Managing personal finances wisely for financial stability and
Fasanara Capital | Investment Outlook | May 31st 2013
1. 1 | P a g e
“Learn how to see. Realize that everything connects to everything else.”
― Leonardo da Vinci
2. 2 | P a g e
May 31st
2013
Fasanara Capital | Investment Outlook
1. Volatility is to resurrect, rebelling to Central Banks’ activities, as they run into
exhaustion mode. Toppy markets are gapping markets. 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 & Nikkei flash crash will increase
in frequency.
2. Rates are the biggest catalyst to equity underperformance. Should rates rise
decisively, equity are most likely to tumble in size, no matter how much nominal
growth stands behind it. So much as this observation sounds obvious, it stands in stark
contrast to market forwards.
3. Observations on Japan: weaker JPY seems the safest bet in town. Higher Japanese
rates seems the cheapest bet in town. Higher Nikkei seems to require the boldest
view to take, as it is digital volatile and two-sided fat-tailed market outcome from now
on (rising higher, gapping down; up the stairs, down the elevator)
4. Japan’s impact on the world: a powerful accelerator in the global monetary
experiment
5. The case for being short Japanese Rates & the Japanese Yen
6. The case for being short the Australian Dollar
7. 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. In
our Multi-Equilibria Markets roadmap, our top picks are as follows: short Japanese
rates & Yen, short Australian Dollar, Long Interbanking /Swap Spreads, long
Currency Pegs
3. 3 | P a g e
Conclusions first: Value Book still flat, Hedging Book shifts gear
This 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 current
small allocation is filled with select Special Sits which still offer asymmetric returns vs
risks in our eyes. We will change that stance only once the disconnect between the
real world and financial markets tighten from here, as a consequence of market
correcting 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 that
stance if markets move side-ways for long enough (which is just another way to
digest their expensiveness, arithmetically equivalent in real terms to a declining
market if inflation is above zero). A century worth of data, does not support longs at
these bubble levels, neither in the Credit nor in the Equity markets. The Credit markets
are all too remindful of 2007 (at that time it was Investment Banks inflating the bubble
through leverage, this time it is Central Banks themselves, with obviously more margin
for 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 for
the US market in our previous Outlook on page 11: US Equities have entered bubble
territory). Let alone a sound risk/return policy, as we observe that there has never been
so 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 the
Hedging Book, as the market misprices the potential for realized volatility to pick
up 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 uncertain
markets where rates cannot possibly rally any further (and Credit can’t either in any
meaningful way), where investors go long on large margin, where shorts are cleaned
out, and where silly talks of the ‘bondification of equity’ spread around. As early as
September 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 High
Yields into Equities; riding the bubble of catch up rallies first (Europe), and Nominal
Rallies later in December 2011/January 2012 (US and Japan, currency hedged). We now
dump that train too, until further notice. Our methodology for Fat Tail Risk Hedging
Programs 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, while
waiting for better valuations before we reassess re-loading on longs. Amongst
hedging strategies, on the list of pre-identified scenarios in our Multi-Equilibria
4. 4 | P a g e
Markets 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 Swap
Spreads(Renewed Credit Crunch Scenario), long Currency Pegs (EUR Break-Up
Scenario). In terms of instrument selection, we follow our methodology for eligible
instruments with target multipliers on exit higher than 10X (and as high as 100X):
Cheap Optionality first, but also Select Shorts, Embedded Optionality and Dislocation
Hedges.
Finally, before we move on with today’s write up, please be invited to our Monthly Outlook
Presentation on the 6
th
of June in 55 Grosvenor street, where supporting Charts & Data will be
displayed for the views rendered here. Please do get in touch if you wish to participate.
Bubble Chain vs Deleverage Chain
Having given up the conclusions first, let us now start this month's note from where we last left the
conversation: two opposing teams are visible at present in the markets, a Bubble Chain and a
Deleverage Chain. The players for the two chains are displayed in the Chart below. For a full
description of the timeline of the two chains please refer to page 2 of the attached: Timeline of
Bubble Chain and Deleverage Chain.
During the month just past, we saw the US market consolidating in bubble territory, showing no
sparkle for more easy upside, and we saw Emerging Markets, their currencies and commodities
showing further weakness. No recoupling in sight, it seems.
Gov
Bonds
Corp
Credit
High
Yield
US /
Japan
Equity
The Bubble Chain timeline
Summer 2011 End 2011 H1 2012 Q2 2013
First entering bubble territory
5. 5 | P a g e
The Bubble Chain reacts to Central Bank’s liquidity and puts dogmatic trust into the holy
promise of open-ended Quantitative Easing, in spite of fundamentals being foretellers of a
parallel universe. Here, chasing the yield (income stream) in the markets has become chasing the
rally (capital gains), which is turn has become chasing the next bubble. The Deleverage Chain
speaks of the real universe, and still tries to price itself against real GDP, against the unfortunate
reality of an end-of–journey Keynesian economy gripped by 40 years of over-leverage with no
growth to support it.
The questions to be asked: is a re-coupling to take place? We suspect so, at some point. From which
side? When?
So much as we would love to have a strong conviction here, we do not. We are left to have to wait for
market patterns to unfold and more data to come in. As Charlie Munger best said it once: “If you’re
not 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 enough
a period, some members of the Deleverage Chain might be forced into joining the Bubble Chain
wagon, by some of its policymakers reacting to adversity in the consensus way. This may be the case
for countries like Australia. Faced with the prospect of painful deleverage, they may resort to money
printing to ‘stimulate the economy’, as Bernanke theorized and Japan executed with largesse. We
expand on this below.
One conclusion, though, is most logical in debating these opposite chains: volatility is to
resurrect, rebelling to Central Banks’ activities, as they run into exhaustion mode: after years of
ripping 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 our
previous Outlook:
Base
Metals
Gold
Miners
Emerging
Markets
Gold
heart
attack
The Deleverage Chain timeline
Jan 2013 Feb 2013 Apr 2013Feb 2013
Showing first weakness in 2013
6. 6 | P a g e
“Irrespective of the right hypothesis, as we stand ready for positive confutation to our own
view, one conclusion seems clear as water: liquidity-driven bubble-prone markets are
vulnerable to sudden digital adjustment and external shocks, when it is least expected
and on the most valuable asset classes too. Toppy markets are gapping markets. Low
volumes, margin calls on levered players, uncertain environment, 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 it should be the number one concern of portfolio risk
management, these days. As we argued in several occasion, we are convinced that a truly
multi-dimensional Risk Management macro overlay strategy is paramount to successfully
(or just quietly) navigate financial markets in the current environment. Discontinuities like
Gold’s heart attack will be recurrent events, increasing in frequency, over the next
several quarters/ years. By the time such gap volatility arises, Central Banks may still be
able to provide the parachute (maybe not), but they are likely to be coming on the scene
after 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 to
expect it where we would least expect it, perhaps.”
In shorthand, ‘toppy markets’ are ‘gapping markets’. This month we had some more empirical
evidence to add to the Gold case study:
- Japan: the NIKKEI lost 7.3% in one day. The largest drawdown since 2011 Tsunami and
1998 Asian crisis.
- Interest rates doubled in Japan, shot up in the US. Rates resurrected to 1% territory in
Japan, while rates volatility reached 2008 credit bubble’s levels. It is remindful of the market
in 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 have
anything to say. Bernanke gave a speech, true, but he tried to say the least possible. If he could, he
would have filled the time slot speaking about the weather.
Japan, China, Australia
Having recently discussed Europe (dormant vulcano) and the US (bubble euphoria on borrowed
money) extensively, let us now look at catalysts markets, whose dynamics may have important
repercussions for global markets in the months ahead: Japan in primis, then China and Australia.
7. 7 | P a g e
Observations on recent market action out of Japan
We would like to offer a few observations on the relationship between Equity, Rates and Currency
in 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. Causality
can be two-way here.
If it is money printing pushing equity higher (and it is just money printing because real GDP is yet
nowhere to be seen, in spite of nominal Q1 GDP), then when equity falls it must mean money
printing 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 interest
rates in the months to come: rates are the biggest catalyst to equity underperformance. Should
rates rise decisively, equity are most likely to tumble in size, no matter how much nominal
growth 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 that
when 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 the
market at approx - 20%. We disagree with the market pricing of correlation here as we believe it
might soon turn out to be +50%. And on the way down! Bonds and equity could fall
simultaneously. And not only because rates have hit their zero bound (if anything, the ECB starts
contemplating negative nominal rates, for example). Such misalignment between our forecast and
the market forwards highlights a valuable opportunity for our strategy: it helps build cheap
hedges against Equity going down, or helps cheapening up good hedges against Rates going up.
The case for being short Japanese Rates
Interest-rate wise, in the short term, we believe samurai-Japan might manage to close ranks and
fight back. At the speed it opted for, Abenomics cannot possibly last for several years: still, it is at his
infant stage now. More money can be poured into the market, open-endedly. The revisions to its
expected 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 confusion
over 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 for
real. Its vulnerability without precedents. The cheapness of an hedge so extreme as to make it
broadly indifferent to the timing of materialization of such bearish view. Therefore, we remain
8. 8 | P a g e
committed to take advantage of a possible renewed compression in yields/vol to build up more
on short Japanese rates positions.
The case for being short the Japanese Yen
Currency-wise, it is hard to imagine a state of the world where the Yen is not significantly
weaker than it is today (even after devaluing some 25% recently).
- Rates could be higher, which means equity would be lower, as debt crisis may
snowball abruptly, and JPY weaker in reflection of such calamity.
- Or rates could be managed down successfully, anchored at zero across the curve
via more monumental money printing, and equity up, just nominally so, as JPY
weakens further, and rapidly so.
The one scenario where the JPY goes back to its highs (around 75 vs USD) seems at present the most
unlikely. The dynamics that the BoJ has set in motion are irreversible. By promising to print so
much, they now can print so much or much more than that. By having selected such an overdose
of monetary expansion, the more bonds sell-off the quicker they might have to step-up their printing
presses. The more they crowd out the private sector on JGBs, the more they will eventually have to
print. 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 for
success in war is burning boats or bridges for escape. The tactic is basically this, taking an army
across a river, burning all their boats, the only routes of escape. Left with two choices when facing
the enemy army, to win or to die, people will do super human feats to survive. Similarly, Abe and
Kuroda today, have put themselves in a corner where they are confronted with one of two
options: print, and buy bonds only, hoping for the market to grow before inflation kicks in; or
print more, and buy all bond and some equity, if inflation kicks in and/or the market does not
grow. 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 taking
by HFs). Higher Japanese rates seems the cheapest bet in town. Higher Nikkei seems to require
the boldest view to take, as it is digital volatile and two-sided fat-tailed market outcome from now
on (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 of
policy was structural, and equity would have rallied more than the currency depreciated (Outlook
and our CNBC interview). Such 'nominal rally', as we called it then, was hedge-able into hard
currency at cheap costs. So we could rent a 'illusory rally', by hedging it out of its fake context. We
9. 9 | P a g e
now are inclined to think the currency itself has better odds than the equity market it
denominates. Rephrased, selling the Yen should make us more profits than buying the Nikkei
and hedging it in USD.
For the records, typically, a 10% trade-weighted weakening of the Yen leads to a 0.3% increase in
inflation 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 deficit
territory. Current account deficit coupled with extraordinary monetary expansion calls for a currency
weaker than the currencies of countries with similar deficits but softer monetary expansions (Japan is
a third of the US, but may expand by more in absolute terms, $1trn in the US vs soon $1.3trn in
Japan)
However, we are prepared to change that stance should we see other countries clearly following
the lead of Japan on the field of monetary disorder. Should Korea, Taiwan, Australia, Europe, or
the US itself, step up their activities then Currency Debasement would be more visible on the
equity markets than it is on cross-pairs.
When Japanese equities corrected, the Pavlovian response of the market sent the yen to stronger
levels. Linearly interpolating from recent positive correlation between weaker Yen and higher equity
market. That can't hold, in our eyes. To us, not just a flamboyant equity market but an imploding
equity market too can drive yen weaker, going forward. Acceleration leads us to breakage points, not
historical correlation.
Interestingly, one more force should help Yen slide further vs USD: this week saw real rates in Japan
plummeting below US real rates for the first time in years. 5yr real rates are at a new super low
beyond -1.5% in Japan (as nominal yields rose less than inflation expectations), whereas they moved
up from -1.5% to -1% in the US (as break even inflation rates lowered). Declining inflation
expectations in the US, possibly on the back of the Deleveraging Chain shown above (whilst Japan
seems kamikaze-committed to 2% percent inflation) are at the basis of such increase in real rates in
the US.
Incidentally then, local Japanese money managers (especially the VAR-shock sensitive ones like
banks, broker dealers, regional and Shinkin banks) should be compelled to divest from shaky JGBs
and sinking Yen, and move to USD cash, pure and simple cash, for a real yield pick-up.
10. 10 | P a g e
Japan’s impact on the world: a powerful accelerator in the global
monetary experiment
Japan policy change is a powerful accelerator to the end game for economies involved in similar
policies the world over. It is that chemical element which gets added to the mix to accelerate the
chain 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, Japan
resolved for samurai-(kamikaze)-style final solution, putting the feet down on the accelerator to
take off and jump over that cliff, into Debt Monetization via Currency Debasement and negative
real 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 of
not following down the cliff if it does not work. Having a real life example in the largest monetary
policy experiment of the last hundreds years might seem to him too good to be true.
Abenomics’ precedent in history: Takahashi policy
For what is worth, Abenomics has a model in history. It is Takahashi policy in 1932-1935, which
managed 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 the
USD, to then stabilize around 40% depreciation.
However, rates were cut 3%, which cannot be done today as they already are at 0%, and fiscal
policy was loosened back then, which cannot be done today (as fiscal consolidation has been
promised 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 believe
reallocation 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 put
forward on bonds. Again, less money for equities (as the BoJ warned that they can
buy equities directly). Equity vol can increase. Thus, again, next bubble might be
Gold or Oil or Grain?
11. 11 | P a g e
- If the next bubble is Gold, there are the least negative repercussions. Gold is
useless, that's why it can skyrocket to silly numbers. It doesn't matter to anybody
(it's like banking reserves nowadays, the largest ever, yet the most ineffective they
have ever been).
- But if the next bubble is Oil, then it is big trouble for Equity. Rising cost of energy
can suck up certain profit margins (US is warned, where corporate profits are the
bubble 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 a
less benign inflation who pushes higher energy input prices first. Weaker yen drives
up import prices.
As we move in a minefield, the most arduous task of policymakers is to try and avoid unintentionally
triggering such chain reactions. Surely, time will run faster now. It won't take another 25 years to
determine the end game for Japan and other monetary expansionists.
At the risk of sounding obvious, ‘path dependency’ affects the final end game for leading-indicator
Japan and other Quantitative Easing champions after it. In many ways, erraticism will inevitably
play a role over causality. We are left to watch events as they unfold, to see which factor takes
center-stage first, and from there we will assess the weight of each factor in contributing to the final
result. All we can do at this stage is to be flat of risk, having higher allocation to cash than
normal, and staying hedged and over-hedged, through cheap optionality-type strategies, as the
market surely underestimates tail risks (realized volatility can be substantial, economically-wise
and politically-wise).
China’s impact on Japan, and vice-versa
Interestingly, in the short term, the velocity of the JPY weakening also rests on China’s growth
prospects. Not so much the China's growth as depicted by government figures, but rather the one
reflected 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 the
board, stronger dollar equates to a weaker Yen, amongst others. Additionally, cheaper oil also
concurs to the shrinking fiscal deficit in the US (together with higher tax revenues and stronger real
estate), with a subsequent stronger dollar in the process. For all these reasons, we have to keep an
eye on China in monitoring our short Yen position in the near term.
12. 12 | P a g e
China may hold the key to what the market has in store in the next few months for a variety of
levers: the dollar index strength, equity markets in EM, and our shorts on JPYUSD and AUDUSD. We
have to watch closely policy moves there. Can credit expansion resumes despite clear signs of
diminishing returns and credit exhaustion? True, china stock of debt is not outrageous when
compared to Developed Markets. However, what matters is not so much Domestic Credit to GDP
ratios, where China lags behind Japan, US (at 150% vs 250%), but rather the speed of acceleration of
credit expansion. Using Total Social Financing (overall credit supply to the economy), total leverage
built up by 60% of GDP in the last 5 years, to 207% of GDP (research). Will it continue now after
watching the monumental policy experiment in Japan?
It is also important to track their undergoing Interest Rate and Capital Account liberalization. We
have 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 its
growth model to internal consumption, the growth prospects of China are heavily reliant on exports
and aggregate foreign demand. At 50% Investment on GDP, and Private Consumption now below
35%, China is way more dependent on the external world than ever before. The remarkable
resilience it showed during the 2009 crisis and the 2011 crisis is history (when its two most important
trade partners imploded - US and Europe respectively). China's instability now is unmistakable and
might call for more expansionary policies, on par with Japanese contenders. It is key to
understand that over the coming months, as policymakers make up their mind and data comes
in.
The case for being short the Australian Dollar
Back in November 2012, we wrote:
“This year we had a great run hedging the China Hard Landing Scenario, expressed via
shorts on the Dry Bulk segment of the shipping industry, heavily sensitive to the
Chinese 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 and
Mining flows. We recently took all profits and closed positions, for the time being. Although
we still believe in the idea, we are on the verge of forceful money supply in China (for a
change) and abroad, and therefore became wary of a short term rebound. If such rebound
materializes, we would like to reinstate positions, this time expanding the scope to the
Australian dollar, the banking sector in Australia, and the Luxury industry, in addition to
Shipping, Mining and the likes.
It is the case that we now like the Australian Dollar short in particular. Less so the short on
Australian banks, for the time being (although we might implement that one too soon, possibly in
relative 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. 13 | P a g e
economy that has not known inflation in the past century), and cause a Nominal Rally of the likes of
Japan. 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 in
the months to come (save for a short term rebound, like the one which could be undergoing in the
next few days, as Fibonacci/Bollinger barriers are tested for AUD/USD together with EUR/USD and
JPY/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. AUD
will 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 allegedly
'successful' Japanese experience. Nominal Rally would follow in the equity
markets, through AUD Currency Debasement exercise (not so much for the same
reasons 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 of
Japan or the US (not so much a resumption of hostilities in Europe, which has last
drove money into Australia, crowding out their govies, which at some point were
80% held by foreigners). A global risk off mode could possible drive AUD down
this 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 is
driving up AUD (and JPY) vs USD: but it is the digital adjustment we fear, a steeper
correction, 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 plan
to leverage on potential pull backs in the short term to build more hedges. In the last few days we
saw dollar weakness across the board, as USD supply emerged on the euro breaking above 1.2900
and traded as high as 1.3060. From a JPM trader: “the USD was pounded across the board yesterday as
a market long at lofty levels ran for the hills, and with month end tomorrow anything is possible from
here. Overall I still want to be short of euro, but we are in a random flow driven market and there is a
plethora of stops above 1.3000 that I simply can’t ignore. Back below 1.2925 and 1.2900 a top short term
could be in place, but frankly I’d rather trade tactically for 48 hours and then get back on trend next
week”
In conclusion, after closing down successfully our shorts on the shipping market, AUD is now our best
guess for hedging weak global GDP and China Hard Landing scenario. The China Hard Landing
scenario is one of six basic scenarios in our road-map for Multi-Equilibria Markets (where the final
outcome is hard to anticipate as it may divert markedly from classical mean reversion: diametrically
14. 14 | P a g e
opposite scenarios are made equally possible, which deflect vastly from the baseline scenario
currently 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 to
be dealt with by pure growth. Four decades of credit expansion which followed the end
of Bretton Woods are now coming to an end, as debt metrics are unsustainable and
growth is gripped down by such debt overhang. The debt as a % of productive GDP/real
output growth is just too high. Policymakers and handy central banks are confronted by
unconventional hard choices between one of two evils:
- Inflation Scenario (Currency Debasement, Debt Monetisation, Nominal Defaults). It
seems the route followed by Japan, the US, the UK. This is a Nominal Default, but still a
default (as it curtails the value of a fixed income claim as surely as a default). As we
previously 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. Of
course the financial assets get bloated up, at present. It is purely a nominal rally, though, not
a 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 across
Europe). Let deleverage unravels, Europe flirted with this option, last month.
Accepting lower returns expectations, not so much outsized risks
We acknowledge that we live in a low yield / low expected returns environment. But one thing is to
get accustomed to lower returns, one thing is to get accustomed to outsized risks. In normal
markets, it used to be low risks for low returns, or high risk for 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 construct low risks for
digital zero or high returns. If the deal is CCC credit (overrated by complacent lagging-indicators
Rating Agencies) offered at 5%/6% return, then we might as well stay in cash (except for tactical
short-dated spots).
Investing for Carry is today the riskiest it has been in ages, as we move on the thin ice of
experimental Central Bank laboratory. By the same token, the opportunity cost for calling
ourselves 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 an
unsettlement of such equilibrium (Multi-Equilibria Markets). This is what we have in mind when we
seek to amass growing quantities of Cheap Optionality, cross assets, methodically, via our
hedging book (Fat Tail Risk Hedging Programs).
15. 15 | P a g e
High cross asset correlation and high downside Beta helps in the process of building this
unconventional risk management policy, as you can aim at hedging one asset class with another for
minimization of hedging expenses.
We suspect that the most flawed idea floating around in complacent markets this quarter has
been that of a “bondification” of equities. Equities are not bonds. Central banks can't bid all
asset classes at the same time. They have to pick up their battle fronts as every other human being
on the planet. Equity will keep his volatility. We should be prepared to take advantage of that. A
steep 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 money
has no mercy for mild fluctuations, making steep correction steeper.
Finally, we will hold our Monthly Outlook Presentation on the 6
th
of June in 55 Grosvenor street,
where supporting Charts & Data will be displayed for the views rendered here. Please do get in touch
if you wish to participate.
Francesco Filia
CEO & CIO of Fasanara Capital ltd
Mobile: +44 7715420001
E-Mail: francesco.filia@fasanara.com
Twitter: https://twitter.com/francescofilia
55 Grosvenor Street
London, W1K 3HY
Authorised and Regulated by the Financial Conduct Authority (“FCA”)
16. 16 | P a g e
What I liked this month
What If Stocks, Bonds and Housing All Go Down Together? About the claim that central
banks will never let asset bubbles pop ever again--their track record of permanently
inflating asset bubbles leaves much to be desired. Read
Next Group That May Be Slammed by Debt: Farmers Read
Cypriot "Blueprint" - How To Confiscate $32 Trillion In "Offshore Wealth" Read
We’re now living in a Lance Armstrong economy. We’ve consumed so many performance
enhancement drugs through QEs that it is hard to know how well the economy is really
doing. Sadly, as Armstrong did, we’ll have an Oprah Winfrey moment when the economy
will have to fess up for all the QEs. Mauldin Economics. Read
W-End Readings
Soros Vs Sinn: To 'Eurobond' Or To Save The Euro Read
In Germany and Switzerland, Li Chooses His Friends Carefully Read
Statistics guru Hans Rosling debunks myths on the "developing world" Video
Learn to read Chinese ... in 6 minutes! Video
“This document has been issued by Fasanara Capital Limited, which is authorised and regulated by the Financial
Conduct 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 distribution
form the basis of or be relied on in connection with any contract. Interests in any investment funds managed by New
Co will be offered and sold only pursuant to the prospectus [offering memorandum] relating to such funds. An
investment in any Fasanara Capital Limited investment fund carries a high degree of risk and is not suitable for retail
investors.] Fasanara Capital Limited has not taken any steps to ensure that the securities referred to in this
document are suitable for any particular investor and no assurance 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 or analysis on which it is based, before the material is
published. Fasanara Capital Limited [and its] personnel may have, or have had, investments in these securities. The
law may restrict distribution of this document in certain jurisdictions, therefore, persons into whose possession this
document comes should inform themselves about and observe any such restrictions.
