John Kleinheinz's hedge fund Kleinheinz Capital recently sent out its year-end market commentary and 2011 outlook. The focus? Emerging markets and why inflation is the biggest threat to the belief that those countries can rebalance global growth.
Emerging Markets / Developing Economies
In the hedge fund's third quarter commentary, Kleinheinz said Russia is the cheapest emerging market. Its commentary this time around focuses on developing nations in general. It feels that food inflation is a large threat as it causes social unrest. However, the most important reason inflation is a concern is because,
... If developing economies cannot grow at above trend levels in a non-inflationary way then the whole proposition that these economies can gently rebalance the world economy may be untrue. The above average rates of growth in markets like China may simply be the result of trade surpluses that arise from lower cost of labor and fast monetary growth spurred by large domestic and foreign investment in capacity. Without real productivity advances and a migration to higher value-added products and services, which would allow higher incomes, the citizens of those countries cannot be expected to upgrade to a Western lifestyle that favors consumption over savings.
End of Bull Market in Treasury Bonds?
Another interesting focus of Kleinheinz's year-end letter is the notion that the three decade-long bull market in U.S. Treasuries is over. In the past, Kleinheinz held some bonds as a hedge. However, it sold out of those positions in the third quarter of last year. Since then, it's begun "tactically shorting bonds ... until we become more certain about the timing and magnitude of a secular decline in longer dated bonds."
On the other side of the spectrum, the hedge fund has also started short positions in the Japanese yen and Japanese government bonds. The rationale behind the play? "Simply put, because Japan cannot afford to let its interest rates go higher, its currency will likely go lower to adjust interest rate differentials, slowing trade surplus and dwindling savings."
Readers will recall that hedge fund colleague Kyle Bass is short Japanese government bonds as well.
At the end of 2010, here were Kleinheinz's Top Holdings:
- Apple (NASDAQ:AAPL)
- Research in Motion (RIMM)
- China Mobile (NYSE:CHL)
- Veeco Instruments (NASDAQ:VECO)
- Monsanto (NYSE:MON)
- Hong Kong Exchange & Clearing (OTCPK:HKXCY)
- LUKoil Holdings (OTCPK:LUKOY)
- Google (NASDAQ:GOOG)
- Major Drilling Group (MDI)
- Yahoo! (NASDAQ:YHOO)
From the third quarter to the fourth quarter, the most notable changes in the upper echelon of its portfolio were Baidu (NASDAQ:BIDU) falling just outside of the top 10, and its position in VECO ramping up a few spots.
Since inception, the fund has seen a compound annual growth rate of 26.6%. Intriguingly, you can replicate Kleinheinz's portfolio via Alphaclone. Investing in Kleinheinz's top 10 US equity holdings returned 19.5% 2010 compared to the hedge fund's actual performance of 22.86%.
To conclude, we'll leave you with a quote from John Kleinheinz's letter that stuck out the most: "A broad correction in stock market multiples will only occur if ten year U.S. government bond rates exceed 5% and corporate earnings growth slows to low single digit levels."