February 17th 2012Fasanara Capital | Investment Outlook WeeklyInvestment OutlookThis time around, maybe for the last time, we expect the ECB and German paymasters to betrying everything they can not to spoil the early signs of improving market sentiment andstabilization of financial conditions, by coming to an agreement on Greece, one way (PSI) oranother (ECB bond swap). Although we are cautious about second-guessing policymakers inthis market, our sense is that a patch-work solution will be found in the short-term toavoid a disorderly default of Greece at a time where (i) Portugal would be following blindly,(ii) Italy and Spain do not look stable enough yet in the eyes of European policy setters, whoare pretending that the German solution works there (spreads have compressed, yes, butnot enough to withstand a Greek event), and (iii) most importantly, the second LTRO is inthe doings, expanded to accept most securities as eligible collateral so as to make it a realbazooka of liquidity, and it would be unwise to jeopardize such effort right at the outset.Our view for the longer-term is unaffected, and we remain bearish. We simply do notbelieve the timing is imminently right for a setback of the liquidity-driven rally of riskyassets. For these reasons, we would think it is risky to go against the massive incrementalmonetary stimulus expected at month-end (possibly a total of 1trn+ by then): it is hard toimagine that such powerful steroids will not affect asset valuations.Sometimes after the LTRO is done and dusted, our undivided attention will be devoted tospot signs of a reversal, as we anticipate the economic fundamentals to eventually prevailon liquidity provisions. Few arguments are worth mentioning to this point. (i) Europeanissues are structural, long-overdue, and our take is that they are being treated with thewrong medicine of more new debt thrown at old unsustainable debt (even after a successfulPSI Greece will bear an unsustainable 120% debt to GDP ratio by 2020). Too much emphasisis put on short-term monetary stimulus in an attempt to overshadow depressive fiscalpolicies, with the result of reducing the risk of immediate tail events in the Eurozone, but
failing to restore growth and setting the stage for actually lower output and a multi-yearperiod of internal devaluation amongst peripheral countries - which actually viciouslyincreases the tail risks themselves in the medium term. (ii) Confidence is a fragile decayingcapital. If the ECB implements its debt exchange, thus avoiding CACs (Collective ActionClauses), it is de facto making others bondholders subordinated: just another badprecedent to have and one which should somehow demotivate even the most optimisticnatural private holders of peripheral sovereign paper (iii) The risk of a renewed creditcrunch is wide open in the medium-term, as the money multiplier has collapsed and mostmoney aggregates are contracting. The ECB survey published last week showed disturbingsigns of tightening credit standards, in particular for certain loans (to non-financial firms), inparticular for certain countries (Italy). Credit in Europe is currently recorded as contractingmore – in relative terms to output – than during the months following Lehman default.(iv) The strength of the Euro does not help either, in restoring Europe’s competitivenessthrough external devaluation (nominal depreciation of the value of the Euro). But thedangerous positive correlation to the balance sheet of the ECB (interpreted by marketparticipant as removing imminent tail risks) prevents its most needed quick depreciation.All the while, we like to derive three conclusions from this macro backdrop when it comesto investment opportunities: (i) Public markets crowding out private markets will meantrouble in the corporate world for weaker balance sheets, (ii) in particular the RefineryIndustry is at risk of a retrenching banking industry, coupled with the risk of higher oil prices(and compressing crack spreads) in the short-term, fuelled by rising Middle Eastern tensions(this week attack on Israeli embassies is a reminder), (iii) in particular the Shipping Industry(especially on dry bulks) is at risk of a retrenching banking industry, coupled with theunmissable much slower Imports in China underway (last month saw a 15.3% year-on-yearfall, more than $37bn), (iv) the more sustained the market is or the more it elevates further,the better it is for the establishment of Fat Tail Risk Hedging Programs – see below.
Opportunity SetMeanwhile, whilst we await to see the market’s temperature after the second round ofLTRO, levels have improved to a level where it is made easier and cheaper to hedgeagainst certain negative scenarios, both through Select Shorts or Cheap Hedges (Fat TailRisk Hedging Programs - more in the February Outlook). The scenarios that may be targeted,at different probabilities (for how low they may be) and costs, range from (i) RenewedSovereign woes, (ii) renewed Credit Crunch and stress in the Banking industry/HY/Lev Loans,(iii) Default Scenario (sequential failures and exit from EU of certain countries), (iv) InflationScenario (as a result of monetary expansion getting out of control, or even Defaults andderailing fiscal train wreck), (v) China hard landing. Such scenarios have still low probability,all of them, in absolute terms, but such probability was never higher than it is today.Our investment philosophy is not to change delta from positive to negative at every turn ofthe market, but rather to have a balanced investment portfolio, where we (i) positionourselves on what we believe are the safest asset classes/capital structures (strong cash-flow generative companies, from countries who still dispose of a domestic currency,preferably senior positions or collateralised positions), until the market emerge from itsdirection-less status and the sky at the horizon is clearer, whilst simultaneously (ii)equipping ourselves with the cheapest hedging programs available, at various points intime, which are reasonably expected to let us endure as large a number of negativescenarios as we can expense.What I liked this week50bn Greek bond swap by the ECB: two reasons More ..David Rosenberg - "Lets Get Real - Risks Are Looming Big Time More ..Trasfer of resouces to peripheral Europe. The new LTRO will boost TARGET2 imbalances -Bank of Italy example More ..Greek bond accounting, encore encore encore More ..109 banks on review for possible downgrade into “non-investment grade” by Moody’s: itmay force selling and artificially distort prices of such obligations. More ..
W-End ReadingsBIS Working Paper. Central banks are increasingly seen as all-powerful, without any limit.The trend towards unlimited intervention combined with ultra-low interest rates doeshave potentially serious side effects on the functioning of the market economy. Threemajor risks: financial dominance, exchange rate dominance and fiscal dominance; and theultimate possible consequence is an inflation surprise. More ..For the ECB, a French (history) lesson from the 1920s. Don’t cook your books. More ..Hedge funds faulted for not being short-term enough More ..Visualizing The True Cost Of War, in a series of simple, easy to understand charts More ..Danny Hillis outlines an intriguing theory of how and why technological change seems to beaccelerating, by linking it to the very evolution of life itself. Video ..Francesco FiliaCEO & CIO of Fasanara Capital ltdMobile: +44 7715420001E-Mail: email@example.com Berkeley Street, London, W1J 8DZ, LondonAuthorised and Regulated by the Financial Services Authority
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