Opportunities Funds Commentary

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Trident Investment Management, LLC
Opportunities Funds Commentary
UPDATE
December 31, 2015
Performance Review
We had expected several major developments entering 2015. First, we had believed that growth would disappoint
globally, falling far short of consensus estimates. Next we had anticipated that liquidity conditions would deteriorate
with the ending of the U.S. Federal Reserve’s quantitative easing (QE), even with continued QE in the Eurozone
and Japan. We had also believed that the Fed would raise rates though not by much, and that this in combination
with the reduced liquidity would result in significant market volatility over the year. Finally, we had expected a
major watershed event or events that could potentially shake markets out of their bullish mindset.
In terms of fundamentals, our expectations were largely borne out. With current fourth quarter estimates, it appears
that global growth for 2015 was about the slowest since 2009. QE has been continued both in Japan and in Europe,
and has even been expanded a bit in the latter. The Fed did raise rates, but only by 0.25% in December, which
was later than we had expected, even though the U.S. economy over the fourth quarter decelerated sharply. In
response to the weakening fundamentals and the prospect of less liquidity, markets proved treacherous especially
in the second half of 2015. Most major markets were extremely volatile, much as we had expected, but the total
moves for the year ignoring the constant violent swings were relatively small. The only exceptions to this were
the commodity and emerging country markets which experienced larger moves with significant accompanying
volatility. We did not however have a watershed event that was, in itself, sufficient to change market perceptions.
We had our share of serious developments – anti status-quo election outcomes in Greece, Portugal, Spain and
Catalonia, a Middle Eastern migrant disaster in Europe and a terrorist crisis in France with the Paris attacks, not
to mention the entry of Russia into the Syrian conflict. Yet, these important events did not dramatically alter the
consistently optimistic market mindset that prevailed through most of the year.
Our portfolios eked out gains for 2015, though they were smaller than we might have expected given how much
our fundamental views played out. The biggest positive contribution to performance came from our fixed-income
positions in South Korea, New Zealand and Australia, all of which benefited due to rate cuts. However, the ultimate
move in fixed income over 2015 was smaller than we had forecast given the bleak economic fundamentals. Our
equity positions also helped, with our long position in Japanese equities being the primary factor. Our credit
positions hurt our performance, even though we were net short credit all year. This came about because our short
positions in high-yield and particularly lower quality energy credits in the U.S. were not affected as negatively as
were our much smaller long positions in the sovereign and quasi-sovereign bonds and credit default swaps of some
of the developing countries.
In fact, the credits of many developing countries that are largely immune to Fed policy and/or commodity prices
suffered more than speculative developed country commodity credits. Our currency positions were a slight
negative to performance, primarily because most of our currency options bled premium. Our small commodity
positions were not material to our performance.
Entering 2016, the global economy appears to have slowed down significantly, almost to the point where a
recession might be imminent. The monetary authorities are starting to acknowledge that their unconventional
polices of QE and negative interest rates may not be the panacea for growth and appear unwilling to expand
their monetary efforts despite weakening data. Thus, the Fed raised rates for the first time in a decade in
December, even if it was by only a paltry 0.25%. The Japanese are still conducting QE but have so far been
resistant to increasing the amounts despite weaker data for fear of creating significant disruptions in their bond
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DEC
market. The European Central Bank expanded its QE in December, but not in the aggressive fashion that
markets expected, despite falling far short of its 2% inflation goal. China does not seem willing to expand credit
aggressively with its leadership implicitly conceding that such a policy might do more harm than good.
UPDATE
In our letter for January 2015 we had expected a very weak global growth outcome for the year which at the time
was considerably at odds with the Wall Street and media consensus. Despite our having been correct on the
reality, market valuations in the developed world did not correct to anywhere near the degree that one might have
reasonably expected under the circumstances. In fact, participants believed in future economic improvement, as
they had consistently done for the last several years, despite the fact that they had been wrong every time. The
costs to investors for being wrong so far have been minimal because the global central banks have worked to keep
markets at levels that are significantly divorced from reality. What is perhaps the big change for 2016 is that the
central banks have started to question the need for unqualified QE. With markets still at lofty levels, even a slight
reduction in the amount of monetary pixie dust could well prove enough to create panic and dramatically change
the investment landscape. Most investors simply have not factored in the sizeable market adjustments that will
likely occur then. We believe this represents a huge investment opportunity.
Our core portfolio themes have not changed much for 2016. Many markets, especially those for commodities
and in the developing world, have declined significantly, if not excessively, in 2015. Paradoxically, many markets
in the developed world where adjustments were most warranted have barely corrected. As such, we can identify
many opportunities today on both the long and the short sides. We have accordingly been boosting our risk
exposure and expect to do so further over the next several weeks.
Market outlook and portfolio strategy
We believe that policymakers by their unconventional monetary policies of the last few years have introduced
significant economic distortions that cannot easily be worked out of the global system. We take up in detail just
what these distortions are and what will be necessary for the eventual adjustment. We then discuss where we see
the best opportunities. We believe strongly that a major market crisis is likely this year.
1. A distorted global economy
We have argued for more than the last two years that global growth would be much weaker than market participants
expected and have also highlighted more recently that the data are suggesting a significant global slowdown rather
than a strong pickup. The table below shows global growth over the years following the crisis of 2008-2009.
Table 1: GDP growth rates (%)
Year
Developed Countries
Emerging Countries
World
2010
2.5
7.3
3.8
2011
1.3
6.1
3.0
2012
1.4
4.6
2.5
2013
1.3
4.6
2.4
2014
1.7
4.4
2.7
2015*
1.7
3.5
2.4
Source: JP Morgan Global Data Watch
* Estimated
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UPDATE
The numbers are anemic for the developed world, and the developing countries have also started to slow, resulting
in steadily weakening global growth. What is perhaps most surprising is the degree of stimulus that has had to be
employed to achieve even the above paltry growth rates. The largest developed countries, the U.S., Eurozone
and Japan, have all had interest rates at zero with QE operative for some part of the last several years. Most of
these countries have also had fiscal deficits considerably in excess of their growth rates. China, the world’s largest
developing country (and second largest economy) did not resort to QE or negative interest rates, but has engaged
in fiat credit extension through its banks to the tune of over $20 trillion since 2009.
Yet, the recovery from the recession of 2007-2008 has been among the weakest on record. In fact, the micro level data
paint an alarming picture. For example, the U.S. boasts the lowest unemployment rate in recent memory, but it has not
seen any meaningful rise in per capita income, while food stamp usage and discouraged workers as a percentage of the
labour force are close to multi-decade highs. The Eurozone is still showing depression-level unemployment rates – at
10.8%, the rate has only increased over the last few years. Japan, which has been a relative success, has nevertheless
managed to eke out a paltry 1.6% in GDP growth with its nosebleed levels of government debt and deficits.
Importantly, the poor growth rates of the last few years have been engendered not just by low interest rates but by
an epic increase in the level of debt. The numbers in this regard are truly amazing and suggest that if too much
debt was the major cause of the crisis of 2007-2008, we are in for a much bigger problem going forward. The table
below shows both the sovereign debt/GDP and the total credit/GDP ratios for many of the major countries of the
world today as compared to 2006. As can be seen, far from deleveraging after the crisis, the world has incurred even
more leverage thanks to zero interest rates and QE. The problem is especially acute in the developed countries and
in China which collectively have balance sheets that are far worse than the banana republics of yore.
Table 2: Country debt metrics
Sovereign debt/GDP ratio (%)
Total credit/GDP
2006
2016*
2006
2016*
U.S.
64
105
307
334
Eurozone
67
94
188
230
Japan
186
245
362
418
China
32
43
164
231
Brazil
66
70
101
139
India
77
65
120
116
Source: Bloomberg, World Bank, Eurostat, BEA
* Estimated
High levels of debt can be reduced in one of three ways. First, there is the prospect of strong growth that in turn will
generate the requisite cash flows needed to service and possibly reduce debt levels. The weak growth rates of the
last few years alone might prove sufficient to keep the debt ratios stable, except for the fact that they were achieved
in the first place by taking on much more debt. As such, any reduction in debt accumulation would likely cause a
collapse in growth making debt service on existing debt much more onerous.
Next, we have the option of outright debt default – a choice that policymakers have strongly resisted despite
the obvious unsustainability of the debt in some cases. Thus, Greece labours with an impossible debt load
approaching 180% of GDP, even after a partial default, and is being coerced into actually taking on more debt
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UPDATE
to keep up the pretence of repayability. Again, most of the problem Euro countries such as Portugal, Italy and
increasingly Spain are in similar straits. There is an equal reticence on the parts of the financial institutions to
acknowledge reality in the corporate debt markets, thanks at least in part to the suspension of mark-to-market
accounting rules in 2009. Thus, most of the firms in the problem Eurozone countries are in technical default
and their bank lenders, if they were to acknowledge the same, are very short of capital. The problem is even more
acute in China where mountains of bad debt, along with unpaid (and certainly unpayable) interest are being
rolled over by the banks creating credit “growth.” In the U.S., selected sectors such as the shale energy industry
are hemorrhaging cash but are still in business thanks to tolerant lenders who are simply unwilling to accept the
scale of the problem and end their provision of cheap credit.
The final avenue for debt reduction is of course that of inflation. High inflation represents a transfer of wealth from
lenders to borrowers and as such is a soft default. This has become the preferred choice of policymakers who have
worked with their QE and negative interest rates to achieve precisely this outcome. We can get a measure of their
“success” at this from the table below:
Table 1: CPI Inflation (%)
2006
2013
2015*
China
2.8
2.5
1.6
U.S.
2.5
1.5
0.7
Eurozone
1.9
0.8
0.2
Japan
0.3
1.6
0.2
Source: Bloomberg
* Estimate
As can be seen, inflation globally has been declining rather than increasing especially in the last few years. This
has occurred because monetary policy works through two channels. First, low rates boost investment and thence
capacity. Absent organic final demand growth, supply will exceed demand and prices will fall until capacity is forced
to exit. However, if rates are lowered further, or fiat credit is extended to failing companies, unprofitable capacity
will remain on stream worsening conditions of over-supply and weakening even healthier producers who are forced
to contend with continuously falling prices. Second, unconventional monetary policy, and particularly QE, boosts
asset prices and disproportionately benefits the wealthy who own most of the assets. Unfortunately, the rich have
a much lower propensity to consume out of increased asset valuations than the other cohorts in the economy. As
such, much less new demand is created than by direct fiscal measures targeted at middle and lower income groups
for example. Thus, the monetary policies pursued have served to increase global capacity considerably but have not
boosted global demand to the same extent. Therefore, these measures have actually exacerbated deflation rather
than create inflation. The only exception to this has perhaps been Japan where monetary policy has worked directly
to weaken the currency to create a modicum of inflation.
The net result is that we enter 2016 with crushing levels of government and private sector debt, monetary policy
reaching its limits and significant deflationary pressures due to excess capacity. Even worse, the world economy
appears to be entering a serious recession rather than a period of strong growth. By most metrics, conditions at the
start of 2007 were considerably more benign than they are today.
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2. A durable resolution
UPDATE
The extend-and-pretend policies that were adopted by policymakers since 2009 have been largely responsible for
the world economy’s current predicament. The economic leaders of the developed world have been unwilling
to follow the examples set by the Asian countries after the 1997-1998 Asian crisis. These nations embarked on
significant restructurings that ultimately returned them to rude health post 1998. While there is some agreement
now that these changes were perhaps more draconian than were really necessary, what should not be lost is the
fact that it was the Western leadership that insisted on the same, withholding support until such changes were
implemented. Many of the same policymakers who argued as to how pain was necessary then seem remarkably coy
about suggesting similar choices for the developed world which is in substantially worse shape today.
Dealing with the root causes of our current economic malaise to arrive at a durable resolution will involve all of
the following measures:
1)A quick return to normal monetary policy across the world with an abandonment of QE and/or negative
interest rates. In a highly-indebted world, inducements for more debt do not make sense.
2) A willingness to accept, if not force, debt restructurings when borrowers are in obvious financial distress rather
than creating more unpayable debt with further lending. At the governmental level, this will mean that
problem countries such as Greece and Portugal should be allowed to default on the bulk of their debt. On the
corporate side, the debt issued in many key global sectors such as China’s real estate and trust areas, U.S. shale
energy, European real estate etc. will have to be written off.
3) A reorientation of fiscal policy to support incomes and more equitable wealth distribution rather than to prop
up asset prices to aid the very rich. This will involve first a removal of the influence of the moneyed special
interests that tend to drive policy for their own ends, next a clear delineation of national priorities and finally,
a willingness to implement painful fiscal changes to implement these aims.
If the above changes are implemented, they will create a serious short-term recession even with mitigating,
counter-cyclical fiscal policy. In fact, the recession will be worse than that experienced in 1997-1998 because most
countries in the world are in much poorer economic shape than in 1997. Moreover, these measures will depress
medium-term growth rates because growth will have to be achieved by “legitimate” means rather than by financial
engineering or obfuscation. While these policies may seem radical when viewed in the context of the developed
world, it should be noted that the Asian countries did in fact implement exactly these policies post 1997 -- they are
straight out of the International Monetary Fund’s standard playbook.
3. Extend-and-pretend
The structural changes necessary to return the world to a sustainable growth path are undoubtedly painful and
global policymakers have adamantly refused to consider them seriously for fear of the consequences. Yet, had
they simply not done anything in 2009, markets would have forced the needed structural resolution with debt
defaults and bankruptcies. However, policymakers intervened then with bailouts and QE and have continued to
do so since. As such, they have destroyed the free markets and any prospect of market-induced discipline and have
effectively abetted the Ponzi debt dynamic already apparent in 2006. Not surprisingly, they have only made the
underlying structural problems much worse.
The crisis of 2007-2008 was undoubtedly caused by too much debt and too much concentration of financial risk.
Yet from 2009, the world economy has added an unbelievable $60 trillion in debt which represents the size of over
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UPDATE
three U.S. economies. The largest financial firms are about 30-40% bigger than in 2006 when they were already
unwieldy and much too big to fail. And the logic for this continued insanity is that there is no alternative – the best
way to avoid hangovers is to stay drunk!
4. Mechanisms for coping
We have now reached a point where the world is literally choking on too much debt and over-capacity. Faced with
this deteriorating reality, the monetary authorities are finally being forced to concede that their policies are having
limited benefits with potentially much higher costs – a painful realization that is making future liquidity emission
more unlikely. Market participants and their shills have responded rather predictably to the changing reality. Their
responses can be broken down into three broad groups based on their agendas.
4.1 Fantasy
The first approach to handling the current environment is to take the view that reality is benign and that improvements
are just around the corner. This is typically combined with the idea that any problems, to the extent they even exist,
originate from elsewhere. This is the favoured Wall Street approach. What is amazing is that virtually all of the
investment pundits claim that the U.S. and Eurozone economies are in decent shape or in any event improving, that
any weakness is temporary, and that the downturns in the developing world, oil, commodities and other markets are
consequences of localized disruptions or vulnerabilities. They are also convinced that problems in the developing
world and China in particular will not affect the developed world very much. Better still, they expect even these
problem areas outside of the developed world will soon be fine, thanks to omnipotent leadership such as in China,
or because of enlightened Western initiatives led by the U.S. (for the Middle East), or of course, technology changes
(for oil). There is no need to solve a problem that does not exist and every market dip is a buying opportunity.
4.2 Bailout
The second approach is to pressure policymakers for more bailout funds, typically in the form of QE to ensure
market stability (whatever that might mean) and thence global growth. In simple terms, the argument here is that
since many developed markets are so grossly overvalued thanks to stupid policy, it is important for policymakers to
do more of the same so that the beneficiaries of such overvaluation can continue to reap the rewards of their selfserving stupidity. This approach is the domain of almost the entire investor community that has already started to
feel the pain of poor liquidity, high volatility and horrendous earnings. In a nauseating recent newspaper article, a
significant investment guru that only a couple of years ago was lauding the supposed “beautiful deleveraging” in
the U.S., is now arguing for more QE by the Fed assuring us there is no alternative. What is starkly apparent from
all this is that to maintain the current crazy valuations in the market one has to rely on the patsy central banker. Or
put differently, the average taxpayer has to bail out the hyper-rich as a condition for stability.
4.3 Obfuscation
The final approach is to acknowledge a problem, but the wrong problem in entirety and suggest a number of
recipes for the solution of this non-issue without addressing the reality. This is the favoured approach of the political
class, especially since 2016 is an election year in the U.S. Thus, almost no U.S. presidential candidates talk about
debt levels in the U.S. or of the parlous nature of its fiscal position, but instead talk of more increased expenditures
for defense and the need to limit immigration. The Eurozone leadership has lost sight of the structural issues that
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UPDATE
might doom the entire Euro project and are instead obsessed with the near-term concerns arising from more
Greek/Portugal/Spain bailouts, refugees and immigration. The current economic malaise moreover, is increasing
voter discontent and the political class is only too happy to create convenient scapegoats and fake solutions.
Thus, we are faced today with a world economy that is rapidly worsening, a total lack of global leadership, and a
media that is unwilling to even identify the problems in question for the masses. The global markets, especially
in the developed world have stayed aloft despite this environment thanks to continued policy support. Even if
the Fed’s QE has ended with a small rate hike to boot, the prospect of more QE from the Eurozone and Japan
keeps the optimists hoping. Unfortunately, it is unlikely that more monetary medicine is forthcoming and the
deterioration in the underlying reality along with the huge levels of debt in the financial system could trigger a
major correction which in many ways could prove more serious than the one in 2008-2009.
6. Conclusion
The world today is plagued with problems which by many measures seem much worse than those that
prevailed at the start of 2007. The crisis of 2007-2008 for those with short memories, nearly brought down every
large financial institution in the U.S. and Europe, not to mention also many large corporations that relied on
financial earnings. It also created a dramatic slowdown in global trade and exported the developed world’s
problems to the developing world. Finally, the crisis exposed the utter incompetence, if not corruption, of
policymakers and regulators. As a group they abandoned their mission to serve the public at large and instead
resorted to extraordinary measures to save bankrupt institutions that should have been forced to shut down with
the dismissal of their incapable managements.
Fast forward to 2016, we have more of everything: more debt than in 2007, larger financial institutions, far worse
sovereign fundamentals in terms of debt and growth and gargantuan global excess capacity that cannot easily
be reduced. The same incompetents that got us into the previous mess are still in charge, and it is plain even to
their limited faculties that their policies are simply not working. Even worse, market participants today, unlike in
2007, are absolutely certain that policymakers will not permit losses and that continued stupidity merits outsized
rewards. The amount of intervention needed to stem losses is becoming unacceptably high especially since the
population at large is not benefiting from such action.
We have the ingredients for a major adjustment if not a crisis in markets. We have long been expecting such a
change, and believe it is essential for a return to economic normality. We believe we are well positioned for this in
our portfolio and hope that 2016 will indeed be a very Happy New Year for us in terms of returns.
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Performance summary at December 31, 2015
Trident Global Opportunities Class A
1 Mth.
3 Mth.
6 Mth.
1 Yr.
2 Yr.
3 Yr.
5 Yr.
10 Yr.
YTD
Since Inception
(Feb. ‘01)
0.3% -2.4% -3.5% 1.4%2.7%1.1% 0.9%10.0% 1.4%
7.8%
CI Global Opportunities Fund Class A
1 Mth.
3 Mth.
6 Mth.
1 Yr.
3 Yr.
5 Yr.
10 Yr.
15 Yr. YTD
Since Inception
(Mar. ‘95)
-2.4%
-3.6%
1.0%
0.8%
0.7%
10.6%
5.6%
1.0%
14.1%
UPDATE
0.3%
Some of the statements contained herein including, without limitation, financial and business prospects and financial outlook may be forwardlooking statements which reflect management’s expectations regarding future plans and intentions, growth, results of operations, performance
and business prospects and opportunities. Words such as “may,” “will,” “should,” “could,” “anticipate,” “believe,” “expect,” “intend,”
“plan,” “potential,” “continue” and similar expressions have been used to identify these forward-looking statements. These statements reflect
management’s current beliefs and are based on information currently available to management. Forward-looking statements involve significant
risks and uncertainties. A number of factors could cause actual results to differ materially from the results discussed in the forward-looking
statements including, but not limited to, changes in general economic and market conditions and other risk factors. Although the forward-looking
statements contained herein are based on what management believes to be reasonable assumptions, we cannot assure that actual results will
be consistent with these forward-looking statements. Investors should not place undue reliance on forward-looking statements. These forwardlooking statements are made as of the date hereof and we assume no obligation to update or revise them to reflect new events or circumstances.
Nothing herein should be read to constitute an offer or solicitation by Trident Investment Management, LLC or its principal to provide
investment advisory services to any person or entity. This is not to be construed as a public offering of securities in any jurisdiction of Canada.
The offering of units of the Trident Global Opportunities Fund are made pursuant to the Offering Memorandum only to those investors in
jurisdictions of Canada who meet certain eligibility requirements. Important information about the Funds, including a statement of the Fund’s
fundamental investment objective, is contained in the Offering Memorandum. Obtain a copy of the Offering Memorandum and read it carefully
before making an investment decision. These Funds are for sophisticated investors only. ®CI Investments and the CI Investments design are
registered trademarks of CI Investments Inc.
2015
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