16.02.18

Snapshots watched the excellent documentary AlphaGo on Netflix recently. It is about an algorithm of the same name created by Google’s Deepmind team to beat Lee Sedol, the world’s best Go player. It is a moving account of a man’s life, work and passion pitted against an emotionless machine that can perform a mind-boggling number of calculations.

The State We Are In

The rules of Go are relatively simple even if the permutations of each move branch into the centillions (that’s very large!).  The markets are even more complex.

At Cairn Capital, we have a proprietary technology system called Nexus that we have been developing since 2004. It is very rich in data and we have been running some simple machine learning algorithms against these data sets to see if we can use them to inform our human decision making when it comes to asset allocation, and eventually, security selection.

The algorithms have been creating states for how they see the world and an obvious but interesting observation came up. Since the global financial crisis, the algorithm has only seen states where the financial sector has dragged down the corporate sector. This is because the financial sector was at the epicentre of the crisis. The algorithm is therefore training itself on this particular type of market environment.  We are in the process of un-training it by feeding it differentiated and longer data sets and default tables.

The reason we mention this is that we continue to think we are entering a new market state where corporate risk is higher than financial risk. This is because corporates will have been leveraging up in the current credit cycle whereas financials have been deleveraging. Financials will also benefit from higher rates through the revenue line whilst corporates will suffer through the interest rate cost line.

Amongst the debris thrown up by the recent market volatility, we are seeing some compelling opportunities in bank capital.

Counter-intuitive Safe Havens

We mentioned last week how we think the recent volatility is being caused by changing monetary policy dynamics and we expect this trend to continue. We note that pricing in the securitised credit markets which were at the epicentre of the last crisis has been very stable through the recent volatility. Recall that securitised supply has been low in Europe in recent years because of the Bank of England’s Term Funding Facility and the ECB’s QE programmes. This has meant that risk that would have been securitised by banks has been retained and pledged with the central banks.  As monetary policy changes and these programmes expire, we expect supply and opportunities to increase in this asset class.

Good luck.

Asif Godall
Co-Chief Investment Officer