Fasanara Capital | Investment Outlook | May 31st 2013
1 | P a g e“Learn how to see. Realize that everything connects to everything else.”― Leonardo da Vinci
2 | P a g eMay 31st2013Fasanara Capital | Investment Outlook1. Volatility is to resurrect, rebelling to Central Banks’ activities, as they run intoexhaustion mode. Toppy markets are gapping markets. Low volumes, margin callson leverage, uncertain macro, evaporating liquidity are all concurring to make that ‘gaprisk’ larger. Discontinuities like Gold’s heart attack & Nikkei flash crash will increasein frequency.2. Rates are the biggest catalyst to equity underperformance. Should rates risedecisively, equity are most likely to tumble in size, no matter how much nominalgrowth stands behind it. So much as this observation sounds obvious, it stands in starkcontrast to market forwards.3. Observations on Japan: weaker JPY seems the safest bet in town. Higher Japaneserates seems the cheapest bet in town. Higher Nikkei seems to require the boldestview to take, as it is digital volatile and two-sided fat-tailed market outcome from nowon (rising higher, gapping down; up the stairs, down the elevator)4. Japan’s impact on the world: a powerful accelerator in the global monetaryexperiment5. The case for being short Japanese Rates & the Japanese Yen6. The case for being short the Australian Dollar7. VALUE BOOK: at present our Value Book remains pretty flat, as markets are toppy,ever more expensive vs fundamentals, and at risk of a steep correction.8. HEDGING BOOK: we currently see most of the opportunities in the Hedging Book,as the market misprices the potential for realized volatility to pick up from here. Inour Multi-Equilibria Markets roadmap, our top picks are as follows: short Japaneserates & Yen, short Australian Dollar, Long Interbanking /Swap Spreads, longCurrency Pegs
3 | P a g eConclusions first: Value Book still flat, Hedging Book shifts gearThis month, we would like to start from the conclusions:1) VALUE BOOK: at present, our Value Book remains pretty flat, as markets are toppy,ever more expensive vs fundamentals, and at risk of a steep correction. Our currentsmall allocation is filled with select Special Sits which still offer asymmetric returns vsrisks in our eyes. We will change that stance only once the disconnect between thereal world and financial markets tighten from here, as a consequence of marketcorrecting or fundamentals improving (we remain skeptical on real growth recovery,as argued extensively, more inclined to see the market correcting, but will remain open-minded as the situation develops and more data come in). Also, we will change thatstance if markets move side-ways for long enough (which is just another way todigest their expensiveness, arithmetically equivalent in real terms to a decliningmarket if inflation is above zero). A century worth of data, does not support longs atthese bubble levels, neither in the Credit nor in the Equity markets. The Credit marketsare all too remindful of 2007 (at that time it was Investment Banks inflating the bubblethrough leverage, this time it is Central Banks themselves, with obviously more marginfor error, but not infinitively so). The Equity markets, from the Mothership US to Japan,are remindful of conditions we have seen already in 2007, but also in 2000, 1987, 1973,1929, all followed by market crashes (we gave our take on technicals/fundamentals forthe US market in our previous Outlook on page 11: US Equities have entered bubbleterritory). Let alone a sound risk/return policy, as we observe that there has never beenso much risk for so little return, over the last century (long–only funds and Sharpe Ratio-driven allocators should feel the discomfort).2) HEDGING BOOK: on the other end, we currently see most of the opportunities in theHedging Book, as the market misprices the potential for realized volatility to pickup from here and for ‘toppy markets’ to be ‘gapping markets’ (Gold’s heart attack,Nikkei flash crash, next?). It makes sense to us to be long volatility in such uncertainmarkets where rates cannot possibly rally any further (and Credit can’t either in anymeaningful way), where investors go long on large margin, where shorts are cleanedout, and where silly talks of the ‘bondification of equity’ spread around. As early asSeptember 2012, we were early to say that equities would have been more ‘defensive’than bonds (‘‘European Equities Will Jump’ Video), as we migrated our book from HighYields into Equities; riding the bubble of catch up rallies first (Europe), and NominalRallies later in December 2011/January 2012 (US and Japan, currency hedged). We nowdump that train too, until further notice. Our methodology for Fat Tail Risk HedgingPrograms should cover our – currently small - exposure to the Value Book, and over-hedge us enough to deliver a positive return in the second half of the year, whilewaiting for better valuations before we reassess re-loading on longs. Amongsthedging strategies, on the list of pre-identified scenarios in our Multi-Equilibria
4 | P a g eMarkets roadmap, our top picks are as follows: short Japanese rates (Inflation &Default Scenario), short Yen (Inflation & Default Scenario), short Australian Dollar(China Hard Landing Scenario), Long Interbanking Spreads and SwapSpreads(Renewed Credit Crunch Scenario), long Currency Pegs (EUR Break-UpScenario). In terms of instrument selection, we follow our methodology for eligibleinstruments with target multipliers on exit higher than 10X (and as high as 100X):Cheap Optionality first, but also Select Shorts, Embedded Optionality and DislocationHedges.Finally, before we move on with today’s write up, please be invited to our Monthly OutlookPresentation on the 6thof June in 55 Grosvenor street, where supporting Charts & Data will bedisplayed for the views rendered here. Please do get in touch if you wish to participate.Bubble Chain vs Deleverage ChainHaving given up the conclusions first, let us now start this months note from where we last left theconversation: two opposing teams are visible at present in the markets, a Bubble Chain and aDeleverage Chain. The players for the two chains are displayed in the Chart below. For a fulldescription of the timeline of the two chains please refer to page 2 of the attached: Timeline ofBubble Chain and Deleverage Chain.During the month just past, we saw the US market consolidating in bubble territory, showing nosparkle for more easy upside, and we saw Emerging Markets, their currencies and commoditiesshowing further weakness. No recoupling in sight, it seems.GovBondsCorpCreditHighYieldUS /JapanEquityThe Bubble Chain timelineSummer 2011 End 2011 H1 2012 Q2 2013First entering bubble territory
5 | P a g eThe Bubble Chain reacts to Central Bank’s liquidity and puts dogmatic trust into the holypromise of open-ended Quantitative Easing, in spite of fundamentals being foretellers of aparallel universe. Here, chasing the yield (income stream) in the markets has become chasing therally (capital gains), which is turn has become chasing the next bubble. The Deleverage Chainspeaks of the real universe, and still tries to price itself against real GDP, against the unfortunatereality of an end-of–journey Keynesian economy gripped by 40 years of over-leverage with nogrowth to support it.The questions to be asked: is a re-coupling to take place? We suspect so, at some point. From whichside? When?So much as we would love to have a strong conviction here, we do not. We are left to have to wait formarket patterns to unfold and more data to come in. As Charlie Munger best said it once: “If you’renot confused about the economy, you don’t understand it very well”.But perhaps we can also ask ourselves a different question: if there is no re-coupling in short enougha period, some members of the Deleverage Chain might be forced into joining the Bubble Chainwagon, by some of its policymakers reacting to adversity in the consensus way. This may be the casefor countries like Australia. Faced with the prospect of painful deleverage, they may resort to moneyprinting to ‘stimulate the economy’, as Bernanke theorized and Japan executed with largesse. Weexpand on this below.One conclusion, though, is most logical in debating these opposite chains: volatility is toresurrect, rebelling to Central Banks’ activities, as they run into exhaustion mode: after years ofripping the easy benefits, the law of diminishing returns is kicking in, and the underlying patient,treated with huge doses of morphine, starts to cough out of breath again. As we wrote in ourprevious Outlook:BaseMetalsGoldMinersEmergingMarketsGoldheartattackThe Deleverage Chain timelineJan 2013 Feb 2013 Apr 2013Feb 2013Showing first weakness in 2013
6 | P a g e“Irrespective of the right hypothesis, as we stand ready for positive confutation to our ownview, one conclusion seems clear as water: liquidity-driven bubble-prone markets arevulnerable to sudden digital adjustment and external shocks, when it is least expectedand on the most valuable asset classes too. Toppy markets are gapping markets. Lowvolumes, margin calls on levered players, uncertain environment, evaporating liquidityare all concurring to make that ‘gap risk’ larger. Once a bubble is recognized for what itis, the ‘gap risk’ that comes with it should be the number one concern of portfolio riskmanagement, these days. As we argued in several occasion, we are convinced that a trulymulti-dimensional Risk Management macro overlay strategy is paramount to successfully(or just quietly) navigate financial markets in the current environment. Discontinuities likeGold’s heart attack will be recurrent events, increasing in frequency, over the nextseveral quarters/ years. By the time such gap volatility arises, Central Banks may still beable to provide the parachute (maybe not), but they are likely to be coming on the sceneafter the detonation, thus unable to soften the market action in between. Now, then,where in the Bubble Chain should we expect the next bust? Gold also teaches us toexpect it where we would least expect it, perhaps.”In shorthand, ‘toppy markets’ are ‘gapping markets’. This month we had some more empiricalevidence to add to the Gold case study:- Japan: the NIKKEI lost 7.3% in one day. The largest drawdown since 2011 Tsunami and1998 Asian crisis.- Interest rates doubled in Japan, shot up in the US. Rates resurrected to 1% territory inJapan, while rates volatility reached 2008 credit bubble’s levels. It is remindful of the marketin 2003 in Japan, where a volatility-induced sell-off drove rates to triple from 0.5% to 1.6%between June and September. Potentially a truly devastating move for the Bubble Chain,if it is to continue from here.Two or three standard-deviation moves. Not bad for a market where peripheral Europe did not haveanything to say. Bernanke gave a speech, true, but he tried to say the least possible. If he could, hewould have filled the time slot speaking about the weather.Japan, China, AustraliaHaving recently discussed Europe (dormant vulcano) and the US (bubble euphoria on borrowedmoney) extensively, let us now look at catalysts markets, whose dynamics may have importantrepercussions for global markets in the months ahead: Japan in primis, then China and Australia.
7 | P a g eObservations on recent market action out of JapanWe would like to offer a few observations on the relationship between Equity, Rates and Currencyin Japan.Interestingly, most commentators concluded that higher rates pushed equity lower on profit taking.We might argue, however, that equity sell-off may also have contributed to higher rates. Causalitycan be two-way here.If it is money printing pushing equity higher (and it is just money printing because real GDP is yetnowhere to be seen, in spite of nominal Q1 GDP), then when equity falls it must mean moneyprinting is insufficient/ineffective, which also means rates are compelled to rise.Whatever the true causality this time around, we do realize the vulnerability of the market to interestrates in the months to come: rates are the biggest catalyst to equity underperformance. Shouldrates rise decisively, equity are most likely to tumble in size, no matter how much nominalgrowth stands behind it.So much as this observation sounds obvious, it stands in stark contrast to market forwards.Decades of data corroborating portfolio diversification theories (à la Markovitz) have shown thatwhen equity goes up, rates tend to go up (and bonds down), more often rather than not. Currently,consistently with such historical dogma, the correlation between equity and bonds is priced in by themarket at approx - 20%. We disagree with the market pricing of correlation here as we believe itmight soon turn out to be +50%. And on the way down! Bonds and equity could fallsimultaneously. And not only because rates have hit their zero bound (if anything, the ECB startscontemplating negative nominal rates, for example). Such misalignment between our forecast andthe market forwards highlights a valuable opportunity for our strategy: it helps build cheaphedges against Equity going down, or helps cheapening up good hedges against Rates going up.The case for being short Japanese RatesInterest-rate wise, in the short term, we believe samurai-Japan might manage to close ranks andfight back. At the speed it opted for, Abenomics cannot possibly last for several years: still, it is at hisinfant stage now. More money can be poured into the market, open-endedly. The revisions to itsexpected size can come as early as October. The inevitable day of reckoning is again postponed.Volatility may subside in the near term, once the policy of Kuroda is cleared out of the confusionover which securities it will buy and when. And once he fine tunes his communication skills, overall.However, recent market action sparks a bad omen for things to come. The fragility of Japan is forreal. Its vulnerability without precedents. The cheapness of an hedge so extreme as to make itbroadly indifferent to the timing of materialization of such bearish view. Therefore, we remain
8 | P a g ecommitted to take advantage of a possible renewed compression in yields/vol to build up moreon short Japanese rates positions.The case for being short the Japanese YenCurrency-wise, it is hard to imagine a state of the world where the Yen is not significantlyweaker than it is today (even after devaluing some 25% recently).- Rates could be higher, which means equity would be lower, as debt crisis maysnowball abruptly, and JPY weaker in reflection of such calamity.- Or rates could be managed down successfully, anchored at zero across the curvevia more monumental money printing, and equity up, just nominally so, as JPYweakens further, and rapidly so.The one scenario where the JPY goes back to its highs (around 75 vs USD) seems at present the mostunlikely. The dynamics that the BoJ has set in motion are irreversible. By promising to print somuch, they now can print so much or much more than that. By having selected such an overdoseof monetary expansion, the more bonds sell-off the quicker they might have to step-up their printingpresses. The more they crowd out the private sector on JGBs, the more they will eventually have toprint. The more the market flies on liquidity-havens, the more it will be addicted to such printing.Samurai-Japan’s policy is remindful of the ‘burning the bridges behind’ war strategy of Sun Tzu.General Sun Tzu (from China, actually), in its “The Art of War”, explains that one technique forsuccess in war is burning boats or bridges for escape. The tactic is basically this, taking an armyacross a river, burning all their boats, the only routes of escape. Left with two choices when facingthe enemy army, to win or to die, people will do super human feats to survive. Similarly, Abe andKuroda today, have put themselves in a corner where they are confronted with one of twooptions: print, and buy bonds only, hoping for the market to grow before inflation kicks in; orprint more, and buy all bond and some equity, if inflation kicks in and/or the market does notgrow. Stop printing and you die.Fight like a samurai, or die as a kamikaze.All in all, weaker JPY seems the safest bet in town (beyond any short term rebound on profit takingby HFs). Higher Japanese rates seems the cheapest bet in town. Higher Nikkei seems to requirethe boldest view to take, as it is digital volatile and two-sided fat-tailed market outcome from nowon (rising higher, gapping down; up the stairs, down the elevator).We have been long Japanese equity as of last December/January as we thought the change ofpolicy was structural, and equity would have rallied more than the currency depreciated (Outlookand our CNBC interview). Such nominal rally, as we called it then, was hedge-able into hardcurrency at cheap costs. So we could rent a illusory rally, by hedging it out of its fake context. We
9 | P a g enow are inclined to think the currency itself has better odds than the equity market itdenominates. Rephrased, selling the Yen should make us more profits than buying the Nikkeiand hedging it in USD.For the records, typically, a 10% trade-weighted weakening of the Yen leads to a 0.3% increase ininflation expectations. The target inflation rate is now 2%.To add to the records, differently than in the past 20 years, Japan is now in current account deficitterritory. Current account deficit coupled with extraordinary monetary expansion calls for a currencyweaker than the currencies of countries with similar deficits but softer monetary expansions (Japan isa third of the US, but may expand by more in absolute terms, $1trn in the US vs soon $1.3trn inJapan)However, we are prepared to change that stance should we see other countries clearly followingthe lead of Japan on the field of monetary disorder. Should Korea, Taiwan, Australia, Europe, orthe US itself, step up their activities then Currency Debasement would be more visible on theequity markets than it is on cross-pairs.When Japanese equities corrected, the Pavlovian response of the market sent the yen to strongerlevels. Linearly interpolating from recent positive correlation between weaker Yen and higher equitymarket. That cant hold, in our eyes. To us, not just a flamboyant equity market but an implodingequity market too can drive yen weaker, going forward. Acceleration leads us to breakage points, nothistorical correlation.Interestingly, one more force should help Yen slide further vs USD: this week saw real rates in Japanplummeting below US real rates for the first time in years. 5yr real rates are at a new super lowbeyond -1.5% in Japan (as nominal yields rose less than inflation expectations), whereas they movedup from -1.5% to -1% in the US (as break even inflation rates lowered). Declining inflationexpectations in the US, possibly on the back of the Deleveraging Chain shown above (whilst Japanseems kamikaze-committed to 2% percent inflation) are at the basis of such increase in real rates inthe US.Incidentally then, local Japanese money managers (especially the VAR-shock sensitive ones likebanks, broker dealers, regional and Shinkin banks) should be compelled to divest from shaky JGBsand sinking Yen, and move to USD cash, pure and simple cash, for a real yield pick-up.
10 | P a g eJapan’s impact on the world: a powerful accelerator in the globalmonetary experimentJapan policy change is a powerful accelerator to the end game for economies involved in similarpolicies the world over. It is that chemical element which gets added to the mix to accelerate thechain reaction, one way or another, for good or for worse.Will it work or not? After living through 2.5 lost decades, half dead in approaching the cliff, Japanresolved for samurai-(kamikaze)-style final solution, putting the feet down on the accelerator totake off and jump over that cliff, into Debt Monetization via Currency Debasement and negativereal rates, to annihilate an unsustainable debt stock.For all intents and purposes, Bernanke himself is watching carefully how the Japan story ends,before changing his own stance, ready to follow if it takes it over the cliff, but most concerned ofnot following down the cliff if it does not work. Having a real life example in the largest monetarypolicy experiment of the last hundreds years might seem to him too good to be true.Abenomics’ precedent in history: Takahashi policyFor what is worth, Abenomics has a model in history. It is Takahashi policy in 1932-1935, whichmanaged successfully to lift Japan out of the Great Depression (although inflation broke out in 1037,after he was assassinated).Back then, the currency played a similar role to today, as the Yen weakened out by 60% vs theUSD, to then stabilize around 40% depreciation.However, rates were cut 3%, which cannot be done today as they already are at 0%, and fiscalpolicy was loosened back then, which cannot be done today (as fiscal consolidation has beenpromised to keep bond vigilantes at bay).Japan’s chances of success are path dependent- If too much volatility in equity is generated along the way, it is plausible to believereallocation into the next bubble, out of equity, might take place. Maybe Cash,Commodity, Gold again?- If bonds suffer from a VAR-shock, then the BoJ will have more of a bid to putforward on bonds. Again, less money for equities (as the BoJ warned that they canbuy equities directly). Equity vol can increase. Thus, again, next bubble might beGold or Oil or Grain?
11 | P a g e- If the next bubble is Gold, there are the least negative repercussions. Gold isuseless, thats why it can skyrocket to silly numbers. It doesnt matter to anybody(its like banking reserves nowadays, the largest ever, yet the most ineffective theyhave ever been).- But if the next bubble is Oil, then it is big trouble for Equity. Rising cost of energycan suck up certain profit margins (US is warned, where corporate profits are thebubble within the bubble).- There is good inflation that rebates on consumer prices for goods and services.There is a bad one who pushes up wages first or wages more than consumer prices.Sucking up profit margins, again.- There is a good inflation that eats the value of debt out there, but there is also aless benign inflation who pushes higher energy input prices first. Weaker yen drivesup import prices.As we move in a minefield, the most arduous task of policymakers is to try and avoid unintentionallytriggering such chain reactions. Surely, time will run faster now. It wont take another 25 years todetermine the end game for Japan and other monetary expansionists.At the risk of sounding obvious, ‘path dependency’ affects the final end game for leading-indicatorJapan and other Quantitative Easing champions after it. In many ways, erraticism will inevitablyplay a role over causality. We are left to watch events as they unfold, to see which factor takescenter-stage first, and from there we will assess the weight of each factor in contributing to the finalresult. All we can do at this stage is to be flat of risk, having higher allocation to cash thannormal, and staying hedged and over-hedged, through cheap optionality-type strategies, as themarket surely underestimates tail risks (realized volatility can be substantial, economically-wiseand politically-wise).China’s impact on Japan, and vice-versaInterestingly, in the short term, the velocity of the JPY weakening also rests on China’s growthprospects. Not so much the Chinas growth as depicted by government figures, but rather the onereflected in the mirror by Taiwan or Korean exports, shipping hire rates, iron ore and the likes.Weaker China means weak commodities, weak commodities reinforce the dollar index across theboard, stronger dollar equates to a weaker Yen, amongst others. Additionally, cheaper oil alsoconcurs to the shrinking fiscal deficit in the US (together with higher tax revenues and stronger realestate), with a subsequent stronger dollar in the process. For all these reasons, we have to keep aneye on China in monitoring our short Yen position in the near term.
12 | P a g eChina may hold the key to what the market has in store in the next few months for a variety oflevers: the dollar index strength, equity markets in EM, and our shorts on JPYUSD and AUDUSD. Wehave to watch closely policy moves there. Can credit expansion resumes despite clear signs ofdiminishing returns and credit exhaustion? True, china stock of debt is not outrageous whencompared to Developed Markets. However, what matters is not so much Domestic Credit to GDPratios, where China lags behind Japan, US (at 150% vs 250%), but rather the speed of acceleration ofcredit expansion. Using Total Social Financing (overall credit supply to the economy), total leveragebuilt up by 60% of GDP in the last 5 years, to 207% of GDP (research). Will it continue now afterwatching the monumental policy experiment in Japan?It is also important to track their undergoing Interest Rate and Capital Account liberalization. Wehave no room here to expand on that and its implications.For all intents and purposes, it suffices to say that despite all the noise about China rebalancing itsgrowth model to internal consumption, the growth prospects of China are heavily reliant on exportsand aggregate foreign demand. At 50% Investment on GDP, and Private Consumption now below35%, China is way more dependent on the external world than ever before. The remarkableresilience it showed during the 2009 crisis and the 2011 crisis is history (when its two most importanttrade partners imploded - US and Europe respectively). Chinas instability now is unmistakable andmight call for more expansionary policies, on par with Japanese contenders. It is key tounderstand that over the coming months, as policymakers make up their mind and data comesin.The case for being short the Australian DollarBack in November 2012, we wrote:“This year we had a great run hedging the China Hard Landing Scenario, expressed viashorts on the Dry Bulk segment of the shipping industry, heavily sensitive to theChinese economy. Back in January, we were convinced China’s imports were slowing down,as reflected by official data and as confirmed by data on Taiwan exports, Shipping andMining flows. We recently took all profits and closed positions, for the time being. Althoughwe still believe in the idea, we are on the verge of forceful money supply in China (for achange) and abroad, and therefore became wary of a short term rebound. If such reboundmaterializes, we would like to reinstate positions, this time expanding the scope to theAustralian dollar, the banking sector in Australia, and the Luxury industry, in addition toShipping, Mining and the likes.It is the case that we now like the Australian Dollar short in particular. Less so the short onAustralian banks, for the time being (although we might implement that one too soon, possibly inrelative value with the Australian Mining sector), as again it may be chain dependent on Japan:should Japan look like a winner in the short term, money printing can follow up in Australia (an
13 | P a g eeconomy that has not known inflation in the past century), and cause a Nominal Rally of the likes ofJapan. Illusory gains, not reliable returns, but still painful to a short seller.We believe the weakening in the Australian Dollar is structural, and as such is set to continue inthe months to come (save for a short term rebound, like the one which could be undergoing in thenext few days, as Fibonacci/Bollinger barriers are tested for AUD/USD together with EUR/USD andJPY/USD). The Australian Dollar could possibly be a loser in more than one possible scenarios:- Deleverage Chain risk. GDP scare on more China Hard Landing evidence. AUDwill be next in the Deleverage Chain we have shown above: from Gold and Miners,to Commodity Markets, to Emerging Markets, to a breakage point on fast-weakening Australian economy- Bubble Chain risk. Money printing machine gets activated following allegedlysuccessful Japanese experience. Nominal Rally would follow in the equitymarkets, through AUD Currency Debasement exercise (not so much for the samereasons as for Japan, where the currency is debased to achieve Debt Monetisation,as Australia has low debt/GDP ratios). Inflation risk is high in Australia.- Bubble Chain implosion, volatility-induced sell-off in a VAR-shock, globally out ofJapan or the US (not so much a resumption of hostilities in Europe, which has lastdrove money into Australia, crowding out their govies, which at some point were80% held by foreigners). A global risk off mode could possible drive AUD downthis time around, much like it did on Lehman-moment, when AUD was 30%weaker than today vs the Dollar. To be true, these days a slightly weaker S&P isdriving up AUD (and JPY) vs USD: but it is the digital adjustment we fear, a steepercorrection, which we believe could invert the sign of the recent correlation.In terms of the execution strategy of such view, we have some shorts in place already, but we planto leverage on potential pull backs in the short term to build more hedges. In the last few days wesaw dollar weakness across the board, as USD supply emerged on the euro breaking above 1.2900and traded as high as 1.3060. From a JPM trader: “the USD was pounded across the board yesterday asa market long at lofty levels ran for the hills, and with month end tomorrow anything is possible fromhere. Overall I still want to be short of euro, but we are in a random flow driven market and there is aplethora of stops above 1.3000 that I simply can’t ignore. Back below 1.2925 and 1.2900 a top short termcould be in place, but frankly I’d rather trade tactically for 48 hours and then get back on trend nextweek”In conclusion, after closing down successfully our shorts on the shipping market, AUD is now our bestguess for hedging weak global GDP and China Hard Landing scenario. The China Hard Landingscenario is one of six basic scenarios in our road-map for Multi-Equilibria Markets (where the finaloutcome is hard to anticipate as it may divert markedly from classical mean reversion: diametrically
14 | P a g eopposite scenarios are made equally possible, which deflect vastly from the baseline scenariocurrently priced in by markets. As argued extensively in previous Outlooks Nov 2012 and Jan 2012).“We live through the end of a Keynesian state, as the level of over-leverage is unable tobe dealt with by pure growth. Four decades of credit expansion which followed the endof Bretton Woods are now coming to an end, as debt metrics are unsustainable andgrowth is gripped down by such debt overhang. The debt as a % of productive GDP/realoutput growth is just too high. Policymakers and handy central banks are confronted byunconventional hard choices between one of two evils:- Inflation Scenario (Currency Debasement, Debt Monetisation, Nominal Defaults). Itseems the route followed by Japan, the US, the UK. This is a Nominal Default, but still adefault (as it curtails the value of a fixed income claim as surely as a default). As wepreviously argued (March Outlook and CNBC interview), Japan is the lead illusionist here,printing more than the US in absolute terms, whilst having a third of its economic output. Ofcourse the financial assets get bloated up, at present. It is purely a nominal rally, though, nota real one. One that can be captured only as long as you can hedge it out of its fake context.Elusive gains vs reliable returns.- Default Scenario (Real Defaults, sequential failures of corporates/banks/sovereigns acrossEurope). Let deleverage unravels, Europe flirted with this option, last month.Accepting lower returns expectations, not so much outsized risksWe acknowledge that we live in a low yield / low expected returns environment. But one thing is toget accustomed to lower returns, one thing is to get accustomed to outsized risks. In normalmarkets, it used to be low risks for low returns, or high risk for high returns. Now we are live througha high risks for low returns environment.Our investment strategy attempts at drifting away from this format to construct low risks fordigital zero or high returns. If the deal is CCC credit (overrated by complacent lagging-indicatorsRating Agencies) offered at 5%/6% return, then we might as well stay in cash (except for tacticalshort-dated spots).Investing for Carry is today the riskiest it has been in ages, as we move on the thin ice ofexperimental Central Bank laboratory. By the same token, the opportunity cost for callingourselves out is the smallest, as returns are pale anyway.On the other end, we believe that the current equilibrium is unstable, and seek positioning for anunsettlement of such equilibrium (Multi-Equilibria Markets). This is what we have in mind when weseek to amass growing quantities of Cheap Optionality, cross assets, methodically, via ourhedging book (Fat Tail Risk Hedging Programs).
15 | P a g eHigh cross asset correlation and high downside Beta helps in the process of building thisunconventional risk management policy, as you can aim at hedging one asset class with another forminimization of hedging expenses.We suspect that the most flawed idea floating around in complacent markets this quarter hasbeen that of a “bondification” of equities. Equities are not bonds. Central banks cant bid allasset classes at the same time. They have to pick up their battle fronts as every other human beingon the planet. Equity will keep his volatility. We should be prepared to take advantage of that. Asteep correction of 20%-30% in the months ahead would be all but unjustified, even in the US.Gold suffered of such heart attack, as liquidity comes and goes, and buying on borrowed moneyhas no mercy for mild fluctuations, making steep correction steeper.Finally, we will hold our Monthly Outlook Presentation on the 6thof June in 55 Grosvenor street,where supporting Charts & Data will be displayed for the views rendered here. Please do get in touchif you wish to participate.Francesco FiliaCEO & CIO of Fasanara Capital ltdMobile: +44 7715420001E-Mail: email@example.comTwitter: https://twitter.com/francescofilia55 Grosvenor StreetLondon, W1K 3HYAuthorised and Regulated by the Financial Conduct Authority (“FCA”)
16 | P a g eWhat I liked this monthWhat If Stocks, Bonds and Housing All Go Down Together? About the claim that centralbanks will never let asset bubbles pop ever again--their track record of permanentlyinflating asset bubbles leaves much to be desired. ReadNext Group That May Be Slammed by Debt: Farmers ReadCypriot "Blueprint" - How To Confiscate $32 Trillion In "Offshore Wealth" ReadWe’re now living in a Lance Armstrong economy. We’ve consumed so many performanceenhancement drugs through QEs that it is hard to know how well the economy is reallydoing. Sadly, as Armstrong did, we’ll have an Oprah Winfrey moment when the economywill have to fess up for all the QEs. Mauldin Economics. ReadW-End ReadingsSoros Vs Sinn: To Eurobond Or To Save The Euro ReadIn Germany and Switzerland, Li Chooses His Friends Carefully ReadStatistics guru Hans Rosling debunks myths on the "developing world" VideoLearn to read Chinese ... in 6 minutes! Video“This document has been issued by Fasanara Capital Limited, which is authorised and regulated by the FinancialConduct Authority. The information in this document does not constitute, or form part of, any offer to sell or issue,or any offer to purchase or subscribe for shares, nor shall this document or any part of it or the fact of its distributionform the basis of or be relied on in connection with any contract. Interests in any investment funds managed by NewCo will be offered and sold only pursuant to the prospectus [offering memorandum] relating to such funds. Aninvestment in any Fasanara Capital Limited investment fund carries a high degree of risk and is not suitable for retailinvestors.] Fasanara Capital Limited has not taken any steps to ensure that the securities referred to in thisdocument are suitable for any particular investor and no assurance can be given that the stated investmentobjectives will be achieved. Fasanara Capital Limited may, to the extent permitted by law, act upon or use theinformation or opinions presented herein, or the research or analysis on which it is based, before the material ispublished. Fasanara Capital Limited [and its] personnel may have, or have had, investments in these securities. Thelaw may restrict distribution of this document in certain jurisdictions, therefore, persons into whose possession thisdocument comes should inform themselves about and observe any such restrictions.