Snapshots is peering through the flames of turmoil in the emerging markets (EM). We expressed concerns about EM valuations in Snapshots back in November (Mongolian Deities) but the ferocity of the current EM sell off has still taken us by surprise.

Cause and Effect and Mary Jane

To be clear, we are not surprised by the sell-off, just the magnitude of it.  In February this year, we wrote “When the world’s central bankers embarked on QE they said that central bank purchases would work through the “portfolio balance channel”. Ex-Fed chair, Bernanke, explicitly described it as pushing investors into holding other riskier assets. As the world’s central banks unwind QE, it would be logical to expect a reverse of some of the effects of QE.”

This is the cause.  The effect is being seen in the bursting of the cryptocurrency bubble, the collapse of inverse VIX ETFs, tightening credit market conditions and now the EM.  Cash burning technology companies are also feeling the heat.  Tesla’s CEO, Elon Musk, is taking solace in whisky and marijuana.  The latter was also allegedly the relaxant of choice for Bear Stearn’s CEO, Jimmy Cayne.

Italy’s Budget

Regular readers will also know that we have been cautious on Italian assets since Q4 of last year.  This view was incorrectly predicated on populist pre-election talk about parallel currencies which, to be clear, we are not adverse to if they are capped at as a percentage of a countries GDP.  In the end, the new populist government decided to shift aggressively to the left with their economic policies and aggressively to the right with their immigration policies. In our view, the economic policies are impossible to fund.

However, moderate fiscal comments from Italy’s Deputy PM, Matteo Salvini, and Economy Minister, Giovanni Tria, are providing the right checks and balances to the aggressive fiscal policy promises of PM, Giuseppe Conte.  We are taking note and adjusting our stance accordingly.  In January, we said we were retaining some buying power for Italian assets. We are now starting to see valuations and fundamentals that support the release of some of this buying power.

CLO Arbitrage

September is turning out to be a very busy month for the CLO market with a large number of managers printing deals.  CLO assets spreads (the underlying leveraged loans) have widened somewhat but CLO liabilities have been widening at a quicker spread as supply meets demand.  Using index averages, the arbitrage between assets and liabilities is now at the tightest level we have seen since the CLO 2.0 market opened up.  To be clear, the arbitrage still works but we are expecting pockets of indigestion.

Good luck.

Asif Godall
Co-Chief Investment Officer