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

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April 1st 2014

Fasanara Capital | Investment Outlook

1. Despite weak economics and high valuations, we suspect that in the absence of an

escalation of tensions in Ukraine, the path of least resistance for markets is up, in

the short term, with a further appreciation of stocks from here. Liquidity conditions

are supportive, complacency all too high and hard-to-die, while the Ukraine’s brain

drain had the effect of focusing mind on the wrong vulnerability for markets (a bit

like Syria did last year). The spectrum of a Third World War is what troubled investors

these days, more than the continued disconnect to fundamentals of frothy valuations

the world over. Gone that geopolitical risk, markets may be let free to unleash their

repressed bullishness and step decisively higher, especially so in certain places like

peripheral Europe and Japan.

2. We prefer Equity to Bonds for the VALUE BOOK within our portfolio. This has

broadly been the case for our portfolios ever since Q3 2012, when we kicked off our own

little ‘rotation’. Within Equity, we prefer Italy, Greece and Japan. We avoid US

markets, as we believe they are toppish, deceptively un-volatile, while substantially

more upside potential is achievable elsewhere in Europe and Japan within the same

baseline scenario. If the positive backdrop created by ample liquidity, stable or slightly

improving economics, neutral geopolitical environment is to materialize, then we see

way more upside outside of the US, namely in peripheral Europe and Japan. A margin

of safety on cheaper valuations exists for peripheral Europe and Japan that does not

exist in the US.

3. Re-allocation of capital flows is the likely driver of Europe out-performance. If you

are a large US allocator, flushed with liquidity from ballooning ETFs inflows, bullish not

by choice but by design, willing to look at the bright side of things and relieved by hopes

of Ukraine uncertainties giving in, then Europe may look like your only viable

destination these days, meaningfully.

4. Within the HEDGING BOOK, we look at adding or increasing the following positions:

receiving EUR short-end rates, paying USD long-end rates, long equity implied

volatility, short select credit spreads and inter-banking spreads

5. As rates in the US spike upward on any sign of economic strength (or receding

geopolitical risks, of late), rates in Europe tend to follow, passively, in Pavlonian

reflexive response. We expect rates to decouple on hard data evidence over the next

few months, as the inflation risk that the US and Japan live through, is likely to

differentiate itself from the deflation risk Europe is avoiding to fight against.

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Path of least resistance for markets is up

In the last few weeks, the Russia-Ukraina crisis took center stage and kept markets within a limbo of

volatile range trading. The geopolitical crisis failed to trigger a powerful correction until now,

while on the other end it prevented the market from breaching decisively into new highs, under

the push of abundant liquidity. Equity markets in the US, Europe, Japan (although the latter

showed dynamics of its own making) and even Emerging Markets are still dangling on a string, under

the Damoclean’s sword of an escalation of tensions.

So far, markets stationed in middle land across Equity and Credit. After some volatility, equities

snubbed the potential downside, dubbing Crimea as a non-event, for the only price they paid for such

uncertainty was to stationing right below markets’ highs (record highs in the US, relative highs in

Europe). Interest rates resisted the temptation of a flight-to-quality rally, while failing to adjust to the

higher levels implied by Yellen’s new timetable. Emerging markets were well bid outright, as of late,

China included.

The resumption of talks between the US and Russia over the week-end is positive news the

markets will be ready to capitalize upon, but it remains to be seen if this is the end of the story.

To us, predicting how the geopolitical landscape can evolve in such instances is not just complex

but flatly impossible. Nor we do attend to build a strategy around it. Sadly, game theory is irrelevant

when measured against human passions and extreme politics. When the accumulation of power

within one of the largest countries in the world lies with one single man, who has been in undisputed

charge for over a decade, game theory is of little use. Is Putin after scoring brownie points in internal

politics, at a time when its economy is dangerously slowing down while inflation ratchets up, or is he

attempting at leaving his mark on history? That is a question we cannot answer.

Surely, geopolitical tensions come at a time when the economic landscape is all too fragile,

valuations sky-high, leverage abundant. The economic recovery in Europe, if any, is still in its infant

stages, a virtual reality confined in the realm of (mis)leading indicators and the narratives of

policymakers, while the real economy in peripheral Europe speak of a different world (going from the

hard data of increased corporate failures, to worsening unemployment, to rising non-performing

loans). In the US, bad weather was the scapegoat for a flurry of weak data releases this whole

quarter, leaving the robust recovery narrated by the FED as yet just a rosy prediction.

Still, despite weak economics and high valuations, we suspect that in the absence of an

escalation of tensions in Ukraine, the path of least resistance for markets is up, in the short

term, with a further appreciation of stocks from here. Liquidity conditions are supportive,

complacency all too high and hard-to-die, while the Ukraine’s brain drain had the effect of focusing

mind on the wrong vulnerability for markets (a bit like Syria did last year). The spectrum of a

Third World War is what troubled investors these days, more than the continued disconnect to

fundamentals of frothy valuations the world over. Gone that geopolitical risk, markets may be let

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free to unleash their repressed bullishness and step decisively higher, especially so in certain

places like peripheral Europe and Japan, as we will argue in this piece.

From here, we see two scenarios playing out, in the weeks to come:

- Russia failing to finalise the terms of a truce with the West, or maintaining it, re-

escalation of tensions as a result, with a possible occupation of East Ukraine, increased

sanctions affecting segments of the Russian economy (not just spot individuals). In such

scenario, we see a more meaningful correction in equities of 20%+ as legitimate. Rates

moving decisively lower on flight-to-quality flows (below 2.50% on 10yr Treasuries). Even

more so now, that tensions seem to disappear from investors’ radar screens.

- Russia truly de-escalating tensions, and agreeing with the West a sustainable game plan

for Ukraine. Markets releasing their normal course of business, catching up on the lost

ground and the time wasted. Markets moving to new highs, SPX above 1,900/2,000

progressively over time, owing also to slightly better data releases in the weeks ahead, as

the Spring necessarily brings with it milder weather conditions. 10yr Treasuries back

around 3%-3.15% in a flatter yield curve, volatility reaching brand-new lows. Equities in

peripheral Europe outperforming, namely Italy, where re-allocation capital flows can be

sizeable. Further compression of spreads, while rates fail to move higher in Europe on

more empirical evidence of disinflation emerging.

As we said, geopolitical matters of this nature are impossible to call. We are therefore

positioning the portfolio for the second scenario, while spending / wasting more money than

usual (and more than most market participants) in dynamically hedging the downside.

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Portfolio Positioning

This month, we will shortcut the Outlook and move straight into portfolio positioning. At present,

our current allocation across the three building blocks of our portfolio looks as follows:

VALUE BOOK: equities over bonds, Europe and Japan over the US

As we see rates rising from here, gradually over time, while the scope for further compression of

spreads is limited, we prefer Equity to Bonds for the Value Book within our portfolio. This has

broadly been the case for our portfolios ever since Q3 2012, when we kicked off our own little

‘rotation’.

Within Equity, we prefer Italy, Greece and Japan. We avoid US markets, as we believe they are

toppish, deceptively un-volatile, while substantially more upside potential is achievable elsewhere

in Europe and Japan within the same baseline scenario.

Benchmark-wise, we see the mother-ship S&P having the potential to finish the year in 2,000-

2,100 area (potential for 10%-15% advance), while getting there in way more volatility to the

downside than it has shown last year. On the way up there, 5 to 10% corrections can return to be

the norm, as experienced in late January this year (we described the kind of volatility we foresee in

details in February Outlook LINK).

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Critically, such potential upside is only achievable on the rosy combination of three key conditions: (i)

abundant liquidity (likely to persist until the first FED rate hike gets vividly visible in markets’ rear

mirror, only accelerated if we get a bad inflation print – more on it below), (ii) broadly neutral

economic landscape (stable or slightly improving data set), and (iii) broadly neutral geopolitical

environment (on exogenous factors out of Ukraine, Syria, East China sea, North Korea and the likes).

Absent one of these elements, steep downside is possible, as valuations are held on the thin air

of central bank liquidity, dramatically disconnected from fundamentals, on record levels of

leverage built into the system, high complacency and thin liquidity (Valuations in Stratosphere).

Predictably, we will continue to monitor incoming data flows and economic data for evidence of any

inflection point on how imbalances evolve from here.

More upside outside of the US: peripheral Europe and Japan

If the positive backdrop created by ample liquidity, stable or slightly improving economics,

neutral geopolitical environment is to materialize, then we see way more upside outside of the

US, namely in peripheral Europe and Japan. Against such baseline positive scenario, the US is

underperforming both Japan and Europe in the short term. Conversely, we believe they share similar

volatility to the downside, for the next few months. A margin of safety on cheaper valuations

exists for peripheral Europe and Japan that does not exist in the US.

To be clear, at Fasanara we remain skeptical of economic recovery in the US (where tapering might

get discontinued later on in the year, and QE re-instated), convinced of a slow motion train wreck in

Europe (where a dismantling of the EUR currency union seem likely to us few years down the road),

and wary of Japan’s over-indebtedness (debt monetization through monumental currency

debasement is the only alternative to a fully-fledged default on obligations, while being the financial

equivalent to such default in forward value real terms, especially to fixed income investors).

However, what matters is the market’s perception of things in the near term, more than Fasanara’s

long-term convictions, all too obviously. Markets can deflect from economic reality for that long,

before they adjust to fundamentals. But ‘that long’ period can indeed be quite long, requiring

investors to stay solvent long enough, before they see the end game to their theories. Markets are

voting machines in the short term, but they are weighing machines in the long run, Buffet is quoted

as saying. True value must emerge only on a long enough timescale. We surely are mis-interpreting

and mis-quoting him here, but we feel similarly of today’s exuberant markets.

For all intents and purposes, we see equities structurally moving higher from here, although in

more volatile cyclical manner than shown last year (more similarly to 2014’s realized volatility). If

forced to embrace the nominal rally, we then prefer to do it where the potential upside is

commensurate to the risks undertaken, which to us means peripheral Europe and Japan, over

the highly priced US markets. The former are still to be lifted out of misery, while the latter trade

closer to the end of their journey.

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Europe on the receiving end of assets re-allocation flows

We see the reallocation of capital flows to continue hitting the shores of peripheral Europe, and

being the main driver of its out-performance. As large US, Asian allocators look at a toppish

S&P, seeking diverse destination for their excess cash, Europe might benefit for pure lack of

better alternatives.

It does not matter what we at Fasanara believe is the true state of affairs for the economy in Europe,

as we maintain our views for a slow multi-year Japan-style deleverage and disinflation process to

take place and eventually undermine the dogma of the common currency (at some point to be

sacrificed for it not to jeopardize the whole common market). What matters is what the market is

likely to believe at each point in time, the interpretation of events it is willing to abide to by then.

Briefly roaming across potential destination for excess capital on abundant liquidity, in the eyes

of large allocators, this is what we see possible:

- By most, including us, the ECB is dreamed to be on the perennial verge of intervention, as

markets avoided calling its bluff-style cheap talk approach to policymaking. The promise of

a banking union is kept alive, intentionally decelerated to avoid failing it, and to capitalize

the most on its waiting-for-Godot absurdist efficacy. To large foreign investors, Europe

may now look great: stable, cheap, with deep liquidity, on the slow mend of its old

wounds, while guaranteeing rule of law.

- Emerging Markets have eliminated themselves from the allocation race, in any

meaningful amount, as they are likely to continue showing high volatility on feeble

financial conditions over the course of 2014, owing to the end of the commodity super-

cycle, the re-onshoring of US manufacturing, rates moving higher in the US, re-instating of

geopolitical risk premium.

- More specifically on LATAM, Argentina is likely to see the situation getting worse before it

gets better, and Venezuela is a clear potential troublemaker in the short term.

- Russia too has likely left the allocation race, as the cheapness of its stocks finds new

justification in unpredictable political behavior, clearly not driven by pure economical

calculations. Markets cannot but factor it in, for the months to come, even on de-escalating

tensions this time around. Fundamentally, Russia was at danger of exit flows well before

Ukraine joined the investors’ nightmares list. GDP for 2013 slowed dangerously down to a

pitiful 1.3%, while inflation is rampant above 6%. True, balance sheet looks ok, as

debt/GDP is just 10%, unemployment low at 5.50%, current account surplus at 2% of GDP,

foreign reserves plentiful. However, high inflation on no growth, with rates being hiked

aggressively to stem outflows, spells trouble for a weak economy overexposed to a

weakening oil price and a fragile currency. Sochi’s largesse itself managed to divert

attention away from internal fragilities, but it was hardly the structural economic policy the

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kind of which Russia needs badly. Political risk premium is the late addition, on the

impact of economic sanctions, but structural weaknesses were served before it.

- Japan is large and liquid, but likely to be already included in most portfolios, while

giving investors headaches these days on excessive downside volatility due to fears of

potential failure of Abenomics

If you are a large US allocator, flushed with liquidity from ballooning ETFs inflows, bullish not by

choice but by design, willing to look at the bright side of things and relieved by hopes of Ukraine

uncertainties giving in, then Europe may look like your only viable destination these days,

meaningfully.

Within Europe, peripheral Europe is dominant choice

Within Europe, peripheral Europe is a dominant choice. In core Europe, France is a clear laggard in

economic terms, mispriced against the emerging fragility of its economy. Germany is the most

exposed to Russia’s uncertainties, and it is just starting to feel the heat of an unjustifiably strong

EUR. The UK market shares the stellar performance of a US-type liquidity-induced market, skating

on thin ice, while also having in common decelerating advances up there at the top (and lately a

stronger currency). At the very least, peripheral Europe is not toppish already. Its economy

languishes in shallow GDP pick-ups, superficial recovery in industrial production trends, but here

the market is fully equipped to plug-in its iron optimism, projecting a rosy future right around

the corner. De minimis non curat praetor.

Within peripheral Europe, Italy is the obvious choice

Within peripheral Europe, Italy is the obvious choice, representing the lion share of the block,

with more GDP and liquidity than all other border countries put together.

What happened to Unicredit recent number release can be quite telling. The Company came out

with a massive miss on headline numbers (loss of Eur 15 bn), gigantic increase in impairment (Eur

9.3bn from 1.5bn run rate), far exceeding analysts’ worst expectations, and yet, the stock went up

close to 7% on that very day.

Post-numbers, the all-too-obvious no-brainer explanation (it always is obvious ex post) was that the

bank had bravely cleaned itself up, finally, in preparation of the cathartic Asset Quality review

coming up later on in the year, now then up for re-rating. More likely, we believe, the only merit in

disclosing way weaker numbers than the worst case scenarios many modeled, may have been

relieving some uncertainties on future releases, permitting the on-going re-allocation of flows by

foreign investors to continue and gain momentum. A program of accumulation was already

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undergoing, and will likely continue in the months to come, unless exogenous factors kick in to

break the eggs in the nest (Russia/Ukraine, larger correction in frothy US toppish markets,

Japan’s fail, China’ fail, etc).

More specific to Italy, the inflection point in politics is added value to incoming foreign flows.

While we can only wish the best to the new premier Mr Renzi, the task at his hand is arduous, and

made harder by an unbearable level of the EUR against most currencies around the world (Chinese

Renminbi included, as of late). As we maintain our view that a crisis in Europe is inevitable to drive

the structural changes needed to reshape the currency union, while keeping the common market

intact, we are left to wonder how long the new government will last. Having said that, it does not

matter too much what we believe the end game will be in the medium-to-long term. What matters

is the honeymoon that the government is likely to enjoy for the next few months, the easy ride

of bold political statements for reforms to take place at some point later on. Critically, the reform

agenda, while downsized and shallower than originally anticipated, may well succeed in getting the

green light from European authorities, all too concerned of a resurgence of Euro-skeptics at next

European elections, and knowing all too well where the buck stops next in Italy, should the premier

fail: Mr Grillo’s party is sitting on the bench all alone.

Beyond Italy: Greek Banks

Outside of Italy, we also like Greek Banks in the short term. While providing less liquidity than

Italy, they are mispriced against the rosy scenario investors seem to be willing to embrace, both

in absolute levels and in implied volatility terms. Their decently-liquid warrants trade at an

implied volatility of 20%, from time to time, hard to believe for stocks who are 80% off the top,

having shown up to 100% realized vol in recent times. As a way of comparison, the implied volatility

of well-diversified blue-chip names like L’Oreal is approx. 18%, hardly a benchmark, but still..

Flows-wise, we are led to believe that large institutional foreign investors have not added

Greece, as yet, in no meaningful way at least. The recent book building on Piraeus, for example,

seems to confirm it. That is a company who managed to get Eur 3 bn plus orders on his Eur 500 mn

bond offer a week ago, 6x oversubscribed, at a paltry coupon of 5.00% on a 3yr maturity (it is even

trading up in the secondary market at over 101%). And now has also issued Eur 1.75 bn of new shares

(ca. 1.5x oversubscribed – but possibly just 1.25x from foreign investors). All too clearly, having

capitalized on bullish sentiment to sort out its finances for the near-term, upside potential

seems achievable, under normal market conditions. Alpha Bank and NBG show up broadly similar

dynamics to Piraeus.

Specific to Greece, a couple positive catalysts are also to enter radar screens soon.

- Greece could come out with a new benchmark government bond issue, possibly right

before European elections. Potentially that is positive read-across factor for Greek assets

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overall. Greece last approached markets in Q1 2010, when it received massive bids of Eur 23

bn for its 5yr benchmark, 4X oversubscribed, the bulk of which from hedges (they later

printed only Eur 8 bn, surely regretting it in hindsight, looking at how dearly the Troika

enlarged funds few months later).

- After such bond issue, successful as bank recap exercises make us believe, if normal market

conditions are to hold for long enough (again, on no exogenous factor intrusion), Rating

Agencies may be up for reviewing Greece rating later in the year. It was April 2010 when

Greek debt was downgraded first to junk status. Positive fallouts are substantial here too.

Beyond Europe, Japan: nominal rally in equities is likely, as BoJ boxed itself in the

corner and has yet plentiful room to expand

Elsewhere, Japan is dangerously running the risk of losing the momentum on its monumental

monetary printing and fiscal injection, aimed at kicking off the animal spirit within the country, and

wages and consumer price inflation with it.

The dismal performance of the Japan Tankan survey overnight is there to testify how tricky the

situation is becoming and how bad is the risk of losing momentum from here: BoJ must be watching

carefully, and with apprehension.

We believe that the worse financial markets perform (Nikkei is -9% YTD), the more inevitable

further monetary interventions become, in the desperate attempt to keep the momentum alive,

debase the currency further, monetize an otherwise unbearable debt overhang. We may be

nearing such timing for an intervention, now that consumption tax kicks in (as of today, consumption

tax is brought up from 5% to 8%).

On such scenario of extreme policymaking, we foresee a nominal rally of equity markets (upside

potential 20,000 on the Nikkei by year-end), counterbalanced by a further depreciation of the

Yen (upside potential 110-120 USDYEN by year-end). The pain inflicted year to date on both the

Nikkei and the Yen made it less of a consensual trade than it used to be - although technicals are

still headwind to the position.

We will not expand here as we have done so extensively in February Outlook. We will present our

updated data set at next month Investors Presentation.

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HEDGING BOOK: receiving EUR short rates, paying USD long rates, long

implied volatility, short credit spreads

We will briefly touch upon the various new-entry hedging opportunities we see valid in the short

term. Again, more details and example trading will be provided at next month Investors

Presentation.

Higher rates in the US

We believe rates will head back to 3%-3.15% territory on 10-year US Treasuries, with the curve

shifting up in bearish flattening. Up until then, we believe there is a genuine case to be made for

us to be short rates.

Such positioning is also a hedge on an inflation scare (Inflation Scenario on our roadmap for Fat Tail

Risk hedging Programs). As we argued in our February Outlook, the tail scenario we see possible is

that of an outlier inflation print:

‘’The single most important data the market has ruled out in dogmatic certainty, is

ramping inflation. Disorderly Inflation, however unlikely, is the blind spot of markets, its

most acrimonious fat tail risk at present. The market seems to know with certainty that

unprecedented monetary printing in the scale of 30% of GDP have no chance in triggering a

disorderly burst of inflation. There was a time when monetary base itself computed

mechanically into inflation expectations. Long gone is that time, and the bag of experience

it carried with it.

Today, no market participant seems to give it any serious credit. If anything, it seems

obvious to most that deflationary pressures still abound: from either robotics and

technological revolution shedding jobs and depressing input prices (the Amazon effect), to

low energy prices (on shale gas revolutionary discoveries and the end of the Commodity

super-cycle), weaker than potential growth, slack in the labor market, weaker dollar on ZIRP

policies, Southern European internal devaluation, Yen devaluation exporting deflation,

China slowing down, etc.

Critically then, as it is totally ruled out, a firmly bad inflation print can do the trick, and

drive a truly major correction. Instantaneously then, on an inflation print unexpectedly

and decisively above 2%, monetary printing would be instantaneously off the table, not

by choice but by imposition, while rate hikes would be suddenly contemplated,

departing from zero bound all too quickly. All of this while the employment markets

seemed to be, housing markets was just making it, robust GDP was still a great prospect but

not so much of a present reality as yet. A bad inflation print would seriously take the

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market on the back foot, leading to overnight fall in confidence, and panic selling across

the board, equities and bonds together, DM and EM together.

Again, a low probability event it is, we concur, but surely one that the market is flatly blind

to. It makes for the classic definition of a tail risk event: one with low probability, but high

impact.’’

In the first quarter alone, US commercial banks lending is well above $ 70 bn, compared with $ 105

bn for the whole of 2013 (GaveKal data). US wage growth is at its highest in four-years (with the FED

disobeying to the Taylor rule there for the first in many years), as the slack in the labor market

might be over-estimated. Real estate prices, financial assets’ prices, food prices, all are in inflation

territory already, most likely. So the idea of an inflation scare in the US is less far-fetched than most

assume.

But the merit of the strategy is valid in the absence of rampant inflation too. Janet Yellen was

clear about the need to hike rates some 6-months after the completion of tapering (i.e. currently

projecting mid-2015). That has the potential to be big news to liquidity-induced market. Hiking rates

can be tricky for overvalued stocks, unless fundamentals have closed the gap from the bottom,

meanwhile. Bad things happen when frothy conditions and levered markets are met by rising

rates, as history has often presented.

The only true hope for markets is for Capex to pick up forcefully from here, in substitution of

buybacks and dividend payout, driving earnings and revenues higher, so that multiples can heal

down, while valuations stay high.

We are skeptical about that happening, as we often argued for earnings to be the bubble within the

bubble, standing at 70-year highs, at around 11% of GDP, while proving several times in history to be

mean reverting. Part of the reason why they stand so high is super-low domesticated interest rates

and a rigged/manipulated yield curve. While skeptical, we will keep subjecting our beliefs to critical

scrutiny, and positive falsification against numerical incoming evidence.

What matters for the short term, though, is that rates are likely to adjust higher around 3%, as

the Spring brings somewhat milder temperatures, almost inevitably. So far, slightly weaker than

expected GDP, inflation, and payrolls numbers helped justify rates remaining in middle-land. We

believe that on the first positive releases in the weeks ahead, rates will swiftly adjust upward.

From the standpoint of money flows, JPM Research calculates that FX reserve managers sold $ 40

bn of US Treasuries in the first quarter, $30bn of which from Russia alone. On any EM weakness,

billions of Treasuries can be expected to flood the market, heightening the case for higher yields in

the US, as the Fed is less a buyer now than it was before (and may even be pleased with the weaker

USD than otherwise would be).

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Europe: silent path to deflation calls for lower front-end rates

Yesterday’s CPI numbers from Europe confirmed a declining headline number, at 0.5% yoy. As a way

of comparison, when Japan started its deflationary adventure, in the early 90’2, inflation was above

1%. It took four years of inertial Central Bank before deflation was to bite.

A form of dislocation within markets in Europe may be that short rates are indeed not that low,

yet. Eonia forwards stand often above the ECB target, a situation which only makes sense if one

is to factor in the possibility of a rate hike by the ECB come 2015. As we believe such hike to be

not practicable, we look at receiving rates as soon as they hit pre-set targets above the ECB base

rate ceiling.

The good news here is that of high but unjustifiable levels of cross-asset correlation across markets

between fast diverging economies like Europe and the US. As rates in the US spike upward on any

sign of economic strength (or receding geopolitical risks, of late), rates in Europe tend to follow,

passively, in Pavlonian reflexive response. We expect rates to decouple on hard data evidence

over the next few months, as the Inflation risk that the US and Japan live through, is likely to

differentiate itself from the deflation risk Europe is avoiding to fight against.

Lately, weak GDP and inflation prints out of the US helped draw the connection to European

misfortunes. True, there are some common grounds for inflation to structurally trend lower, as

argued above. Still, we do not believe such connection to persist.

As the hands of the ECB are tied behind its back, Draghi keeps its freely available remaining

tools for last, delaying as much as possible their use. For all intents and purposes, we believe

that a sub-par intervention is likely in the near term. We see 3 possible intervention by the ECB,

not necessarily at this week’s meeting, but soon enough, ranked in reverse order of likelihood:

- BOE-type Funding for Lending programme. Designed to benefit lending to SMEs,

alleviating the pain on Southern Europe strangled corporate sector

- Rate cut on refi rate MRO or repo rate. Taking real rates more decisively into

negative territory, now that disinflation pushes them higher. Negative nominal

rates are more difficult, while possible, as we learn from market participants that

banks are not even prepared to process the change from an operational standpoint.

- Un-sterilising SMP operations. At present, the ECB sterilizes its now-terminated

Secutities Market Programs via weekly time deposits designed to drain the liquidity

generated by such SMP purchases. It would be enough to stop offering such time

deposit to inject liquidity in the system for approx EUR 180bn

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Excess liquidity in the European banking markets stands at just EUR 102bn as we speak, from

144bn a month ago, from peaking at EUR 813bn two years ago. The deposit facility stands at EUR

28.7bn. The liquidity current account at EUR 180bn.

On tightening liquidity, Eonia (overnight unsecured inter-banking rate) and other short rates

exceeded 30 basis points at times (before compressing again to 15 basis points), well above the

MRO base rate itself. Penalty kick area, against our views.

Implied Volatility to see new lows, target entry point possible

Volatility indexes may soon head to new lows, on a new leg up of risky assets. If they were to do so,

we look at long volatility positions there for inclusion in the portfolio, as we believe

Russia/Ukraine headwinds, geopolitical tensions, Abenomics’s potential headwinds, China’s

woes, all have the potential to destabilize markets yet again, in stark contradiction of such lows

in implied volatility. The end of central bank activism in the US, while it may or may not turn out to

be final, calls itself for higher average volatility, on historical norm.

While we often downplayed VIX and similar instruments as too expensive for static hedging

purposes, we would now look at potential dips into new lows as potential entry points. If we are

right about implied volatility dipping lower from here, we would regard such levels as

representing low downside against our states of the world in the months to come.

Spreads Compression starts to be interesting for shorts

Similarly to implied volatility, we will look at credit spreads compression in the weeks to come for

potentially taking the other side of the trade (i.e. paying spreads) for hedging purposes. Given

the current exposure of our Value Book, most of our exposure resides with equities in Italy and Japan

(currency over-hedged here). Therefore, few spreads in particular come to mind: BTPs versus Bunds

at 130-150basis points (currently at 180-190), rates on the belly of the Japan government yield

curve (primarily through options with minimum 20x multipliers on exit), CDSs and spreads on

Japanese corporates (moving to multi-year lows).

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TACTICAL BOOK

There is no room here to discuss properly the Tactical Book. We will do so at next month Investors

Presentation.

Cross-Markets Recap

Before we go, to recap, our current and expected positioning for the few weeks to come is

formed against such convictions as:

- US: neutral on real economy, neutral to bearish on equity, bearish on bonds

- Europe: bearish on real economy, bullish on equities and bonds

- Within Europe, long Italian equities, long Greek banks, long Disinflation

- Japan: super-bearish on real economy, long equities for nominal rally, short yen, hedged on

tightness of rates/credit spreads

- China: bearish on economy, inevitable GDP slow down exposing imbalances, but market has

priced it in for the short term. Thus, tactically long segments of the market there

- Emerging Markets – open eyes on Argentina, Korea, buying tactically on dips over the next

few months

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Thanks for reading us today. For those of you who may be interested, we will offer an update on our

portfolio positioning to existing and potential investors during our Bi-Monthly Outlook

Presentation, to be held next month. Supporting Charts & Data will be displayed for the views

rendered here. Specific value investments and hedging transactions will be analyzed. Please do get

in touch if you wish to participate.

Francesco Filia

CEO & CIO of Fasanara Capital ltd

Mobile: +44 7715420001 E-Mail: francesco.filia@fasanara.com Twitter: https://twitter.com/francescofilia 55 Grosvenor Street London, W1K 3HY

Authorised and Regulated by the Financial Conduct Authority (“FCA”)

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What I liked this month

Nouriel Roubini warns that even as many threats to the world economy have receded, new ones

have quickly emerged. Read

Robert Schiller: the importance of narratives in driving markets Read

Japan: Worst Recovery Ever, Regular Wages Decline For 21 Consecutive Months Read

Consensus Trades: Best And Worst Performers In Q1 Read

W-End Readings

Nigel Farage: Who Are You? - 4oD - Channel 4 Video

Are Emerging Markets Too Toxic To Touch? Read

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