Dear all,
I hope you have had a Happy Christmas. Below I share my thoughts on the year past and opportunities for the New Year ahead. If historians were to look back at 2011 they may note the insipid equity markets and dismiss it as a year of the “Lost Decade”.
They may further establish that neither indolent Governments nor aggressive Main Street, i.e. the 99%, fully appreciated the machinations of Wall Street and its will to survive & prosper.
Despite an increasingly uncertain future and a transformational decade (bringing to mind the curse “May you live in Interesting times”), returns remain sufficiently compelling that in spite of the vast challenges there remain incredible opportunities waiting to be exploited by the discerning investor. Importantly these opportunities no longer lie only in frontier markets but rather in our very own backyards and in markets previously deemed uninteresting.
Francis Fukuyuma predicted the “End of History” at the end of the Cold War; instead different clashes, ideologies have kick-started another global revolution whose consequences we have yet to experience let alone understand.
Sincerely,
Z.i.L
From the Desk of Zachary I. Latif
The violence of the market correction has created dislocations in certain sectors & alpha-generated returns are possible in secured assets, high-yield & financials across the credit spectrum selectively.
Investors back in the 1980s were known as "Yield Pigs" because of their relentless pursuit for yield as rates dropped from double-digits to low singles. Investors sacrificed credit quality for high yield and it led to the artificial bubble in the Junk bond market, which collapsed spectacularly later that decade. In a comparatively similar (indeed UST's and Gilts are now at record lows!) rate environment, the hunt for Alpha remains the same but the unflattering term PIGS is now used to categorise perhapsthe most lucrative yet volatile part of the investment market; ie the European sovereign space!
Perhaps the biggest shock was when Italian 5yr spreads went north of 7% and a spate of ECB leaders just watched terrified in impotence. Does 7% for 5yr Italian paper however really capture the right risk reward for what remains the third largest bond market in the market and what does it say about the € project, when the UK Gilts for 30yr duration trades inside of 3% against that?
The primary generators of wealth creation in the West over the last 2 centuries, the banks were despised for their inability to de-lever successfully and still required significant capital from over-levered sovereigns, who were also under fire from consistent investor pressure. However these battle scarred, brow beaten investors are no longer focused on fundamental value and there isopportunity in a value-driven approach in credit, in light of a market that is pricing in nearly a 50% default rate in Crossover (an index of high yield European credit names).
It proved to be a year of 2 halves; the first characterised by a rapid surge towards a normalised pre-07 world, while the second derailed on the back of issues in the continent and slowdown fear in the UK-US economic zone. Investors tend to have the ability to embrace trends, and the shift continued towards EM; in Asia, the Arab spring revolutions capturing popular imaginations globally, while Africa remained a lucrative after-thought.
The € project on the brink of collapse has been saved from the embers of extinction thanks in main to surreptitious quantitative easing introduced by the ECB through the LTRO program & consequently support in the covered bond and various other secured assets. Covered bonds now yielding north of double digit returns and secured on first lien basis to a bank’s prime real estate portfolio should be top of any discerning value driven investor.
Perhaps it is fitting to end with this warning that systemic risk remains a persistent overhang not necessarily because of the structural issues but in Government management and response. It speaks of the contradictions this year that consistent fears of a double-dip recession may itself prove to become a self-fulfilling prophecy in no small measure to media hysteria about the weakened consumer and unprecedented pre-Christmas discounts. Yet strikingly at the same time, Central London nightclubs have enjoyed a record year on the back of the infamous 1%?
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