CAIRN CAPITAL “Expect a Brutal 2012”

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Cairn Capital, one of the world’s largest hedge funds, today manages about $25billion.

In their January 2012 letter, they discuss their thoughts for 2012:

They think Euro-Zone recession will be much worse than the general consensus thinks.

They think QE is running out of effectiveness. Their conclusions are below:

The conclusions have not really altered a great deal in terms of Europe’s place on the investment map apart from two key changes – overall credit valuations are good and there is a high degree of stress priced into financials:
EZ countries will continue to diverge in economic performance terms but remain heavily linked in risk terms. Longs in government bond safe havens will remain in place despite lack of value. Foreign private sector selling pressure on the periphery and demand for protection on core spreads will re-emerge once again.

Banks will continue to deleverage via both sides of the balance sheet albeit at a slower pace than Q4’11. Concerted liquidity action has a history of enabling senior bank spreads to outperform. The same is true for subordinated debt of quality financials where net issuance is negative and deleveraging is better for debt than equity holders in all but the most extreme events.
Corporates still have the best balance sheets in aggregate but cannot be immune to cycle swings, allocation shifts or sovereign stress. Issuance is unchallenging through this year and the process of disintermediation will continue with borrowers looking directly to deep pools of real money
reducing historically high reliance on bank loans.
The structural debt overhang in Europe still means I have a fundamental dislike for peripheral corporate and financial risk and it still has negative implications for core government bond spreads. These hedges/shorts associated with peripheral and core sovereigns will become more attractive once again as this early year liquidity driven sugar rush squeezes existing shorts out.

Once markets approach the tight end of ranges and/or discount a recovery scenario too fully, we will become more cautious once again.
For now, credit looks the best place to be in fixed income on an outright valuation, relative allocation and longer term balance sheet basis. The valuation argument still depends on a country comparison but peaking volatility enhances credit valuations further even though liquid benchmark indices are close to our immediate spread tightening targets.

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