Fasanara Capital’s investment outlook for the month of May 2017, titled, “Fake Markets.”

Also see Q1 hedge fund letters

“Learn how to see. Realize that everything connects to everything else.” – Leonardo da Vinci

1. Fake Markets: How Artificial Money Flows Kill Data Dependency, Affect Market Functioning and Change the Structure of the Market

Hard data ceased to be a driver for markets, valuation metrics for bonds and equities which held valid for over a century are now deemed secondary. Narratives and money flows trump hard data, overwhelmingly.

‘Fake Markets’are defined as markets where the magnitude and duration of artificial flows from global Central Banks or passive investment vehicles have managed to overwhelm and narcotize data-dependency and macro factors. A stuporous state of durable, un-volatile over-valuation, arrested activity, unconsciousness produced by the influence of artificial money flows.

2. Be Short, Be Patient, Be Ready

Markets driven by Central Banks, passive investment vehicles and retail investors are unfit to price any premium for any risk. If we are right and this is indeed a bubble (both in equity and in bonds), it will eventually bust; it is only a matter of time. The higher it goes, the higher it can go, as more swathes of private investors are pulled in. The more violently it can subsequently bust.

The risk of a combined bust of equity and bonds is a plausible one. It matters all the more as 90%+ of investors still work under the basic framework of a balanced portfolio, exposed in different proportions to equity and bonds, both long. That includes risk parity funds, a leveraged version of balanced portfolio. That includes alternative risk premia funds, a nice commercial disguise for a mostly long-only beta risk, where premia is extracted from record rich markets that made those premia tautologically minuscule.

3. Discussion Paper – EU Populism and Smoking Mirrors: the Latest Case of Marine Le Pen

We do not buy into the notion that populism is in recess in Europe, as portrayed by mainstream media. However desirable such view may be, hard data are not supporting it. It is politics and electoral laws that prevent the rise to power of populists in Europe, more so than electors themselves.

Without a successful migration strategy and a sustainable recovery in GDP, populism remains on the rise, moving along trend-line. Further chances for regime change will present themselves.

It follows that risk stays high with Europe – political, economic, financial. Until a proper fix is found, and a stable EU set-up, it is possible for an adjustment to occur through creative destruction (never let a good crisis go waste) or populism. A moment of discontinuity looms ahead, as policy inaction and instability breeds insecurity and disruption.

Discussion Paper – Oil: A Weak Present And No Future

OPEC/non-OPEC arrangements are only relevant for the short-term, and an extension to the output cut could lend a hand and provide for an ephemeral relief rally. Critically, Oil remains weak on a fundamental perspective, as new technologies both boost supply and crash demand at speed. Supply-wise, oil’s rally last year sowed the seeds for its future structural decline, as it helped producers hedge future production and lock-up profit margins, while they could continue to work on costs compression and productivity gains. As an example, breakeven costs for US frackers are now below 30$/bbl, while some of the Majors look at average operating costs of 10$ per barrel.

Supply is likely to only rise from here, as testified by the increasing count for horizontal rigs, and a staggering number of drilled uncompleted wells (DUCs) await to come onstream – over 5,000 (read EIA and here). Moreover, new fracking technologies in the US are spreading to super-basins in Mexico and Argentina. Demand-wise, energy efficiency and energy storage (battery technology) inescapably hold the prospect of a future characterized by a lower demand meeting abundant clean and cheap energy.

Fake Markets – How Artificial Money Flows Kill Data Dependency, Affect Market Functioning and Change the Structure of the Market

These days, it seems acknowledged by most that we live in the age of ‘post-truth’, ‘false equivalency’, ‘alternative facts’ and ‘fake news’. All concepts that revolve around the irrelevance of hard facts, truth, objectivity or accuracy: as frustrating as it is, this refers to the proven and full ability to cherry pick across data – or worse, fabricate them – so to support whatever argument one has, while advancing whatever agenda behind it. Hard facts are a thing of the past, what matters now is what works, what is instrumental to achieve a goal. David Hume’s ‘matter of facts’ are repealed and replaced by opportunism, sophism, or Machiavellianism.

In financial markets, we may be observing a similar phenomenon. Hard data have ceased to be a driver for markets, valuation metrics for bonds and equities which held valid for over a century are now deemed secondary. Narratives and money flows trump hard data, overwhelmingly.

Consider this: US GDP for the first quarter came out at less than a fourth of what was expected only in February, yet equity markets found reasons not to bat an eyelash, and be higher now than they were back then. US equities are valued at cyclically-adjusted multiples only seen in the two of the most glamorous bubbles featured in history books (1929 and 2000), against levels of potential GDP way lower than back then, yet volatility is at all-time lows: VIX dipped below 10 – to follow realized volatility at 7 – something rarely seen before, except perhaps in days when markets are shut down.. Indeed, amazingly, US equity volatility was lower than long Treasuries volatility, over the last 4 years.

‘Fake Markets’ are defined as markets where the magnitude and duration of artificial flows from global Central Banks or passive investment vehicles have managed to overwhelm and narcotize data-dependency and macro factors. A stuporous state of durable, un-volatile over-valuation, arrested activity, unconsciousness produced by the influence of artificial money flows.

  • Fake markets are no longer data-dependent, but rather liquidity-induced and prone to focus minds on any one piece of available good news out there, even if isolated within a This is to become the dominant narrative: sometimes it is ‘chasing yields’ that matters, and not recession/deflation; sometimes it is ‘chasing growth/reflation’ that counts, and not rising yields/political instability; sometimes it is ‘one quarter of earnings’ only, and not yet another GDP shocker/nuclear tensions.
  • Fake Markets are characterized by the structural underestimation and mispricing of risks: passive investment strategies are the least suited to apply any premia to any risk, as they unemotionally move along and go with the flow; Central Banks on their part are by nature most active when risk is high, thus depressing the price of risk right when risk abounds.
  • Fake Markets also seem to be associated with evanescent liquidity, the false belief in a deep liquidity that does not exist: as most passive investment vehicles overstate theirdiversification and oversell their liquidity (way and beyond the capacity of the underlying), liquidity
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