July, 20th 2020

Resonance FM: The Naked Short Club

Interview with Fasanara Capital


Fasanara discusses with Dr Stu:


  • S&P/Nasdaq became ‘’Fugazi Markets’’. The S&P is at 3,000. But It could obviously and clearly and without much trouble be at 4,000, so much so as it could plausibly also be at 2,000 - and it wouldn't really matter much, because it's trading like Bitcoin and it's trading in complete disconnect / disrespect from fundamentals. Any level could quickly be justified and rationalised ex-post. That’s a testament to how fake markets became. And anybody that tries to give it a fundamental explanation is a little bit, you know, wishful thinking or in complete denial.

  • Bonds are fake-cash. The emperor is naked. We lost an entire asset class: and the largest of all.

  • The rules of the game in investing have changed dramatically: the new topography of the market is randomness and futility. Our basic view is that markets have entered chaotic territory: big moves very quickly, routinely. At the edge of chaos, in phase transition zone, rare events become typical.

  • Chaos will rule markets for the foreseeable future, with intermittent flash crashes. W-shaped recovery for markets, followed by another W-shaped recovery, and another W after that.

  • The need to go off the beaten path to deliver real value: Experience vs Experimentation. The fallacy of thinking you know it all and therefore you don’t have to experiment into new things, at a time in which the world around us is changing so much so fast. Transformational times are graves to well-travelled market participants.

  • The digital disruption revolution accelerates: all is tradeable around us. In the new world, the new capital markets span well beyond the futile S&P and empty US Treasuries.

  • Short-Termism and MMT; inflation to resurrect. In many ways, MMT is like QE, populism and full lockdowns: the Pavlovian panic response of a society grown soft and entitled, swapping short-term solutions for long-term problems, without hesitation. Zimbabwe has just exceeded 30 percent monthly inflation rates. If it gets to 50 percent, you can welcome back hyper-inflation.

The Naked Short Club Transcript

[00:32:17] Dr Stu: Pleasure. Now, we had you on the naked short club about three months ago. Soon after the lockdown in the U.K. and since then, a great deal has happened and also now the question is… Francesco, in your view, where are we going from here in terms of the economy and the markets and even opportunities?


[00:32:42] Fasanara: Hello, Dr. Stu. For a while now, we have been quite bearish on public assets, both bonds and equities, but in particular equities. And we thought that we were living in ‘’Fake Markets’’ where there was a complete disconnect from fundamentals, where valuations didn't make much sense and where the old rules of investing were completely flipped upside down. We were thinking this already three years ago, to say the least.

In my opinion, the Coronavirus has exposed the true colours of markets, and their fakeness. So, it really exposed the extent to which we can really refer to fake markets, but it did not really discover anything new. Simply put, the tip of the iceberg emerged, thanks to the virus. Of an iceberg that was there beforehand, just beneath the level of the surface. Nowadays, this is very clear to everybody. If we look at the line of the S&P, against the lines of unemployment, consumer spending, economic activity, corporate earnings and things like that, it's very clear that the disconnect is dramatic, ludicrous, and the S&P is in La-La Land. It is now before everybody’s eyes. Except, this was a pre-existing condition to coronavirus. Now, we only know more how grotesque that disconnect has become. So, at this very moment, I would say that the market is behaving similarly to Bitcoin. So, it's now a Bitcoin-type market. The other way we call it is ‘’Fugazi Markets’’ … because it does not really matter where it is trading at… It does not really exist. It can be here, it can be there, and it doesn't make much difference. So, rephrased, today the S&P is at 3,000. But It could obviously and clearly and without much trouble be at 4,000, and it could also be at 2,000 and it wouldn't really matter much, you know, because it's trading like Bitcoin and it's trading in a complete disconnect from fundamentals. And anybody that tries to give it a fundamental explanation is a little bit, you know, wishful thinking or in complete denial. Right. So, the S&P could be four thousand, three thousand, two thousand. And it does not really matter at all, is my bottom line. The market is taking a life of its own. It is a complete momentum and liquidity-driven quantity, looking at all the wrong things. And because of that is completely unreliable.


You can trade on it to try to monetize its volatility. There are still some good & truthful investment strategies that can play in a market like this. But the market itself is completely unreliable. And the rules of the game have changed dramatically. You know, there used to be a time when earnings mattered. There used to be a time when consumer spending, unemployment, economic quantities mattered. There used to be a time when it made sense to listen to the press conference of the central bank. And there used to be a time when it mattered to listen into earnings releases and commentary. But those times are long gone. In times like these, all those linkages are broken, in a way which is quite grotesque and Truman Show-type.


As the rules of the game have changed dramatically, we need to rely on something else in navigating markets. Our own recipe for markets, looks at markets as complex adaptive systems. Complexity theory / chaos theory / systems theory help a great deal in interpreting market behaviour; things become clearer to filter when it's about the system and not just the sum of its parts. Complexity science can help you to detect regime shifts as they come along.


Our basic view is that markets have entered chaotic territory. They have entered the phase transition zone already more than two years ago. So, there is really nothing new about this. Chaotic territory is defined by two main characteristics. One is big market moves; and two is for those moves to be happening in a fast fashion. So big moves, very quickly. And so that means, rephrased, the possibility for intermittent flash crashes. Big downs. Big risks. At a moment's notice. Happening in a succession, routinely, in the market. That is the new conceptual framework of the market, its new topography. And what we are dealing with. We will see again a big fast drawdowns. We will see again the Nasdaq crashing down 30, 40, 50 percent in a fast fashion. I think that the Nasdaq is actually a very good candidate to be up for it next. It could happen in a week. It could happen in a year. Doesn't really matter. It could happen anytime. It does not need a trigger because in systems theory, you do not need one. The theory is all about de-linking yourself from linear thinking, from cause and effect relationships, where for everything to happen you need to have a trigger. This is just a quirk of the human brain. To ask what the trigger is for the next downturn is the wrong question, because a system in transition, at the edge of chaos, needs no trigger to enter non-linear dynamics, to show runaway effects, to exhibit weird behaviour.


There will be one, incidentally. Like last time around it was the Coronavirus, although it was not needed. The previous time, it was the default of Lehman, although it was not needed. The system was full beforehand, and ready to transition.


Prior to the latest crash, smaller and shallower dips in the market were attributable to the RMB devaluations, commodity meltdowns, VIX complex implosion, etc. But the reality of nowadays markets is different, in my opinion, insofar as it does not need any specific trigger to go into a fast drawdown. It will happen again. It will happen routinely, in our opinion.


Investment strategies should be adaptable to this new environment of chaotic behaviour. Not trying to fight it. Not resorting to all the classical metrics of valuation which are now completely redundant and irrelevant. I mentioned earnings. I can mention consumer spending, but also measures of traditional market analysis such as price-earnings multiples, CAPE-adjusted Shiller multiples, Price on Sales for equities, inflation linkages for bonds. The linkage to inflation for bonds is completely gone, for example,  and things like that.



[00:38:56] Dr Stu: I'm wondering whether what you're doing is suggesting that the whole crypto space really isn't worth playing and at the moment, because there's certainly a lot of people who are taking a great interest in what's going on there, including a lot of institutional investors from Fidelity downwards. And we're seeing central banks, including that in the U.K., looking at putting together cryptocurrencies. I wonder whether you have anything to say in terms of the current sleaze destabilized system, in terms of what might happen with digitalise currencies as an alternative to fear. I also wonder whether you have anything to say about not at a high level, but on a practical level, how you can capture the opportunities that are out there anywhere. This side simply volatility, trading and. I wonder whether in your view, the correction which you've spoken before, is going to be a long term one or whether it's going to be yet another short and sharp bunch downward and then back upward. So really, three main questions.



[00:40:12] Look, I mean, when I say that the S&P is playing like Bitcoin, I don't mean that with disrespect for either one of them. If anything, one could say that the evolution of Bitcoin is challenged by the fact that the whole S&P market is behaving like Bitcoin at the moment.


The wave of RobinHood day traders is further confirmation of a pre-existing condition of futility in markets, moving in complete randomness.


When it comes to Bitcoin, I don't have a philosophical view about it. I'm not an enthusiastic apologist, meaning that I don't believe it is going to necessarily change the world. To me, it doesn't really matter. To me, it's just another mathematical quantity or trading instrument. So much as anything else. So, to me, if you want to play in the field of Bitcoin, you can. There is more volatility in Bitcoin than there is in the EuroDollar, and there is more inefficiency. So, go for it.


It is really a game of monetisation of volatility. Therefore, it's actually quite interesting. I would say that the world is changing before our eyes. I would say that trading in public markets or in Cryptos is quite the same, these days. And it is not because Cryptos have raised their status, but perhaps more because public markets have lost theirs, behaving silly billy. They've lost a lot of their traditional market analysis. They've lost a lot of their being grounded into number crunching, as was the case in prior decades, where price discovery was left to market agents (and not taken over by Central Banks).

New markets emerge: the crypto markets and bitcoin. But there are also other markets that are coming to the fore. I'm thinking about the fact that nowadays, given the digital revolution and digital disruption, you are allowed to trade on so many more things which are quantifiable and tradable instruments type. So, we are really living through transformational times. I'm thinking about digital lending. I'm thinking about the revolution undergoing in the banking world, where a lot of functions are taken away from commercial banks and given to other agents in the market which utilize new advanced technologies, and make everything tradable around us. I think that the new world, the new capital markets are well beyond the S&P and US Treasuries. They go into multiple directions today. If you want to be a money manager in the modern setting, you need to be open-minded. You need to have very little pre-conceived ideas.


You need to work against yourself, you know, especially when you have been in the industry 22 years. And there is some experience there. Right. And experience goes in the way of experimentation very often. There is a trade-off between experience and experimentation. When you think you know too much. You think you know all and therefore you don't experiment into new things, at a time in which the world around us is changing so fast. This is the biggest mistake that you can be exposed to as a firm.


At Fasanara, we take a lot of youngsters in our troops, something we believe into firmly. Very often the greatest advantage that they have is that they're less experienced and therefore they're more open-minded, more flexible, more able to see the trends, more able to risk it all off because they have less to lose. And, you know, this is a point in time in history, a turning point in history. I think it pays a lot to be open-minded. It pays a lot to be flexible, to be humble, too. To go into new things, to be experimental, to be a little bit of a laboratory.

[00:44:27] Dr Stu: In terms of the real economy. Are you seeing any positive signs at all?

[00:44:36] Fasanara: I don't see as many negatives as most of the market commentators see. I see the coronavirus as a one-off. And in particular, not so much the COVID itself, which can always come back in a second or third wave, but the reaction that the coronavirus, which in my opinion was a panic reaction, in the form of the full lockdown, a broad-based lockdown. I don't think that even if there is a second wave, there will be the same panic reaction to it. And the real damage to the economy does not come from the coronavirus itself but comes from the reaction to it, the panic reaction. If the next waves are not accompanied by the same type of reaction, I see the impact on the real economy less severe, less meaningful. I'm not trying to say that that there won't be a recession, of course. There will be a recession, inevitably, and the recession could be severe. Of course, it will last two or three quarters. But I don't think it will be longer than that. I don't expect a long wave of economic depression to come off this, because it is a one-off my opinion. So, I’m a real contrarian because I'm negative when other people are positive, like on the S&P. And I'm more positive when other people are negative, like on the real economy.


I also think that Coronavirus brought a lot of positive news from the viewpoint of policymaking when it comes to monetary printing and fiscal policy. In Europe, for example, I saw the ECB moving at a much faster speed than ever before. And that was a very positive thing. At one point, more than 1 trillion was made available, despite all the political fragmentation across Europe. It was a very good thing. To put together a fiscal plan was also very good, and most unexpected.


And I want to be even more positive about it, although I may enter wishful thinking territory myself: I believe that there is a great chance that COVID has given the

right political capital to strike a better balance in income, to narrow the income gap.


Income inequality could narrow down somehow in the next two, three years as a consequence of two factors at play. One is re-distribution. Better distribution of capital from policymakers, both monetary and fiscal, into the real economy, into consumers, households, spenders and SMEs, as opposed to banks and large corporations only. I have a positive view there, which is also like an auspicious, in my opinion.


On the other end, the other force is cheaper prices in public equities. I think that the S&P should be cheaper and maybe cheaper as a consequence of the need for the income gap to be rebalanced. Not only from the bottom up, but also from the top down.


We've lived through an environment in the last decade, ever since Lehman, where policymakers believed that there they should go after the trickle-down effect, make their markets richer in order for it to trickle-down into in the real economy, and ultimately create more animal spirit, employment, output. I think that that view may change in the next two to three years. Out of populism, out of political pressure, the opportunity is there for a change in the direction of travel there. And there's never been true that the S&P should trade higher for the real economy to recover. It has never been true. And this is the opportunity to expose that lie and do something about it.



[00:49:18] Dr Stu: If that happens, then great, because one of the problems that we face still is the effects of all the government opening of the spigots. After the great financial crisis and that money, to a large extent, plunging itself into inflated US prices rather than onto banks balance sheets rather than into Main Street. Francesco, it's been superb to have you. Of course, I wish we had more time. I would like to ask you if you've looked through your own looking glass a year out. Where would you see the real economy a year from now? Where would you see the markets a year from now? And what letter would you assign to the shape of the economic recovery?



[00:50:02] Well, I guess if I need to be schematic about it, I will probably assign a U shaped recovery to the real economy. The wave can be longer, but no longer than, in my opinion, 18-24 months. So if I can answer with a bit of a tricky answer and give you a longer-term I would say 24 months for a high confidence in a full U shaped recovery.


When it comes to financial markets, I expect a W shaped recovery, followed by another W, and another W after that. So, I think that we will go into more jumping up and down territory, more chaotic environment. You have less and less liquidity. The market will keep on exposing these gaps, the markets of fake markets and on and on.


Next in line, in my opinion, is the Nasdaq, which is very, very big and very, very bloated. And could release of potential energy at any point soon. I'm a big believer in technology, but to believe in the fourth industrial revolution is not to believe into a stratospheric Nasdaq.


And again, I think the S&P could be anywhere between 2000 and 4000. And it doesn't really matter to the real economy. It follows that you can flip between the two a few times over.


If I have one more minute to answer your questions; yes, it is true that the pension plans are in danger and that those are pensioners. But at the same time that is a risk redistribution question. That is a policy-making question, more than anything else. You don't need to boost the S&P for the pension funds to be fine. You can always recapitalize them with monetary printing or with straight fiscal transfers. To believe that to help the pensioners you need a higher equity market is misleading: there is surely a lot of leakage and inefficiency in that transmission channel. And that leakage is part of the income inequality gap that is unsustainable and has dire political implications. And therefore, yes, my wishful thinking type of view is that we can do something about it in the next two or three years. The opportunity is there.



[00:52:19] Dr Stu: Let us hope. Finally, and this is almost a yes/no question. We spoke last time on the Naked Short Club about the new approaches to modern monetary theory (MMT) whereby it’s okay for countries with reserve currencies to keep printing that money, at least until a certain point. Do you subscribe to that or not? Because there are certainly a lot of people who come on the Naked Short Club and out there generally who think that we're heading for massive inflation simply because the money supply has been increased. But there is an increasing number of people equally who don't buy that. What's your view on that?



[00:52:58] Fasanara: Well, I don't subscribe to MMT, but it doesn't mean that I don't think it will happen. I think it will happen, indeed, given that the main driver for it to happen is the same that justifies the broad-based lockdown after coronavirus: as a society, we grew very entitled, soft, and always choose the short term solution over the long term problem. We are short-termist agents. MMD comes handy as a new theory in days like these because it buys time.


Inflation, by the way, shouldn't be forgotten. As you know, Zimbabwe has just exceeded 30 percent monthly inflation rates. If it gets to 50 percent, you can welcome back hyper-inflation. So inflation has not disappeared. I think that all of what we are doing these days, at some point down the line, will emerge in the form of inflation. It won't be a year from now, probably two or three. But eventually, we will get there. Also, thanks to the de-globalization trends, re-onshoring and Balkanisation of economies.



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