, China/Russian relations has been defined by battle for control of the far east. If the US can bring Russia into the fold, then China become extremely exposed on oil imports, just at the US was in the 1970s.

China like the US in the 1970s is now heavily reliant on the Middle East for its oil. Bringing Russia into the fold would make energy a choke point for the Chinese economy.

Kissinger is no longer with us - so I don’t know if this is part of the plan. But Trump has always signalled that China is the true enemy of the US, not Russia. And a secure Russia would probably go along with a strategy that weakened China, if only to prove the importance of Russia to both the US and China. The thing is Kissinger had a clear aim of avoiding an open clash between the USSR and USA. Trumps aims tend to be less clear, at least to me. If it is the Kissinger line of thinking, then the current rally in Chinese tech is clear trap. But if we are moving to sphere of influence, and deal with China, then perhaps they are a buy. I find geo-politics difficult to read - but all I know is that government spending is going to go up globally - and that is bad for bonds. Japanese bonds continue to be weak.

Politics is a funny thing I have found. It is not always clear how politicians are going to behave - which I why I suspect voters loved the move to free markets in the 1980s and 1990s - it was a move away from domineering politicians. Having fallen out of love with free markets - we are moving back to domineering politicians. Markets think a deal with Russia is bad for oil prices and good for China - but I could see the reverse being true.

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I am at heart a thematic investor. I find a theme that I really believe in, and then commit to it. This has pros and cons. I will ignore assets that are doing well that don’t fit this theme so can miss out on substantial upside, but the pro is if I am right, I tend to boss the market. And the simplest, biggest theme I can find is that we are moving from an era of excess capital to capital scarcity.