Fasanara Capital | Investment Outlook | May 3rd 2013
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2 | P a g eMay 3rd 2013Fasanara Capital | Investment Outlook1. Chasing the yield (income stream) in the markets has now become chasingthe rally (capital gains), which is turn is chasing the next bubble. TheBubble Chain now expanded from Govies and High Yield into US Equities.2. Current bubble environment reminds us of the price of wanna-be AAApaper during the 2007 bubble. This time around, it is not InvestmentBanks pushing assets into unsustainable territory but Central Banksthemselves - with obviously more margin for error, but not infinitely so.3. But the Bubble Chain was not alone. Another chain was also in sight in thepast few months, a Deleverage Chain. The lack of GDP impacted themarkets that are still trying to price themselves against real activity (asopposed to Central Banks liquidity): Commodity Markets, EMs, Gold.4. The bubble Chain and the Deleveraging Chain send inconsistent signson the state of the economy/financial markets: one of the two will haveto give in at some point, allowing for a re-alignment.5. What has Gold’s ictus taught us? Liquidity-driven bubble-pronemarkets are vulnerable to ‘gap risk’. Toppy markets are gappingmarkets. Low volumes, margin calls on leverage, uncertain macro,evaporating liquidity are all concurring to make that ‘gap risk’ larger.Discontinuities like Gold’s heart attack will increase in frequency.6. Correction of 20%-30% in the US in the months ahead would be all butunjustified. Strategy-wise, we are not buyer at these levels, so we takeprofits on optional longs too and go flat, waiting for better valuations.Missing a rally is not as bad as incurring into a potentially severe loss.7. One thing is to get accustomed to lower returns expectations, one thingis to get accustomed to outsized risks. In normal markets, it used to below risks for low returns, or high risk for high returns. Now we are livethrough a high risks for low returns environment.
3 | P a g eNominal Rallies and the Fallacy of GrowthDuring the month just past, the market moved along the path of expected outcomes.- Italy managed to form a grand coalition government, after two months ofinconclusive discussions, and a relief rally was generated out of it, spreading tothe whole of Europe.- Nominal rallies on Central Banks liquidity were manufactured in the US andJapan, where equity markets reached new highs.- Conversely, also as expected, economic fundamentals deteriorated further,with the bulk of economic indicators signaling slower growth or outrightcontraction for most G10 countries.The disconnect between financial markets and the real economy increasedmarkedly under the threat of monetary activism and financial repression. A waveof newly printed Dollars, Japanese yen and British pounds, together with the expectationof money printing by the ECB (now that Italy is again an eligible recipient of NorthernEuro parental controls), forced bonds to new lows and investors into lower qualityassets with shaky fundamentals, lower and weaker on the capital structure, fromsubordinated debt to equity.Chasing yields has now turned into being afraid of missing the rally. Thecomplacency we saw in January has now returned to the markets, as Central Banksrepresent the only game in town and no clear catalyst is in sight to spoil the party.To us, chasing the yield (income stream) in the markets has now become chasingthe rally (capital gains), which is turn has become chasing the next bubble. Tovisualize the bubble formations deliberately provoked by financial repression policies,we can reconstruct the following timeline:GovBondsCorpCreditHighYieldUSEquityThe Bubble Chain timelineSummer 2011 End 2011 H1 2012 Q2 2013First entering bubble territory
4 | P a g eFirst it was government bonds, since summer 2011, rallying to rock-bottom levelsnever seen by market participants, no matter how old they were. In the followingmonths yields reached their 200-years lows in Germany, 220-years lows in the US, 140-years lows in Japan (and 500-years lows in Holland). As Central Banks monetized debtstock and fiscal deficits, closing the funding gap of insolvent governments, the publicsector crowded out the private sector, pushing it into the next bubble.The next bubble was Corporate Credit and High Yield. HY, in particular, ralliedstrongly early in 2012 and all across the year, until some 6X net debt / EBITDA capitalstructures could enjoy 5% yield-to-maturity. Low historical default rates argumentswere soon called up by experts to rationalize the event from a fundamental perspective.And after yields compressed to farcical levels, it was time to alleviate covenants andimpoverish the collateral/recovery value standing behind such yields: lite-covenant newissues counted for 30% of total issuance in 2012, vs 5% in 2005 (admittedly anotherbubble year, in pectore), whilst reaching record volume issuance at $700bn or so (morethan in 2007, yet another infamous bubble year, this time a mature one, and ready tobust a year later).From High Yield, as of August 2012, the bubble virus moved onto to front attackEquities. And equities inflated progressively, first in Europe (on the anticipation ofunlimited money supply by ECB, who had just rediscovered its basic function of lenderof last resort to insolvent southern Europe), then in the US (who was later to reach newall-time highs in 2013), and finally in Japan (who learned the trick of currencydebasement from the FED and decided to implement it in truly monumental fashion - formore than 20% of their GDP in one single year).Whilst equities were reaching new highs, investors competed to outbid the mostsubordinated credits. Virtually no country in Emerging Markets wild frontiers space isleft around the world with a 10% yield attached to it (with the notable exceptions ofVenezuela, Argentina and Pakistan). This month we learned that Rwanda was offeredhalf of their GDP in a new bond issue (heavily over-subscribed) for less than a 7% yield(video). Earlier this year, Ivory Coast did some similar magic. In the developed markets,this week BBVA issued a $1.5bn super subordinated paper (Non-Step-Up Non-Cumulative Contingent Convertible … which really means the 9% coupon could be paid,but it can also not be paid and then make no big deal about it): total bids exceeded 9bn.And the list goes on.As we argued multiple times, ‘the current bubble environment reminds us of theprice of wanna-be AAA paper during the 2007 credit bubble, under the sign-off ofbullet-proof Rating Agencies calculations. At that time too, shorting credit was madeinexpensive. Timing for the bubble to burst was uncertain, as it is now, but inexpensive
5 | P a g emeans that it did not matter that much after all. This time around, it is not theInvestment Banks (and their financial engineering) pushing credit intounsustainable territory but the Central Banks themselves (and their financialengineering) - with obviously more margin for error, but not infinitely so.As we argued in February Outlook, ‘perhaps, the name of the game in 2013 is tomake sure to invest into a real rally as opposed to a fake one, or to investdeliberately into a fake rally, after careful assessment of the costs of hedging it outof its fake context. We believe that paying attention to the visible and not so visiblefacets of Currency Debasement cross-markets holds the key to safely navigating themacro picture in 2013’.To complete the picture, joining the race to Currency Debasament, the ECB hascandidly admitted their open-mindedness to negative nominal rates. As we arguedback in January Outlook:‘’ We could even imagine a situation where the ECB decides to bring nominalrates to negative territory, quite extraordinarily. Indeed, negative rates wouldlikely spur repayments of LTRO money by banks in core Europe (from the 30th ofJanuary onwards, loans can be early redeemed), thus further compressing ECB’sbalance sheet, in favor of peripheral Europe. Liquidity would float more efficientlywhere it is most needed, leading to a better use of capital from the viewpoint of theCentral Bank. As the issue has been to date one of Liquidity Trap and falling MoneyMultipliers (the difference between base money printed by the Central Bank andM2/M3 aggregate/money supply actually injected into the economy byCommercial Banks loans to household and businesses and other means) this maywell be a tool being discussed in the closed rooms of the ECB. Destroying the costof capital to the extremes might manage to kick start not only loan supplybut also loan demand, which is now minimal, as the private sector fails tofind a reason to borrow money at even low rates. Negative nominal rates maysound like heresy today, but should market return to full crisis mood, we believethey are a real possibility. For once, we have comfortably lived through negativereal yields for a good year now. Moreover, Denmark and Switzerland have alreadyimplemented them, in a desperate attempt to preserve their undervaluedcurrencies. Additionally, after all, we live through the largest policyexperiment of modern financial history, where new records are registered bythe day, and no clear economic theory within Modern Capitalism is left torelate to (be it Keynesian or monetarist).’’
6 | P a g eThe Deleverage Chain timelineBut the Bubble Chain was not alone in the marketplace. While Central Banks weregambling fast and furious on asset values, provoking inflation in financial levers in thehope of spillover to the real economy and housing, another chain was also in sight inthe past few months, this time a Deleverage Chain. The lack of GDP is the elephantin the room of today’s debt-laden economy, and this impacted perhaps themarkets that are still trying to price themselves against real activity (as opposedto Central Banks’ liquidity): commodity markets and Emerging Markets.First it was the Gold mining stocks showing signs of stress, as they headed markedlylower end of last year / earlier on in the year. Shortly afterwards, base metalcommodities felt the hit from expectations of a slowing economy and falling demandfor functional commodities. Growing evidence of China slowing down was then apowerful accelerator. As if a $8trn economy could grow at 8%+ forever, which wouldmean doubling its size in less than 9 years, which would mean creating an output thesize of the whole France every 3/4 years. We have always being skeptical about that,thus incorporating China Hard Landing Risk Scenario in our road map for fat tailcatalysts, as we do not see the scope for exponential growth in a finite environment. Butthe market seems to be surprised by that at every juncture, showing that unreasonableexpectations are structurally built in there (and in the capex plans of the miningcompanies around the world for that matter). Other EMs showed their fragility (ineverywhere expect their credit markets), from Russia to Brasil to India and on and on. Inthe end, it was time for Gold’s heart attack, as it fell off a cliff while underfundedfinancial players panicked to get out of the way until it cleared around a bottom.BaseMetalsGoldMinersEmergingMarketsGoldheartattackThe Deleveraging Symptoms timelineJan 2013 Feb 2013 Apr 2013Feb 2013Showing first weakness in 2013
7 | P a g eConcurrently, in deflationary land, we also recorded declining CPI rates, lower economicactivity indicators and weaker GDPs in most countries.Let us try out few hypothesis out of recent empirical evidence. Contrary toconventional wisdom, and recent evidence from the last 20 years, the expansionin G10 balance sheets seems to be benefiting local markets more than it isbenefiting emerging markets.It used to be that the credit expansion of developed nations exported inflation and droveup unit labor costs and asset prices in foreign nations first, before it was having anyimpact on local markets (perhaps, as in the process Treasuries got bought by suchforeign nations, which are now crowded out by the FED). Different factors might be atplay, and we do not have space enough here to investigate in details. Amongst others,the acknowledgement of financial players that EMs failed to bring any diversificationinto their portfolios (as they proved to be highly correlated to Development Markets inthe last ten years, and with an higher Beta even, thus expanding volatility for the samelevel of expected returns – instead of the diversification benefit one could have wishedfor). Also, more in the real economy realm, money printing is specifically targetingCurrency Debasement now, in our opinion, a domestic policy intended at competitivedevaluation and debt monetization: the result is the most desired tentative repatriationof manufacturing sector in the US, for example, or the competitive advantage forJapanese tech and automakers over South Korea and other contenders to what is left ofglobal GDP growth.Again, we have no space here to expand on the theme. Suffice it to say that we may beseeing something developing here, thus have to keep monitoring the DeleverageChain for more evidence over the coming months.Bubbles Chains vs Deleverage Chain: re-coupling?Most obviously, the re-coupling between the bubble Chain and the DeleveragingChain might happen with the former coming down, or the latter catching up. Orthey can meet half way. Surely they send inconsistent signs on the state of theeconomy/financial markets and we believe that one of the two will have to give inat some point down the road. One chain may be hinting to the Inflation Scenario weforesee, the other into the Default Scenario we still see equally possible. Time will tell.If the deleveraging forces will prevail over the inflationary forces remains to be seen.We suspect that, at present, the Inflation Scenario will have the lead first.Currency debasement in an attempt to reach Debt Monetisation is the holy
8 | P a g emission of G4 governments, as deleverage/deflation brings with it social unrestand reshuffles of political elites. However, absent a Crystal Ball, we still maintain ourlong-term outlook for Multi-Equilibria Markets (as argued extensively in previousOutlooks Nov 2012 and Jan 2012).While the two chains fight each other out, we will continue to test our hypothesis forpositive falsification as the situation evolves. Jury is still out. And in uncertain times asthese ones no one is allowed the luxury to have strong convictions.What has Gold’s ictus taught us? Gapping MarketsTwo weeks ago, Gold’s heart stopped beeping for some time. In a matter of few daysGold lost 30% of its value. As we write, some ground has been recouped, but the damageis there. As negative as we are on global economies held on the thin air of Central Bankliquidity, the movement has surely caught us by surprise and has brought us to questionthe motives of such interesting market action. Here again the jury is still out, but wecan tentatively think of few possible theories, and expose them for testing in thecoming weeks:- Deleverage / Deflation hypothesis: Gold’s flash crash comes after months ofweakness in commodity equities on lower GDP expectations, lower currenteconomic activity (epitomized by China slowing down), and is the precursor ofdeflation in other financial asset classes. Implication: If this was true, equityand HY markets would be catching up, sooner or later, on much lowervaluations.- Recovery hypothesis: Gold as a safe haven is in no need, as the economy is onthe path of true recovery. Implication: if this was true, government bondswould be following, sooner or later, on steadily rising yields, in advance ofCentral Banks planning their exit strategies.- Supply / Demand hypothesis: marginal buyers of Gold are on the loose, whilstsellers are coming up. Cyprus disposing of their gold? There are various ways todispose of its gold: to us, selling it to the market in block trades is the leastefficient one, both to the seller and to the recipient of the sale proceeds. That iswhy we are skeptical about this. In the world of LTROs, rehyphotecations,structured Repos and regulatory capital trades/accounting gimmicks, it seemsnaïve to consider it the only option for monetization. Moreover, I always thoughtmarginal supply / demand has less relevance for a ‘Giffen good’ like Gold, whosedemand tends to rise when prices are higher, and fall when prices are lower. The
9 | P a g estock of Gold is more relevant, and such stock is not tradeable for 80% of thetotal.- Technicals / market structure hypothesis: a large flow of 400tons wasenough to detonate margin calls on an asset class whose ‘financialisation’ isremindful of oil in 2008. For Oil too, the total volume of derivatives was some 15times higher than the underlying available for immediate delivery.Time will tell. For what is worth, we tend to believe the last hypothesis is the morerelevant one, at present. For this reason, we bought on dips, using gold industrymore when proxying our target exposure to equity (in optional format, again).Gold to us is a currency, not a commodity, and one currency which is in limited supply,vis-à-vis paper currencies in unlimited open-ended supply. Numbers should matter, atsome point down the road: this year alone $2.5trn are being printed by FED, BoJ, BoE(ECB might round it up soon), from $1.15trn last year. This compares to net global bondsupply of $2trn only. But they might be able to buy equity too (Japan’s original idea). Sothis is also equivalent to almost 50% of Japan’s GDP, 70% of its market cap at thebeginning of the year (55% now), 15% of the US market cap. In comparison, newly mintgold is valued around 0.12 trn this year. Looking at the stock instead of the flow, thetotal value of Gold ever mined is approx $8.1trn (170,000 tons at $48mn each),compared with total global money supply M3 aggregate of $70trn (and this is calculatedagainst historically low levels of money multipliers, as current levels of base moneycould mean much higher money supply on historical standards). When Gold was lastdelinked to paper money (end of Bretton Woods in 1971), the ratio was around 20%.And we did not even compare Gold to global debt overhang (public and private), atalmost $140trn. This is simple arithmetic. Coming back to raw data helps putting thingsin perspective. These numbers might be totally irrelevant in the short term, but it isworth to keep them in mind when drafting long term financial plans. Now more thanever, as the paper currency debasement going through globally is accelerating atexponential speed and is without historical parallels to refer to.If anything, by the look of the actual demand which was provoked by the fall in prices,one could argue that Paper Gold plummeted on those days, while Physical Gold neverreally weakened that much (as portable gold coins like American Eagles, CanadianMaple Leafs and Krugerrands became hard to source). The divergence between thetwo has now being initiated, pretty much like when Sovereign CDS instrumentsstarted to price in the skepticism over their enforceability (well before their actuallegal ban last – which may itself also see an equivalent in the gold market one day in thenot so distant future, like Executive Order 6102 in 1933, when Roosvelt made it illegalfor Americans to hold gold coins, bars and certificates for investment purposes). Let
10 | P a g ealone the instruments being used to gain exposure to Gold, as counterparty risk andcollateral to one’s contract is questioned (for example, it seems that physical inventoryat COMEX is free falling in 2013).Paper Gold prices could be manipulated down and never adjust to the ballooning moneysupply (once this one picks up speed on base money creation). What it takes is simpleregulation on exchangeability at a predefined rate, for example. However, should a defacto Gold Exchange Standard be established by market participants increasinglyturning to Gold as a store of value against monetary madness and such holders of Goldrefusing to sell at fictitiously low prices, such manipulation would end up beinghighly deflationary, thus preventing the chief target of policymakers: DebtMonetisation. That is why we believe that any manipulation would be short-livedand Gold prices, also just paper Gold prices, have a one-way road ahead in thelong term: up.Irrespective of the right hypothesis, as we stand ready for positive confutation to ourown view, one conclusion seems clear as water: liquidity-driven bubble-pronemarkets are vulnerable to sudden digital adjustment and external shocks, when itis least expected and on the most valuable asset classes too. Toppy markets aregapping markets. Low volumes, margin calls on levered players, uncertainenvironment, evaporating liquidity are all concurring to make that ‘gap risk’larger. Once a bubble is recognized for what it is, the ‘gap risk’ that comes with itshould be the number one concern of portfolio risk management, these days. Aswe argued in several occasion, we are convinced that a truly multi-dimensional RiskManagement macro overlay strategy is paramount to successfully (or just quietly)navigate financial markets in the current environment. Discontinuities like Gold’sheart attack will be recurrent events, increasing in frequency, over the nextseveral quarters/ years. By the time such gap volatility arises, Central Banks maystill be able to provide the parachute (maybe not), but they are likely to be comingon the scene after the detonation, thus unable to soften the market action inbetween.Now, then, where in the Bubble Chain should we expect the next bust? Gold alsoteaches us to expect it where we would least expect it, perhaps.
11 | P a g eShort-Term Strategy: We reduce positions and turn defensive. Potential forheavy re-pricing is real, especially in the US, if Gold is any guideWe do believe that equities in the US entered bubble territory, as they have joinedthe Bubble Chain we visualised above. Which does not mean that they cannot risefurther from here. Indeed, no less than three weeks ago we reiterated our long positionsthere, although we transformed cash longs into optional longs (as a dramaticallyexasperated skew allowed us to buy 12 calls against one put, symmetrically around thespot, leaving us with leverage to the upside and a margin for correction of 10% on thedownside). However, at 1600on the SPX we do believe that we are more in bubbleterritory and we better remind ourselves we are in one, not to be caught in theirrational shopping spree of the herd mentality. As we reiterated in past write-upsobsessively compulsively, we try to differentiate between nominal rallies and realrallies, between real gains and elusive returns, as we try to ride a rally as long as webelieve we can hedge it out of its fake context. For the Nikkei, this meant going longNikkei but hedging the Yen devaluation (which would otherwise have killed the bulk ofthe equity rally YTD: 17% vs 13%). For the US, it means to have the means to hedge apotential re-pricing to the downside, which we now feel is overdue.At current rates, we prefer to turn defensive and take profit on most longs, as webelieve May may be the month for a correction to take place. Potential upside islimited, especially in the US, whilst we see more margin for Europe.US Equities have entered bubble territoryFrom a technical standpoint, the graph of the S&P has some striking similarity withOil in 2008, Gold in 2011, Tech stocks in 2000, and Housing market in 2007. Afierce determination of the market to buy on any new low, attempting with frustrationto not miss the rally, making the chart go parabolic. We learn with alarm that NYSEmargin debt has reached 2007’s peak levels at $370bn (Chart). The leverage forequity investors is high and getting higher, a sign of desperation in chasing therally (not just the yield). Critically, margin calls can accelerate the demise of even thebest in class, Gold docet. CAPE (cyclically adjusted P/E) are in red flag territory atabove 20, again reminiscent of past market bubbles. The classic P/E ratio is lessinformative, as profit margins are at historical highs, which are unsustainable in adeteriorating economic landscape. Weaker GDPs (real or nominal) will be the sunshining on the snow of US profit margins. US corporate profits, profit margins andinvestors’ dogmatic confidence in them are indeed the bubble inside the bubble,as they form the fictitious foundation of valuation ratios. Should they compress as
12 | P a g ethey will, equities would re-price yet for the same level of average P/E multiplesbeing priced in.From a fundamental standpoint, we do not believe in global decoupling in GDP rates(global recessions as a cascade phenomenon). Most recessions in local markets forG10 countries have coincided with recessions on a global scale. This was true in the70’s, in the 80’s, in the 90’s, in 2000, in 2008. As Germany and France are gettingcloser to economic contraction, while Japan, UK, Italy and Spain GDP are outrightshrinking, we find it hard to believe that the US will remain unscathed as the yearprogresses. Conversely, we remain skeptical of GDP picking up in those countriesanytime soon, as we think of it as the elephant in the room of today’s crisis resolutionpolicies. International trade linkages are the key transmission channel for recessions tospread around: 46% of revenues in the S&P is built on foreign sales (60% for theheavy tech sector). On top of everything, fiscal tightening should be a direct hit tocorporate profits and margins, as the public sector deficit moderates at the expenses ofthe corporate sector (whilst household savings rate grows from here).Again, this is not to say that US equity is on the verge of collapse. However, a steepcorrection of 20%-30% in the months ahead would be all but unjustified. Goldsuffered of such heart attack, as liquidity comes and goes, and buying onborrowed money has no mercy for mild fluctuations, making steep correctionsteeper.Strategy-wise, we are not buyer at these levels, so we take profits on optionallongs too and go flat, in expectation of more attractive valuations. We will not bechasing yields and rallies at these levels, as the upside is limited and the gap down apotentially damaging one. Missing a rally is not as bad as incurring into a potentiallysevere loss. Basic arithmetic indicates that if one loses 40% on a specific position, hehas to make +67% performance just to go back to where he started. Let alone thepossibility, of fat tail scenarios kicking in on such correction, pushing the house ofcards of financial engineering down with it.‘In 1720, Sir Isaac Newton owned shares in the South Sea Company, the hottest stock inEngland. Sensing that the market was getting out of hand, the great physicist mutteredthat he ‘could calculate the motions of the heavenly bodies, but not the madness of people’.Newton dumped his South Sea shares, pocketing a 100% profit totaling $7,000. But justmonths later, swept up in the wild enthusiasm of the market, he jumped back at a muchhigher price – and lost 20,000 (or more than $3mn in today’s money). For the rest of hislife, he forbade anyone to speak the words “ South Sea” in his presence’. (from BenjaminGraham ‘the intelligent investor’).
13 | P a g eInflection point for our Value BookFor more data points on our Strategy positioning, and how it is derived from ouroutlook, please refer to the attached Appendix (Portfolio Buckets). Let us just say thatwe are currently effecting yet another inflection point in the Value Book. While we filledit with export champions Senior Secured High Yield securities (from northernEurope and the US) at end 2011 / early 2012 (which reached bubble territory shortlythereafter), while we moved to Equity in September 2012 (missing August rally to besurer of money printing green light by German Constitutional Court), we now lighten itup. Few weeks ago we substituted cash longs for optional longs (as we thought thebubble would inflate some more before correcting hard or soft, quickly or progressively,and skew-ness in the market allowed for heavily asymmetric profiles). Now we closeoptional longs too, waiting for incoming data before reconsidering. We think therisk of gapping markets is high on historical standards. Not yet a correction in creditperhaps, but in equity it could well be. Hedging programs run in parallel to our Valuebook and we currently are seeking ways to increment them as cheaply as possible.Accepting lower returns expectations, not so much outsized risksWe acknowledge that we live in a low yield / low expected returns environment. Butone thing is to get accustomed to lower returns, one thing is to get accustomed tooutsized risks. In normal markets, it used to be low risks for low returns, or high riskfor high returns. Now we are live through a high risks for low returns environment.Our investment strategy attempts at drifting away from this format to constructlow risks for digital zero or high returns. If the deal is CCC credit (overrated bycomplacent lagging-indicators Rating Agencies) offered at 5%/6% return, then wemight as well stay in cash (except for tactical short-dated spots). The carry strategy istoday the riskiest it has been in decades, as we move on the thin ice ofexperimental Central Bank laboratory. By the same token, the opportunity cost forcalling ourselves out is the smallest, as returns are pale anyway. We might as welljust embrace fully the liquidity trap and financial repression environment. On the otherend, we believe that the current equilibrium is unstable, and seek positioning foran unsettlement of such equilibrium (Multi-Equilibria Markets). This is what we havein mind when we seek to amass growing quantities of Cheap Optionality, crossassets, methodically, via our hedging book (Fat Tail Risk Hedging Programs). Highcross asset correlation and high downside Beta helps in the process of buildingthis unconventional risk management policy, as you can aim at hedging one assetclass with another for minimization of hedging expenses.
14 | P a g eParadigm shift in the markets and the need for a unconventional portfoliomanagement toolsAll in all, to us, the paradigm shift in the markets calls for a decisive shift in portfoliomanagement, along the following key guidelines:- Portfolio should account for tail scenarios to stay with us for the foreseeablefuture, bubble-prone markets on excess liquidity, vulnerable to downside shockscares. In our world, this is implemented via our proprietary methodology forFat Tail Risk Hedging Programs- Thus, the need for a truly multi-dimensional risk management policy, HedgingBook, running in parallel to the Value book, whereas this typically belonged todifferent silos of the asset management industry (and still is). Hedging meansbothering to spend the cash needed in expensing such overlay.- Use cross-asset correlation to your advantage , at a time when diversification(a’ la Markowitz) no longer helps as everything is correlated to everything else,and on top of things rates can’t fall no more, mathematically, as they did for thebest part of the last 40 years, complicating things for the most widely heldasset class – Credit – and its use within a portfolio.- Fully invested portfolios are no longer optimal. The Value book can at timesbe heavily underinvested so as to adapt to unstable and gapping markets,whilst replacing cash positions with optional positions and synthetics on lowvolatility.Again, we will send out these write-ups on a monthly basis only (as opposed to weeklyor biweekly as previously was the case). For any intra-month update on theviews/positionings please feel free to get in touch. Also, please be invited to ourMonthly Outlook Presentation on the 9th of May in 55 Grosvenor street.
15 | P a g eWhat I liked this monthBundesbank declares war on Mario Draghi bond bail-out at Germanys top court.Bundesbank unleashed assault on every claim made by ECB to justify OMT. ReadWorld factory orders flash warning signals despite booming markets ReadHow much liquidity is there: JP Morgan Research ResearchThe global hunt for yield drove investors this morning to offer Rwanda almost halfits GDP as its bond offer was wildly oversubscribed. VideoW-End ReadingsGeneration jobless. The number of young people out of work globally is nearly as bigas the population of the United States. ReadHow Empires Fall. Parallels between the Roman Empire’s demise and today’ssocieties. Expansive, sclerotic bureaucracies that lost sight of their purpose… Soon theinstitutional culture is one of self-aggrandizement, gaming of departmental targets,protection of budgets and a collapse of the work ethic to the minimum level needed toavoid dismissal…. When a storm arises--a conflict with neighbouring powers, anoutbreak of plague, a disastrous drought--the imperial tree falls, not because thechallenge was too great but because the core of the tree had been weakened by thegradual loss of surplus, purpose, institutional effectiveness, intellectual vigour andproductive investment. ReadThe Silent Epidemic In A Broken, Deranged System: Stress. America has hit 90million people who are not in the workforce. I say few dare mention state-cartels anddebt-serfdom, because once you question these you question the entire debt-based"growth" that underpins our social order. If people refuse to become debt-serfs, thesystem will implode. ReadFinancial sector ups and downs and the real sector in the open economy: Up bythe stairs, down by the parachute. Sharp fluctuations in the financial sector havestrongly asymmetric effects, with the majority of real sectors adversely affected bycontractions, but not helped by expansions. Read
16 | P a g eLong Live China’s Slowdown. Just as China must embrace slower growth as a naturalconsequence of its rebalancing imperative, the rest of the world will need to figure outhow to cope when it does. ReadFrancesco FiliaCEO & CIO of Fasanara Capital ltdMobile: +44 7715420001E-Mail: firstname.lastname@example.org Grosvenor StreetLondon, W1K 3HYAuthorised and Regulated by the Financial Conduct Authority (“FCA”)“This document has been issued by Fasanara Capital Limited, which is authorised and regulated by theFinancial Conduct Authority. The information in this document does not constitute, or form part of, any offer tosell or issue, or any offer to purchase or subscribe for shares, nor shall this document or any part of it or thefact of its distribution form the basis of or be relied on in connection with any contract. Interests in anyinvestment funds managed by New Co will be offered and sold only pursuant to the prospectus [offeringmemorandum] relating to such funds. An investment in any Fasanara Capital Limited investment fund carriesa high degree of risk and is not suitable for retail investors.] Fasanara Capital Limited has not taken any stepsto ensure that the securities referred to in this document are suitable for any particular investor and noassurance can be given that the stated investment objectives will be achieved. Fasanara Capital Limited may,to the extent permitted by law, act upon or use the information or opinions presented herein, or the research oranalysis on which it is based, before the material is published. Fasanara Capital Limited [and its] personnelmay have, or have had, investments in these securities. The law may restrict distribution of this document incertain jurisdictions, therefore, persons into whose possession this document comes should inform themselvesabout and observe any such restrictions.