After spending over two millennia and billions - if not trillions - of dollars studying the atmosphere around us, I find it amazing that we are still terrible at predicting future weather patterns. Weather, like finance, is a dynamic system. What one person opines or sees in data, another will see the converse opposite. Think about August of last year, Gold bugs and debt skeptics felt that they were seeing the beginning of an impending debt spiral whereas value investors, all over the planet, scooped up stock due to their belief in the intrinsic value of securities supported by both historic valuations and multiples. Just like weather, one strategy will not triumph over another unequivocally. Over long periods, those with a value orientation have tended to fair well, whereas those who have correctly picked market downturns have made vast sums over short periods. Lorenz, the godfather of Chaos Theory, would have likely found that these convexities create the preconditions for Chaos. Chaos, and its related fields, examine how the effect of small occurrences dramatically affect the outcome of seemingly unrelated events in the future.
"Banks have turned into gigantic gambling institutions. You never know what you own. I wouldn't touch them if you pointed a gun to my head"
Bill Fleckenstein - Fleckenstein Capital
I believe that globally we are seeing a number of these small occurrences unfold. Occurrences that will no doubt have a profound effect on our future and we will all look back on and this "how did we not see this". Everything is easier with the benefit of hindsight. We all have a friend who "predicted" the housing crash but how many do you know who made themselves substantially wealthier because of it? It is the who part of todays economic equation that this letter aims to look at.
In the present economic environment, whilst most of us are thinking about if Greece will obtain a bailout in March, I believe that we should be thinking about who has been purchasing the European debt since the profligacy of the EU member states has been highlighted. Whilst the ECB's LTRO program has undoubtedly prompted a number of European banks to purchase European debt, we would be foolish to believe that these are the only institutions in the market. For instance, back in November, the worlds largest money manager Blackrock was scooping up BTP's (Italian Bonds) for their attractive yield. A move that many of us may find unbelievable given the global macro climate but, given the more recent collapse in yields, it seems like a very clever trade. Over the longer term, I couldn't disagree more with a fiduciary financial institution taking such a verantly stupid move but, as discussed earlier, I have a different investment agenda. However, Blackrock aren't the only player in the market and this is where it gets interesting.
"I ask anyone to give me an example of an economy beefed up by huge amounts of quantitative easing that did not inflate tremendously when or if the economy improved"
Julian Robertson - Tiger Capital Management
See whilst you and I were still recovering from the credit crisis that gripped the global economy, a few select and particularly astute individuals were buying Credit Default Swaps on a wide variety of global sovereigns. However, as these individuals have slowly watched their investment thesis unfold more beautifully than Beethoven's fifth, the Eurocrats decided it was time to change the rules over and over again. Short Selling Bans, CDS bans, Free money LTRO programs, PSI deals....the list goes on. Being the determined individuals that many of these investors are, they were not about to sit down and let their John Paulson moment be ruined. Instead, many of these investors have decided to purchase the very debt that they have backed for default to gain a place at the table. Think about it this way, with 12 Month Greek bonds yielding a phenomenal 629% (Graph HERE), gaining a seat at the PSI table has become very very cheap indeed. Just today, I was told by Skandi hedge fund trader that CDS trades similar to this are becoming increasingly popular in the region in order to force a default.
"Equity markets may rally on this news because they are focused on getting a deal done, but anyone in fixed-income should now consider retching under their desks as we all just took one of the biggest screwings of our lives that may well not be a singular event."
Mark Grant - Southwest Securities
Whilst, I am unable to speculate about the effectiveness of such actions by CDS holders, I do believe that it highlights, what I feel, is a gaping whole in the European defence. Bring more people to the table and you stand a far lower chance of avoiding a default. Moreover, if we think about Greece and who the predominant holders of the debt are, the true concentration is with domestic banks and pension firms. However, if one is to look at the likes of Italy, Spain or France, the debt holder base is far wider and is unlikely to incorporate the same streamlined interests. Can you imagine, Mario Monti and Nicolas Sarkozy trying to explain to Blackrock's Larry Fink or China's Zhou Xiaochuan that they must face a not so voluntary haircut on their debt holdings...I think not and this is the problem. Another way to think about this common conflict is to examine the EU as an organisation itself, how should I put it..."too many ruin the broth"...or in other words, there are so many competing interests that very little of real substance is every achieved. To think that the same would not apply to an industry where people live and die by their figures would be, by all accounts, moronic.
It is these small details that build the really big picture and help those patient enough to formulate highly successful investment strategies beyond the thematic opinions that flood the financial marketplace. As Kyle Bass of Hayman Capital has said, "we like to evaluate the plumbing" before investing a penny; and since inception, Hayman has performed exceptionally for its investors and Bass has made an exceptional name for himself. There are thousands upon thousands of these small events everyday that can both add value or flip your own thesis on its head, however every now and again it is these small details that dictate or restrict how the future can be played out as in the case of Europe. To offer a couple more examples of the who that have strung to my leading of asking why, I have provided a couple more topics I could have openly talked about today below.
1) The Chinese Sovereign Wealth Fund (CIC) recently purchased 9% of Thames Water, the company that provides clean drinking water to all London residents
2) Gasoline follows a very similar trend to Gold and has outperformed the precious metal significantly over the last 4 years. China and India have made some of the biggest investments in US energy resource companies that produce the fuel.
Sometimes it just pays to ask who before even confronting the why.
Before I introduce the articles for the week ahead, it is worth noting the latest note out of Europe that is likely to put yet another hurdle to the PSI deal for Greece. As of this weekend, the bailout being proposed will subordinate the holdings of private bondholders against the holdings of the ECB. A move that Bill Gross of Pimco has already commented upon, adding that it "subordinates all holders of Euroland sovereign debt". One things for sure, you can guarantee that the Eurocrat response will be filled with yet more humorous incompetency.
Onto the articles. This week we start with a case study by Howard Marks, the successful CIO of Penn's Endowment Fund. The study looks at Marks' opinion on a number of different investment styles and his approach to liquidity and risk that allowed the fund to function effectively during 2008-2009. Secondly, we look at a Bloomberg article that talks about the fraudulent $6 Trillion (Yes, I said trillion) in US treasuries that were just seized from a safety deposit box in Zurich. Thirdly, Grant Williams takes another look at Greece and why he feels a default is inevitable despite the messages coming out of Europe. And last but no means least, we share the letter sent out by Fitch last week that upgraded Icelandic debt to BBB- (Investment Grade) after the country defaulted in 2008 proving that Greece really does have another option. Enjoy!
1) Assessing Performance Records - Howard Marks (Click Here)
2) Record $6 Trillion of Fake US Bonds Seized - Bloomberg (Click Here)
3) Things That Make You Go Hmmm... - Grant Williams (Click Here)
4) Icelandic rating upgraded to BBB- (Via Reuters) - Fitch (Click Here)
Best Regards George Adcock Founder If you would like to receive bi-weekly comment emails like this in the future, please send an email to email@example.com with the words "add me" in the subject line. All email addresses will be held with complete confidentiality and there is no profit motive in any piece of writing disseminated.
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