THE GURU OUTLOOK: HEDGE FUND MASTER JULIAN ROBERTSON

Julian Robertson is the former head of Tiger Management Corp., one of the first hedge funds. He is best known for turning $8MM in seed capital into $22B at the peak of his company’s existence in 1998. Ironically, his refusal to buy into the tech bubble proved to be the cause of his downfall.  He was of course, ultimately proven right.  Today, he spends his billions in philanthropic efforts.

Robertson made waves in a late 2007 when he called for a “doozy of a recession”. At the time, it seemed like a rather shocking statement as the slow-down in the economy appeared to be relatively benign. We all know what happened next.  Robertson had shorted CDS and sub-prime securities and made millions in the downturn.  Robertson was unfazed by the downturn as he then turned bullish on certain equities and was a dip buyer in late 2008 and early 2009. He has proven prescient throughout his career and the last few years are nothing more than the cherry on top.

In a recent interview with the Financial Times he outlined his current outlook. Roberton’s overall macro theme is not unlike trades we highlighted in last week’s edition of the Guru Outlook which were largely based on massive money printing and an inflationary environment.  Robertson believes the Fed’s money printing is likely to cause rampant inflation and could eventually force the Chinese and Japanese to stop purchasing long-dated treasuries.  He thinks interest rates could skyrocket as high as 15-20%.

As of late last year Robertson had implemented a curve steepener trade to benefit from falling short-term rates and rising long-term rates, but has recently switched to a curve caps trade as short-term rates obviously can’t fall any further.  Without getting into the gory details, Robertson is essentially buying puts on long bonds via swaps.  Robertson details the transition:

“The curve steepener was a measurement of the differential between short and long term rates and we figured short term rates would go down and long term rates would go up. We didn’t do well on the long term part, but the short term part worked out so well that actually we made a little money on the trade. Short term rates are nothing, so they can’t really go below nothing. We’ve shifted the curve steepeners, which are basically long-term puts on long-term bonds… highly leveraged and they’re like puts in that you know what your risk is, it’s measured by what you paid for the put. I think (long term rates) can go to 15, 20%….

Although he is effectively betting on inflation, Robertson, curiously, does not like gold.  He recently referred to gold bugs as “crazy” and likes the bond short better than the gold long.  Of course, David Einhorn and John Paulson would take issue with his stance.   Robertson is highly critical of the current monetary policy:

“I ask anyone to give me an example of an economy beefed up by huge amounts of quantitative easing that did not inflate tremendously when or if the economy improved. I think what we’re doing now will either fail, or it will result in unbelievably high inflation – and tragically, maybe both. That would mean a depression and explosive inflation, which is frightening.”

At this week’s Value Investing Congress Robertson highlighted some of his favorite positions.  Robertson likes Mastercard (MA) and Visa (V) likely as a continued play on mounting U.S. private debt.  He also likes certain tech names including Intel (INTC) and Google (GOOG) which he described as good value plays.  He also detailed some other micro and macro positions in the FT interview (he does not necessarily own the following positions, however):

Long:

  • Apple (AAPL)
  • Gold Stocks
  • Goldman Sachs
  • Aussie Dollar

Short:

  • $US Dollar
  • Copper

As for the macro outlook – Robertson believes we have simply kicked the can down the road.  He sees some relief in the economy in the medium term, but still believes we are bogged down by all of the same problems that caused the financial crisis to begin with:

“I really do think the recession is at least temporarily over. But we haven’t addressed so many of our problems and we are borrowing so much money that we can’t possibly pay it back, unless the Chinese and Japanese buy our bonds.”

Despite his mild bullishness on certain sectors and names Roberton’s long-term outlook is none too uplifting :

“we’ve got to face this problem of the major purchaser of our bonds maybe not being around later, maybe not being around to bail us out, and I think that’s something we have to look at seriously. And because there is such a serious problem for us, that causes me to probably be missing out on a lot of the profitability that is inherent in today’s stock market.”

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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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Comments

  1. “Robertson believes the Fed’s money printing is likely to cause rampant inflation and could eventually force the Chinese and Japanese to stop purchasing long-dated treasuries. He thinks interest rates could skyrocket as high as 15-20%.”

    I find it very interesting that China just did their first bond offering denominated in their own currency, which was very well received by the markets. everyone who follows the ascendancy of China kinda assumes, i think, that the baton hand-off from the US to China will take many decades and is some kind of abstract, distant threat like global warming. Granted, China’s export growth model has always been based on selling to the US consumer, which locks China into the US economy and forces them to support a strong dollar. In public, China is not saying anything that would damage its vast dollar reserve and USTreasury holdings, but by their actions, it’s clear that they are accelerating their timeline to decouple from the US economy and their forced support of the US dollar, ie using their dollars to buy up hard assets all over the world, still buying US treasuries but shifting purchases to shorter maturities to be less exposed to a US fiscal implosion, and initiating a massive domestic stimulus program that emphasizes domestic consumption.

    With the domestic currency bond offering, we are now seeing China take baby steps towards developing robust, domestic capital markets. Developing a local debt market is very important, i think, because it gives China more legitimacy than its equity markets alone, which are still viewed as highly speculative. Although debt has been toxic to the US economy, I think it is key to China’s development as it tries to grow an internal consumer market.

    Things are happening so fast with respect to China that I don’t think you can think of the relative fall of the US and the rise of China in terms of decades anymore. I don’t know when, but someday a lot sooner than we think, China will float its currency. After that, the inevitable will happen where China stops buying US Treasuries. If Robertson is right, this will be a nuclear bomb for the US economy and we will be living in a totally different world.

  2. No pain, no gain. The US and the World must go through a signficant crisis or crises to get thing back in balance. Why should it be different today than in the past?

    Gold. How high must future inflation be to make gold worth over $1,000 an ounce. Quite high. If inflation runs briefly at 15% from 2011 to 2015 then a gold price of $1,100 now is probably perfectly sane. Alternatively, if inflation rises to a more or less permanent plateau of about 6%-7% (from an averge of 3%) then today’s gold prices will ultimately make sense. For now it is speculation that inflation trumps deflation. Currently the money supply is growing at a torrid pace in China but consumer prices are falling. The additional liquidity is going into asset speculation and infrastructure projects. Same in the US and much of Europe.

    I doubt anyone has a clue just how much bad debt the world’s financial institutions hold. The estimates from the Fed, IMF, big bank analysts, etc in 2007 and 2008 seem to have been wildly understated. It is moving target anyway. Credit issues are no longer in focus, which makes them dangerous.

    Equities usually do very poorly (in the short-term) during periods of high inflation due to the increase in the discount rate used to calculate what a reasonable P/E would be (that creates a great buying opportunity), but ultimately over the long run (say 20 years) equities keep up with inflation quite well so long as you don’t buy them (and better yet sell them to buy later) at bubblish market peaks (1965, 1972, 2000). From a long-term perspective the market is not cheap nor especially expensive right now. In the short-run, it might be expensive (if we quickly see deflation or inflation pick up or profit margins deteriorate due to lack of sales increases following all the cost cutting.) Or it might be inexpensive, if inflation stays low but positive, interest rates stay low and margins continue to improve (Goldilocks scenario).

    The key question is whether there will be a significantly better buying opportunity in the near future (next year or two) or not. When will Mr. Market suffer his next depressive episode?

  3. Robertson says, “I ask anyone to give me an example of an economy beefed up by huge amounts of quantitative easing that did not inflate tremendously when or if the economy improved.”

    How about Japan in the last 20 years? I guess you can argue the Japanese economy has not improved yet. And perhaps that is our fate, years of a stagnant economy with low T bond rates.

  4. I would have to agree. Those expecting rampant inflation and higher rates are going to be disappointed.

  5. There is no way the government is going to LET rates go that high. It will essentially bankrupt us or put us into a spiral of destruction. The government is well aware of this. People are discounting the U.S. government’s abilities to influence the markets through fear. How different things would change if Geithner and Bernanke came out and said that banks were encountering problems again and Iran and Israel went to war…

  6. @jack
    you might want to read postings from pettis when you say

    “still buying US treasuries but shifting purchases to shorter maturities to be less exposed to a US fiscal implosion, and initiating a massive domestic stimulus program that emphasizes domestic consumption”

    their massive stimulus program is going into more overcapacity and speculation (in commodities, RE, and stocks). they do not have enough internal demand to “go it alone” so to speak. they need their US and Euro customers as they are mercantilists.

  7. Japan’s public external debt and term structure is totally different then the US. US duration is getting shorter and is held by Asians. They’re not comparable.

  8. I believe that if China and/or Japan pulls back even marginally in their purchase of US Gov’t paper, all rates (short, intermediate and long) will rise dramatically. First, who is out there aside from these two to buy our trillions second, who would buy any 30 year paper at 4% and finally, since when has our Gov’t ever been able to regulate LT Rates?

    In fact, I am so convinced that Robertson has it right, I’ve been trying to find someone that understands “CMS Rate Caps” so I can enter an order to duplicate his trade. Even if I’m wrong, these things are some kind of leap option so I know my maximum exposure at the outset.

    Giacomo

    PS – Does anyone know who I might go to that can execute orders in these Rate Cap vehicles. The houses I’ve dealt with are all familiar with Robertson’s video, but no one seems to know anything about these particular derivatives.