There is an important anomaly within an established 100-year global climate cycle that has appeared in both of the last two centuries, and we are on the verge of a recurrence of this anomaly. The anomaly is represented by a temporary counter-trend move lasting several years within the uptrend in global average temperatures during the first half of the 100-year cycle, while global average rainfall continues in an uptrend. This phenomenon was named a “cold wet saddle” by early climate scientists.
The significance of this anomaly is that cold and wet conditions globally on average, including during cold wet saddles, are associated with a reduction in international wars but outbreaks of rebellions, revolts, insurrections, civil disturbances, civil strife, civil wars, revolutions, anarchy, piracy, gangs, religious controversies & wars, dysfunctional governments, liberalization of laws, economic boom and bust, and volatile prices for goods and services.
It is therefore no surprise that during the past two cold wet saddles equity markets as represented by US equities have exhibited greater volatility and/or sideways action, likely reflecting the effects of the social and economic uncertainties associated with those cold wet periods. In year 2000 the long bull market in US equities ended and was succeeded by a series of cyclical bull markets with a notable lack of overall trend. Interestingly, year 1998 saw the beginning of a decline in global average temperature down to the present day of over 1 degree Fahrenheit, down to nearly the 200-year average temperature of 57 degrees despite the impact of global warming. This decline will have been imperceptible to many, as both hot and cold extremes have increased around the globe. The winter of 2013-14 was the coldest and snowiest in modern times in parts of the Northern Hemisphere, including the U.S., Canada and Japan. In addition, since 1998 global precipitation has been at elevated levels. Meanwhile, we have already seen the Arab Spring and the civil war in Syria, and a continuation of other civil wars around the globe. Ukraine and Iraq appear to be joining the list.
The recent decline in the Earth’s temperature may be due to a combination of both long-term and short-term climate cycles, and the developing cold wet saddle anomaly promises to be a potentially lengthy, 10-year cold wet period starting next year in earnest. The prolonged cycle of wide weather ‘extremes,’ the worst in at least 1,000 years, is expected by experts to continue and perhaps become even more severe. This bolsters the case for the developing cold wet saddle to be more pronounced than usual. Whilst climate cycles are not the sort of thing that allocators typically pin capital market strategies on, the grim message coming from this century’s cold wet saddle is that it will be an extreme one, heralding a scenario of heightened social, political and economic uncertainty in the years ahead. There is already a high level of uncertainty affecting capital markets due especially to western debt problems and aging populations. It appears likely that uncertainty will become significantly greater in connection with this climate anomaly, and probably to the detriment of equity markets.
The impact of the cold wet saddle anomaly therefore seems likely to lead to an increasing interest among investors for market neutral strategies that can make money in the capital markets. Investors will likely seek, and Fund Promoters and Fund Sponsors will provide, a number of Fund vehicles and products to deliver these strategies. In the Hedge Fund space there will likely be a growing appetite for strategies such as equity market neutral, equity long/short, corporate restructuring strategies that are market neutral, and convergence trading arbitrage strategies involving similar securities and a market neutral stance. Equity market neutral and global macro strategies tend to have low market risk, but the latter strategy does get involved in currency bets, carry trades and yield curve bets. Great care is needed in selecting managers because convergence trading and corporate restructuring Funds have large downside risk exposure due to event risk, as do credit risky securities (bonds that are not US Treasuries). Whilst it is anyone’s guess whether investors will on the whole ultimately make money from these strategies, it seems likely that if this trend toward market neutrality becomes another fad on Wall Street, Fund Sponsors and Promoters could likely experience another golden age.
What does this have to do with offshore Fund Directors? Simply put, Directors that are aware of this unfolding scenario will be better placed to monitor and vet the strategies of their investment managers. They will be able to differentiate better in advance to avoid problems. They will be part of the elite group that will have an advanced and enhanced ability to manage risk, and thus an advantage over their peers. If you come across an offshore Fund Director, ask them what Hedge Fund strategies they favour over the next ten years!
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