Volatility and Value

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.

This week, Elana talks with Mark Fishman, CEO, Aesir Capital Management.

What is your outlook for alternatives?

The alternatives space is fraught with challenges.  I believe we will see a lot more volatility and price discovery moving forward as investors were forced into buying historically high yielding securities at historically lower yields over the past several years.  The reversal of emergent Central Bank policies will find fewer buyers and more sellers of many less-liquid products and those trapped in private loans, CLO tranches and poorly structured high-yield instruments will be punished as the door is narrower on the way out than it is on the way in.  In the world of equities, I believe we are entering into markets where the black boxes only provide liquidity when you don’t need it and that negative surprises will be met with substantial discounts to current valuation.  Another way to say this is that the markets will be volatile and create a lot of relative value on the heels of liquation phases.  I like the opportunity set for the more liquid alternatives space as I think the less liquid space will be faced with a price discovery, so that if mark-to-market or liquidity is important, it is a space I would avoid unless prices become a lot more attractive.

In 2008-2017, global Central Banks flooded the world with liquidity to prevent a global financial collapse. After the economic disaster that we witnessed in 2007 and 2008, this environment created new types of carry trades across the liquid and illiquid investment spectrum, while the zero to near-zero interest rate policies allowed financially weak corporations to issue debt at low absolute levels to better their balance sheet while not doing much for their absolute growth or advancement of their business.  This interest rate savings from low-quality companies allowed a lot of direct lending and ‘zombie’ companies to exist but be much more challenged during a rising-rate environment.   At the same time, many public companies loaded up their balance sheets with a lot of very low coupon debt, using that debt raise to pay dividends and to back their own stock.  Corporate America has taken advantage of the access to low-cost capital during this period of loose monetary policy. 

What is your outlook for the economy?

We are starting to witness the aftermath of the Federal Reserve’s emergency policies of adding liquidity, which are now being reversed with the Fed’s balance sheet reduction, a rise in U.S. and LIBOR interest rates, a slowdown in the housing markets and increased volatility throughout all markets.  The U.S. economy is growing at around 3% and we still await an infrastructure build to happen.  U.S. unemployment, already at the lowest level since the Nixon Administration, continues its plunge toward multi-year lows and the Fed continues to push rates higher as they see the specter of wage-related inflation on the horizon.

The Fed wants to be able and ready to use traditional Fed techniques and policies in the future to positively impact the economy and needs to move away from emergency techniques they used during and after the 2008 economic crisis.  While the White House’s rhetoric is against raising rates, the Fed’s job is to foster a strong U.S. economy and a stable financial system, and to help manage the banking system.  Part of this is to protect the economy from inflationary threats in a high employment/rising wage pressure environment.  To me, this means the Fed will continue to raise short-term rates and that inflation is brewing in the weeds. 

What keeps you up at night?

What keeps me up at night is a repeat of Europe post the U.S. stock market crash of 1929.  After the 2008 crisis we saw the world flooded with liquidity from Central Banks vs. 1929 when the Central Banks drained liquidity.  During the recent crisis, the Fed’s balance sheet rose from 5% of GDP to its present ~20% of GDP.  While I think the U.S. economy is relatively strong, it is the long list of geopolitical risks that I am worried about. 

If Europe continues to roll over and slips into a recession at the same time that China’s economy is shrinking, this will bode poorly, as their Central Banks are trying to come off of their quantitative easing/accommodative policies.   

While this is happening in real time, we have an emergence of the right across the globe from the U.S. to Italy, France, Germany and Brazil.  A result of severe economic damage is isolationistic governments, blame on foreign cultures and a return of the right.  It is akin to a bad rash that keeps coming back and always results in some damage.  China has all but taken control of the South China Sea, Russia is on a military rebuild and expansion and Europe is seeing new/old challenges with Catalonia/Spain, Flanders/Belgium as examples of regions looking to create independence.  As the regional challenges mount, military rebuilds happen and the U.S. retreats into a more isolationist perspective looking at money over stability, we may be creating a backdrop of Central Banks’ removing liquidity while global economies weaken.  This would lead to rising geopolitical risks, rising economic challenges and the potential for the need of central banks to revert to an accommodative stance as the result of a destabilization of the equity markets and the world seeing a significant repricing of risk.  Simply trying to sell assets, especially the illiquid assets, in that market will be disturbingly painful, likely more painful than in 2008, and the forced liquidation phase would be significant.  Volatility will rise and liquid investments will have less liquidity at any given price, but this is a “stock picker’s” market and the risk discipline with tighter bands and a better sell discipline in strategies that empower the short side as well as the long side have a lot of positive alpha potential.