1. summitV I E W summit creek
But the most important point is that almost
two years since a normal financial panic, the
polity has still not managed to absorb the
consequences of that event. The politically
summitVIEW
contrived corporation, and particularly
the financial corporations, stands accused
of undermining the wealth of nations. As
Adam Smith understood, markets are not
natural entities but the result of political
decisions, as is the political system that
The creates the allocation of risk that allows
markets to function. When that system
Global Crisis of Legitimacy appears to fail, the consequences go far
beyond the particular financials of that
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This report is republished with permission of STRATFOR. Segments of
article shown below. The entire article is worth reading. Click the link event. They have political consequences
above to access the article. and, in due course, geopolitical conse-
June 2010
he crisis was rooted in the appearance that it quences. (emphasis added)
was triggered by the behavior not of small town
banks or third world countries, but of the global fi- George Friedman, PhD, Founder and
nancial elite, who took advantage of the complexities CEO STRATFOR
of law to enrich themselves instead of the sharehold-
ers and clients to whom it was thought they had prior Willem Buiter, chief economist of Citi, uses
fiduciary responsibility. rather blunter language. “Today’s ‘best of
breed’ may be the same dog that yesterday
This is a political crisis then, not an economic one. was fit only for the World’s Ugliest Dog
The political elite is responsible for the corporate Contest – an indicator of just how far the
elite in a unique fashion: The corporation was a po- fiscal conditions in most advanced indus-
litical invention, so by definition, its behavior de- trial countries have deteriorated,” he says.
pends on the political system. But in a deeper sense,
the crisis is one of both political and corporate elites, The difficulty for governments is that
and the perception that by omission or commission loading deficit reduction on to still fragile
they acted together — knowingly engineering the economies in the coming decade of ageing
outcome. In a sense, it does not matter whether this is and increased demand for public services
what happened. That it is widely believed that this is rarely brings popularity. This week Greece
what happened alone is the origin of the crisis. This has shown that there might not be any al-
generates a political crisis that in turn is translated ternative.
into an attack on the economic system.
Chris Giles, Financial Times, London
April 28, 2010
But for now, the important thing is to understand that
both Europe and the United States are facing funda- Investors pour money into emerg-
mental challenges to the legitimacy of, if not the re- ing-market bonds
gime, then at least the manner in which the regime
has handled itself. The geopolitical significance of Investors are fleeing from sovereign debt
this crisis is obvious. If the Americans and Europe- of Western European and other developed
ans both enter a period in which managing the in- countries, shifting funds into emerging-
ternal balance becomes more pressing than manag- market bonds. The move is an effort to
ing the global balance, then other powers will have bolster returns, but is also a bet on the
enhanced windows of opportunities to redefine strength of emerging markets. “Any num-
their regional balances. ber of [issuers] are able to come to market
see disclaimer on last page that wouldn’t normally be able to -- and

2. summit creek
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June 2010
they can come at lower spreads than they other- U.S.A. where we have massively indebted State
wise would,” said Matthew Ryan, a co-manager and local governments. And then … well, take a
of the MFS Emerging Markets Debt Fund. look at the mania in Toronto and Vancouver real
estate as an example. Bubbles will be popping.
The Wall Street Journal (06 May 2010.)
David Rosenberg, Breakfast with Dave, Gluskin Sheff
Canary in a Coal Mine & Associates, Inc., May 6, 2010
....Dubai was the real canary in the coal mine Debt Ratios to Rise Further
on the sovereign credit front, and now Greece
is very likely going to be the touch-off point In the final analysis, if the EU lends money to
for other high-debt/high-deficit countries with Greece or to any other problem country in the
weak economic structures such as Portugal, zone, debt ratios (including contingent liabili-
Spain (already rumoured to be in talks with the ties) in the region will only rise further. It will
IMF) and even Italy. Next will be the U.K. whose be interesting to see how the rating agencies end
balance sheet is not far off from what Greece up handling this. It cannot be lost on them, or
looks like and looming political uncertainty to the global investment community, that while
boot. So it pays to not be complacent at this time, loans, guarantees and central bank provision-
and to try to identify what the next chapters of ing can deal effectively with liquidity issues,
the deleveraging book are going to be — espe- they are ineffective in addressing what’s really
cially since the McKinsey report tells us that the at stake here, which are structural fiscal issues.
aftermath of a global credit collapse typically So the deal over the weekend is only going to
last 6-7 years. It doesn’t mean that we won’t go be successful insofar as they are backed up by
through whippy bear market rallies like we did meaningful reforms (it must be emphasized
in the past year, but these rallies, despite their that the rescue package critically hinges on the
intensity, are rallies you rent in a secular bear Club Med countries accepting deep budgetary
phase. Do not overstay your welcome. retrenchment notwithstanding their weak eco-
nomic structures. Indeed, it will be interesting to
Once we are through with Euroland and the see how Spain can manage to meet EMU deficit
U.K., perhaps the next problem spot will be requirements at a time when the unemployment
China where the government is tightening to rate is currently at 20%, just as one example.)
combat what well could be a significant prop-
erty bubble. Then it may come right back to the David Rosenberg, Breakfast with Dave, Gluskin Sheff
& Associates, Inc., May 10, 2010

3. nteresting the recent return of the label Gen-
eration X in the mass media. Until I read an
interview of a man from Canada who popular-
ized the term Generation X, consideration of the
“generational-descriptor” was little given. Curi- adjustment to an energy force. In that adjust-
ously, I find the label somewhat suitable. ment there are patterns of flow that disperse the
energy. To the naked eye the swirls in the water
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Upon graduating from college I read I was a are vortexes of bubbles and beauty. In flow dy-
member of Generation X. I thought, what to do namics the turbulent disruption would be mea-
with this name? Perhaps X means I should go sured and modeled.
ahead and follow my immediate response. Since
I’m of the X generation perhaps my generation In past periods of disruption (we’ve had a few
is meant for little. To what does a generation even though they are now merely words and im-
amount when they bear a letter with such nega- ages to the many with short term memories) a
tive connotation? Shall I head for a remote island transition ensues. As one who sits just behind a
and enjoy the passing of time staring at the sea large passing generational wave, I wonder how
the transition will unfold for the country and the
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since my generation will amount to little? Why
were we not generation Y? Now, I’d take gen- developed world. Speculating on outcome and
eration Y over generation X any day of the week. opportunity is daunting and exciting.
June 2010
Generation Y has such existential qualities. Gen-
eration X: watch out for the gangsta. Generation One daunting concern is the economic and gov-
Y: welcome the philosophers. ernmental obligation the baby boomer genera-
tion has decreed it deserves in its fade to glory.
Recently, though, I’ve come to appreciate the As a Generation X member am I to have the same
subtleties of my generational moniker. Wikipe- fate of prosperity and wealth of the boomer gen-
dia, for what it’s worth, says of Generation X the eration? Is my generation at an inflection point
following: where economic outcomes for many do not meet
indoctrinated dreams and expectations? Con-
Coming of age after the Vietnam War had ended, versely, what exciting prospects await those
their political experiences and cultural perspective who embrace the oncoming waves and prepare
were shaped by the end of the cold war, the fall of accordingly?
the Berlin wall, and a series of US economic calam-
ities such as the 1973 oil crisis, the 1979 energy
crisis, the early 1980’s recession, and the savings
and loan crisis - instilling a sense of economic un-
certainty and a reduced expectation of long term
fidelity between employers and employees.
Further, TIME magazine in an article from April
16, 2008 asked is Gen-X: The Ignored Generation?
Generation X, Wikipedia further states, “was
originally referred to as the ‘baby bust’ genera-
tion because of the drop in the birth rate follow-
ing the baby boom.” SummitVIEW’s response
and view is that following the baby boomer gen-
eration is like bobbing in the water just after the
force of a boat’s wake passed through. Disrup-
tion ensues with settlement forthcoming.
What waves will be forthcoming? What is the
Disruptions in the global economic framework cycle of disruption and opportunity passing
over the last three years represent the passing through? Everyone is familiar with the refrain
of the baby boomer generation. As a member that if you don’t know history you are bound to
of Generation X, I feel as if I’m bobbing in the repeat it. Certainly, one can still be aware of his
water after the wake of the baby boomer genera- or her history as a country or people and still
tion blew through, leaving disruption and tem- succumb to historical tendencies. I find fascinat-
porary chaos in its wake. The interesting infer- ing the United Kingdom’s modern history. The
ence here is that the disruption one feels as the country pushed itself to the edge of bankruptcy
wave passes through is not so much chaos as an twice within a century. The consequence of the
www.summitcreekcapital.com

4. What does exist is systematic risk or, rather, en-
dogenous risk. Humans have a tendency to-
wards excess and that tendency is reflected in
the systems we build. The next wave of financial
research and innovation will center on under-
standing our endogenous risk. What are the best
measures of endogenous risk and how best does
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one respond and invest according to the levels of
endogenous risk? As these measures are qualita-
tive and quantitative in nature, new models will
need to be built. As I mentioned there are excit-
ing prospects for my time, Generation X.
Recently, the Nobel Prize winning economist
William Sharpe published a piece in the Finan-
cial Analysts Journal (FAJ) May/June 2010 issue
titled Adaptive Asset Allocation Policies. In the
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article Sharpe asks, “Why should market values
first blowup was loss of global leadership, eco- inform forecasts? Because an asset’s current mar-
ket value reflects the collective view of the prob-
June 2010
nomic and political. The consequence of the sec-
ond blowup remains to be seen. abilities of future prospects. This information is
valuable and should be taken into account when
For the first time in over six decades the UK has managing a portfolio.” Further, summarizing
a coalition government. The last time there was his argument, Sharpe adds “The inevitable con-
a coalition government was in 1945. In a post clusion is that an investor’s asset allocation, ex-
World War II bombed-out environment one can pressed in the traditional manner as percentages
imagine the disruption socially and politically in of total value in each asset class, should change
the United Kingdom. To think in 2010 no politi- over time to reflect changing market values, even
cal party could come up with a vision for the fu- if the investor’s characteristics are unchanged.
ture to inspire voters to elect a government with This conclusion is the key tenet of this article.”
a mandate is amazing, really.
In the same FAJ publication, the magazine editor
The question that has fascinated me over the Rodney N. Sullivan, CFA offers the following in
years is how does humanity break patterns of the Editor’s Corner:
excessiveness. Tales of excessiveness riddle our
history as humans. Whether flying too close to The primary tenets of investment success can be
the sun or staring into a reflective pond, the al- found in a liability-sensitive form of the Tobin-
legories are many to remind us we can and do Sharpe two-fund separation theorem, which holds
take what we enjoy to excess, often with dras- that all efficient portfolios can be formed with a
tic consequence. Knowing these stories has not combination of the risk-free asset and the market
stopped the many from finding reason to con- portfolio of all risky assets.1 Because all investing
tinue ways of excess. Just look to the continued is intended to support future consumption, one
use of leverage to gear the US economy and to must also incorporate expected future needs, or li-
drive financial institution profitability for a re- abilities, into the portfolio strategy. Therefore, this
cent example. strategy means constructing a multi-horizon plan
that matches the asset mix with the liabilities.2
The sensation of bobbing in the wake of a large
wave is telling for me. Interestingly, I believe A combination of current endogenous risk fac-
we are at a time when tendencies towards excess tors, asset-liability management (or liability
can begin to be measured. Answering questions driven investment), and investor risk aversion
related to why we embrace excess I leave to the should form the basis of one’s portfolio construc-
philosophers. Answering questions associated tion process. Building a portfolio that reflects the
with the relative level of excess I find engaging market’s endogenous risk will prove, over time,
and exciting. 1. See James Tobin, “Toward a Theory of Market Value of Risky Assets,” Review of Economic Stud-
ies, vol. 25, no. 2 (1958):65–86; William F. Sharpe, “Capital Asset Prices: A Theory of Market Equi-
librium under Conditions of Risk,” Journal of Finance, vol. 19, no. 3 (September 1964):425–442.
As we have witnessed in this still new millenni-
um, risks exist. The Great Moderation proffered
2. See M. Barton Waring and Duane Whitney, “An Asset–Liability Version of the Capital Asset
Pricing Model with a Multi-Period Two-Fund Theorem,” Journal of Portfolio Management, vol. 35,
by Alan Greenspan and others is non-existent. no. 4 (Summer 2009):111–130; Philip H. Dybvig, “Using Asset Allocation to Protect Spending,”
Financial Analysts Journal, vol. 55, no. 1 (January/February 1999):49–62.

5. to be ineffective at protecting ones wealth and
purchasing power. As we have seen in the re-
cent past, often the risks of the market far out-
weigh potential rewards. As markets adjust to
potential economic outcomes one should assess
if the adjustments reflect his/hers needs and be-
“
liefs of those future outcomes.
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In closing, the words of James Montier of the
renowned investment advisory firm GMO LLC
summarize well the beliefs of Summit Creek
Capital. In the recently released paper “I Want
to Break Free...” Montier writes:
In this paper, I argue that policy portfolios and
various successors (such as risk parity and life-
cycle/glide-path funds) are deeply flawed from an
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investment perspective. In particular, two common
failings they share are a mismeasurement of risk
and an indifference to valuation. I conclude that a
June 2010
strategic asset allocation that alters the asset mix
based upon the opportunity set offered by Mr. Mar-
ket makes far more sense from an investment per-
spective. (In modern parlance, this translates as a
benchmark-free, real return focus.)
In words that echo SummitVIEW’s, Mr. Montier
closes his article by saying:
A willingness to be contrarian is also vital. You
will inherently be doing the opposite of what every-
one else regards as sensible. Being a contrarian in-
volves three separate elements: 1) having the cour-
age to stand against the dominant view; 2) being
an independent thinker; and 3) having the firmness
of character to stick to your guns. All three of these
traits are unnatural of human beings!
Providing that one can be patient and contrarian,
there is simply no reason why strategic asset allo-
cation implies static asset allocation. Changing the
asset mix of your asset allocation in response to the
fluctuating opportunity set offered by Mr. Market
seems like common sense to me. Sadly, of course,
common sense tends to count for little in the world
of high finance!
Perhaps it takes a Gen-X member to put to prac-
tice the asset allocation suggestions made above.
Why not? Generation X, as quoted above, is in-
stilled with a sense of economic uncertainty.
SCC rests its pursuit of exemplary financial ser-
vice in its dedication to understanding endog-
enous risk through analysis of historical, politi-
cal, economic, and social factors. The pursuit, in
Disclaimer: All material presented herein is believed to
an effort to sound as academically high-brow as be reliable but we cannot attest to its accuracy. Neither
possible, is called dynamic beta analysis. the information nor any opinion expressed constitutes a
solicitation by us for the purchase or sale of any securities.
www.summitcreekcapital.com