1. July 27th 2012
Fasanara
Capital
|
Investment
Outlook
We
hold
onto
the
contents
of
our
three-­‐phased
market
view,
as
we
position
for
the
market
to
(i)
remain
into
volatile
range
trading,
before
(ii)
drifting
lower
on
renewed
market
pressures,
possibly
seeing
new
lows,
and
(iii)
being
then
re-­‐flated
back
by
policymakers’
fresh
intervention.
In
the
long
run,
under
our
Multi-­‐Equilibria
market
theory,
we
give
it
a
decent
chance
for
the
bubble
to
bust
in
one
of
several
possible
ways,
potentially
leading
to
an
Inflation
Scenario
(Nominal
Defaults)
or
a
Default
Scenario
(Real
Defaults)
and
their
various
possible
declinations.
Phase
I:
‘Deflating
Further’
In
the
near
term,
on
Phase
I,
we
expect
the
market
to
give
in
to
its
downside
risks.
The
catalyst
could
be
Spain,
its
banks’
recapitalization
needs
(as
the
EU
has
deliberately
delayed
to
assess),
it
may
be
its
illiquid
and
insolvent
Regions,
its
tumbling
Real
Estate,
its
capital
flights
or
its
street
riots.
As
we
monitor
capital
flows
closely,
for
example,
in
the
last
fortnight
we
sensed
the
first
serious
capital
outflows
away
from
Spain
by
some
of
the
large
Corporates
in
the
country.
Up
until
very
recently,
no
real
outflows
had
really
been
triggered
by
local
household,
local
banks
and
local
corporates.
To
the
end
of
June,
most
of
the
350bn
rise
in
Target2
liabilities
held
by
the
Bank
of
Spain
with
the
Eurosystem
would
account
for
foreigners
only,
leaving
Spain
through
either
repatriating
deposits,
selling
Spanish
equities/bonds
or
foreign
banks
redeeming
loans.
No
more
than
10%
of
it
was
driven
by
local
players
rundowns
(to
be
precise,
in
the
previous
12
months,
Spanish
Corporates’
deposits
fell
by
just
16%,
Spanish
Household
by
tiny
4%).
It
will
be
interesting
to
read
through
July
data
for
Target
2
exposure,
as
soon
as
they
are
available.
However,
it
seems
the
case
that
locals
have
proven
quite
resilient
up
until
now,
keeping
the
systemic
risk
on
their
books
unabated.
The
rising
risk
of
bank
runs
in
Spain
is
therefore
not
priced
in,
and
one
of
the
key
vulnerabilities,
as
data
shows
that
it
has
not
even
began
as
yet.

2. Likewise,
Italy
and
Greece
are
dangling
on
a
string,
for
some
of
the
same
reasons.
This
week,
we
record
a
most
concerning
bearish
flattening
of
the
government
bond
curve,
one
of
the
indicators
we
had
on
our
checklist
for
spotting
dangerous
market
momentum:
2yr
yield
in
Spain
(and
Italy
to
a
lesser
extent)
closed
much
of
the
gap
to
10yr
yield,
with
both
reaching
to
new
highs.
Not
surprisingly,
yesterday
Mr
Draghi
deemed
it
opportune
to
come
out
with
an
unusually
bullish
statement,
for
he
would
’do
whatever
it
takes
to
save
the
Euro’.
Maliciously,
yesterday
was
also
the
first
day
of
holiday
for
Ms
Merkel,
as
Draghi
may
have
timed
his
outing
wisely,
capitalizing
un-­‐disturbed
on
his
window
of
opportunity..
Phase
II:
‘Reflating
Back,
following
new
intervention’
We
believe
that
such
market
capitulation
will
lead
into
a
fresh
new
intervention,
on
Phase
II,
as
it
will
manage
to
build
enough
political
consensus
around
such
policy
move.
In
other
words,
we
believe
that
further
market
weakness
and
street
riots
are
needed
to
trigger
the
intervention.
Such
intervention
is
likely
to
be
shaped
in
one
of
two
different
ways:
(i)
SMP
direct
purchases
of
government
paper
by
the
ECB
(possibly
leading
to
a
more
widespread
TARP-­‐like
program
of
asset
purchases
in
the
next
12
months,
despite
Draghi’s
current
reluctance),
or
(ii)
providing
the
ESM
with
a
banking
license
(despite
Germany’s
current
reluctance),
so
that
it
can
increment
its
firepower
from
Eur
500bn
to
infinity,
having
access
to
ECB’s
liquidity
operations.
Such
bimodal
outcomes
are
the
two
faces
of
the
same
coin:
the
ECB
is
prevented
from
giving
unlimited
financing
to
governments,
under
the
limitations
of
its
founding
treaty,
but
it
can
give
unlimited
financing
to
a
bank
(and
so
it
has
done
with
LTROs
and
MROs).
ESM
would
therefore
become
the
Trojan
horse
of
the
ECM’s
SMP
operations,
with
yet
another
layer
of
complex
financial
engineering
thrown
in.
On
the
other
hand,
we
believe
that
alternative
interventions
are
not
realistic:
(i)
Eurobond
would
take
ages
to
implement,
as
multiple
treaty
changes
are
required,
and
the
necessary
referendums
that
go
with
it;
(ii)
LTROs
would
be
ineffective,
as
the
lack
of
eligible
collateral
is
a
major
constraint,
let
alone
the
concentration
of
local
risks
it
has
morphed
into
(exacerbating
the
negative
feedback
loop
between
Sovereigns
and
Banks).
Both
interventions
deliver
some
sort
of
Debt
Mutualisation
across
the
Euro-­‐area,
filling
the
void
of
unsustainable
imbalances
across
the
region,
buying
some
more
time
to
the
Euro,
delaying
the
day
of
reckoning
for
‘debt
saturation
without
growth’
in
peripheral
Europe,

3. effectively
inflating
the
bubble
even
further,
adding
new
debt
and
new
leverage
to
the
existing
unsustainable
debt
overhang,
so
as
to
attempt
to
keep
the
whole
system
afloat.
Debt
Mutualisation,
if
properly
and
timely
implemented,
could
potentially
set
the
basis
for
a
more
sustainable
Europe.
We
hold
doubts,
but
definitively
quite
a
bit
of
time
can
be
bought
through
that.
Germany
is
key,
as
it
has
the
most
to
lose
in
that
framework.
The
next
six
months
are
key
in
assessing
this
probability.
On
our
count,
even
if
such
forms
of
Debt
Mutualisation
were
to
occur,
their
chances
of
success
are
nowhere
near
par.
We
rendered
some
of
the
reasoning
on
it
in
our
latest
Outlook.
Essentially,
we
argue,
the
fundamentally
flawed
Euro
construct
meets
a
dangerously
high
level
of
over-­‐indebtedness
in
the
system,
on
a
near
global
scale.
The
fragile
Eur
fixed-­‐exchange
system
is
all
the
more
inherently
unstable
when
measured
against
a
level
of
leverage
by
major
economies
which
grows
increasingly
unbearable
as
a
percentage
of
GDP,
real
productivity
and
industrial
production
(the
latter
stripping
out
the
borrowing
factor
from
GDP
aggregate
numbers).
And
the
denominator
of
the
troubled
‘global
Debt/productive
GDP
ratio’
receded
some
more
recently.
In
the
last
fortnight,
we
had
more
evidence
of
China
hard
landing
and
US
slowing
down.
In
the
US
in
particular,
latest
GDP
numbers
were
not
only
retrenching,
but
also
dependant
for
most
part
on
personal
consumption
expenditure,
where
(i)
half
of
it
was
due
to
a
drawdown
of
savings
rates
as
opposed
to
real
output
growth
or
real
wages
and
(ii)
the
rest
was
perhaps
due
to
the
boost
in
disposable
income
provided
for
by
the
extended
transfer
payments
and
tax
cuts
(cumulatively
a
whopping
1.4trn
in
the
last
year).
Now,
as
the
‘fiscal
cliff’
approaches
and
the
savings
rate
accelerates
its
rise,
the
fairy
tale
of
a
strong
recovery
in
the
US
might
just
be
about
to
dissipate.
And
with
it,
so
it
will
delusional
peak
profit
margins
of
American
corporations,
lying
on
the
thin
ice
of
an
unsustainably
debt-­‐laden
economy.
Overall,
the
global
framework
we
operate
into
does
not
help
the
Euro
cause
in
the
long
term,
even
before
accounting
for
Europe’s
negative
externalities
abroad.
Phase
III:
Busting
of
the
Bubble.
To
us,
the
same
fact
that
the
current
level
of
10yr
government
yields
in
the
US
has
not
been
seen
for
220-­‐years,
in
Japan
for
140years,
in
Germany
for
200
(and
in
Holland
for
500
years),
speaks
for
itself
and
calls
for
abnormal
market
conditions
on
abnormally
long
historical

4. evidence
and
time
series.
Our
outlook
for
Multi-­‐Equilibria
Markets
means
just
that.
As
opposed
to
simple
mean
reversion,
the
dust
in
the
markets
could
settle
in
diametrically
opposite
ways
and
the
system
might
find
its
new
equilibrium
in
there.
The
expectation
that
things
will
be
sorted
out
and
the
old
trend
on
the
old
framework
will
resume
might
not
only
prove
delusional
but
also
preclude
one’s
strategy
from
capturing
amazing
value
in
the
current
context,
namely
what
we
refer
to
as
Fat
Tail
Risk
Hedging
Programs.
We
suspect
Europe
cannot
manage
to
paddle
forever
in
the
middle
of
the
distribution
curve
and
avoid
the
edges
of
these
cliffs.
As
per
Herbert
Stein's
Law:
"If
something
cannot
go
on
forever,
it
will
eventually
stop’’.
The
base
case
of
a
stagnant
Japan-­‐style
slow
deleverage
could
lead
into
Fat
Tail
Risk
Scenarios
at
any
time
over
the
next
4
years.
Scenarios
include:
Inflation
Scenario
((Nominal
Defaults,
Debt
Monetization
and
Currency
Debasement),
Default
Scenario
(Real
Default
and
Debt
Rescheduling/Haircut),
Renewed
Credit
Crunch,
EU
Break-­‐Up,
China
Hard
Landing,
USD
Devaluation.
Opportunity-­‐Set
In
opportunity
land,
we
believe
the
most
interesting
value
investment
right
now
in
Europe
is
to
take
advantage
of
such
market
resilience
to
provide
one’s
portfolio
with
your
own
home-­‐
made
backstop
facilities
and
firewalls.
In
fact,
Risk
Premia
are
nowhere
near
where
they
ought
to
be
should
one
factor
in
the
even
vague
possibility
of
partially
failing
European
policy
making.
Our
leit-­‐motiv
remains
to
take
advantage
of
current
market
manipulation
and
compressed
Risk
Premia
to
amass
large
quantities
of
(therefore
cheap)
hedges
and
Contingency
Arrangements
,
thus
balancing
the
portfolio
against
the
risk
of
hitting
Fat
Tail
events
in
the
years
to
come.
If
we
do
not
hit
them,
then
great,
it
will
be
the
easiest
catalyst
to
us
hitting
the
target
IRR
on
the
value
investment
portion
of
our
portfolio
(what
we
call
Safe
Haven,
or
Carry
Generator).
If
we
do
hit
one
of
those
pre-­‐identified
low-­‐probability
high-­‐impact
scenarios,
then
cheap
hedges
will
kick
in
for
heavily
asymmetric
profiles
(we
typically
targets
long
only/long
expiry
positions
with
10X
to
100X
multipliers).
Such
multipliers
are
courtesy
of
market
manipulation
and
‘interest
rate
rigging’
provided
for
by
Central
Bankers.
Look
no
further
than
that,
as
we
believe
that
they
represent
the
only
truly
Distressed
Opportunity
right
now
in
Europe.
Timing-­‐wise,
the
next
6
months
may
provide
the
most
interesting
window
of
opportunity.
Beyond
that,
perhaps
within
18
months,
it
may
be
the
next
most
crowded
trade.

5. Portfolio
Construct
Our
personal
roadmap
to
successfully
riding
current
financial
markets
is
based
on
the
following
portfolio
guidelines:
-­‐ Keep
the
Dry
Powder,
on
a
slim
and
nimble
liquid
portfolio,
heavily
under-­‐investe
-­‐ Accumulate
nominal
returns,
on
safe
senior-­‐secured
short-­‐dated
corporate
exposure
from
northern
Europe
(Value
Investment
section
of
the
portfolio)
-­‐ Unload
it
fast
on
triggering
target
IRRs
and
meeting
Carry
Accumulation
plans
-­‐ Amass
large
quantities
of
long-­‐only
long-­‐expiry
heavily-­‐asymmetric
profiles
to
insure
and
over-­‐hedge
against
pre-­‐identified
Fat
Tail
Scenarios.
Accumulate
a
treasury
of
optionality
over
time,
banking
on
system-­‐wide
dislocations
and
mis-­‐
pricings
(leading
us
into
Cheap
Optionality,
Select
Shorts,
Embedded
Options
and
Dislocation
Hedges)
-­‐ Follow
methodically
and
meticulously
the
list
of
pre-­‐identified
Fat
Tail
Scenarios
and
match
it
to
the
list
of
pre-­‐identified
Eligible
Instruments
(Fat
Tail
Risk
Hedging
Programs
section
of
the
portfolio)
From
here,
on
this
construct,
two
outcomes
are
we
prepared
for:
-­‐ Pitfalls
in
Europe
on
the
way
to
restoring
imbalances
due
to
under-­‐execution
of
austerity
programs,
and
‘adjustment
fatigues’,
leading
to
the
possibility
of
steep
market
corrections
and
the
chance
for
us
to
reload
fast
on
the
Value
Investing
part
of
the
portfolio,
at
cheaper,
safer
and
more
sustainable
valuations
(acceleration
of
the
ramp
up
of
the
portfolio)
-­‐ Fast
forward
to
Tail
Events:
best
case
scenario
for
our
strategy

6. What
I
liked
this
week
Ray
Dalio:
Don't
Assume
Germany
Will
Bail
EU
Out;
"Fat
Tail"
A
Real
Possibility
Read
Swiss
base
money
spikes
as
the
SNB
defends
the
peg
Read
End
of
game?
Don’t
bet
on
it
Read
Natural
gas
up
44%
from
the
lows
Charts
W-­‐End
Readings
Former
Reagan’s
Budget
Director
David
Stockman:
‘This
market
isn't
real.
The
2%
on
the
ten-­‐year..
those
are
medicated
rates
created
by
the
Fed
and
which
fast-­‐money
traders
trade
against
as
long
as
they
are
confident
the
Fed
can
keep
the
whole
market
rigged’
Video
How
things
change,
China
FX
manipulation.
The
renminbi’s
weakness
appears
to
stem
from
the
actions
of
market
participants
rather
than
those
of
policymakers
Read
Francesco Filia
CEO & CIO of Fasanara Capital ltd
Mobile:
+44
7715420001
E-­‐Mail:
francesco.filia@fasanara.com
16
Berkeley
Street,
London,
W1J
8DZ,
London
Authorised
and
Regulated
by
the
Financial
Services
Authority
“This
document
has
been
issued
by
Fasanara
Capital
Limited,
which
is
authorised
and
regulated
by
the
Financial
Services
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.