Fasanara Capital’s investment outlook, key takeaways from the market environment.

1. Seismic Activity On The Rise

When policy shifts increase in frequency, the likelihood of policy mistakes rises with it. We expect 2015 markets to be erratic, volatile, potentially chaotic, characterized by policy shifts, if not policy mistakes

2. No Volatility No Gain

Eventful markets carry risks but also uncommon opportunities. We do not think such eventful markets are best played through defensive portfolio behavior. Avoid the trap of a ‘timidity portfolio’. There is nowhere to hide.

3. The Role Of Optionality

Unconventional monetary and financial environment calls for unconventional money management. To us, this is best played through cheap optionality, convexity and heavily-asymmetric profiles

4. Crystal Ball

Our Target Levels for S&P, Nikkei, Eurostoxx, Fed Fund Rates, US Treasuries, Bunds, BTPs, WTI, Gold, USD, JPY, EUR, CNH, inflation, spreads

5. Deflation Is A Multi-Year Process

Deflation is a process, not a data point. It takes years to reverse deflationary trends, absent a shock. Deflation in Europe is just beginning

6. Three Big Trades for 2015

European Deflation Trades. Optionality in Peripheral Europe. Japan Entering Second Phase of Abenomics

Fasanara Capital: Seismic Activity On The Rise

Hardly a month can go by with more events in it than the one just past.

  • Equity markets moving down in size earlier on, to erase losses quickly afterwards, erratically, and take a leg up on ECB’s historical move into heavy QE, after days of fine-tuning it with orchestrated leakages and blitzes of communication to markets.
  •  SNB dropping the towel on unsustainable currency floor to the CHF/EUR (we wrote how to position for de-peg CHF/EUR through Call Spread Options in 2012 and 2013 – attached HERE, on pag. 14), provoking an epic 30% intra-day move on a major currency cross, something which has the same probability of a new Glaciation on planet Earth, when measured against historical volatility (i.e. how probability is measured by any risk management VAR model nowadays)
  • Bank of Canada and Bank of Singapore unexpectedly cutting rates, debasing currencies and following up on the lead of BoJ / BoE / ECB

And the list goes on and on.. This month alone, the following Central Banks felt compelled to ease monetary policy: ECB, SNB, Denmark, Turkey, Canada, India, Egypt, Albania, Peru’, Uzbekistan, Pakistan, Russia. Yes, even Russia!

Actually, Denmark eased three times in the space of two weeks, in January.

Signs of desperation? Uncertainty reigns? Time will tell. One thing is for certain: when policy shifts increase in frequency, the likelihood of policy mistakes rises with it. Accidents happen, when you stay out there in the open for long. No wonder why Gold picked up on it, and started to give signs of life after years of lethargy.

A few comments:

  • Can we call the SNB policy shift a policy mistake? Yes, we can. Of course, the peg was unsustainable. It was so already in 2012, when we first flagged up that FX reserves had reached 60% of GDP (while China had been dubbed a currency manipulator for much less). Of course, Switzerland was doing peripheral Europe no favor when buying those 300bn+ worth of Euros while trying to debase their currency, at a time when (i) Europe fiscal policy was tightening amid badly-sized austerity policies, (ii) monetary policy was tightening (rates lower but ECB balance sheet shrinking by Eur 1 trn), and (iii) EUR was appreciating (sole currency appreciating globally, even against healthy ones like Norwegian Krone and, well .. Swiss Franc). So, a de-peg was overdue. Still, there were several ways to engineer that, for triggering less of a 30% intra-day move. SNB thought that cutting rates to -0.75% would have counterbalanced the effects of the outright drop of the peg: they mis-calculated. In doing that, it provoked unnecessary casualties in its reference market, the one where it is expected to safeguard price stability. Most importantly, it lost credibility, arguably the most important asset of any Central Bank. Without credibility, the leverage of any policy tool is debatable.
  • And what can we say of a Central Bank of Russia unexpectedly cutting rates after having raised them massively lately, to stem currency implosion, inflation shock and bank runs? With Brent Crude having floored for just 10 days (while WTI timidly testing new lows), after losing 60% of its value, and perhaps reading itself for a further 50% drop, with a Ruble 106% weaker than 6 months ago, such move is difficult to rationalize. Probably not a policy mistake (in line with so many other EM Central Banks), but surely proof of erratic behavior, making any investor uncertain whether to hold that currency anytime soon, at any price.
  • And what can we say of the Central Bank of Denmark being in the market every other week with rate cuts? Have they grown bored of inactivity? Or do they not quite know what needs be done yet, and try out some?

Fasanara Capital

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