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We are macro investors. That means that we are
constantly exposed to the shifting sands that the
worlds increasingly powerful gaggle of central bankers
- and the capital flows they encourage - impose on
global financial markets. However we tend to stick to
our big (and often bearish) views, something that
means our performance comes with hot and cold spells.
The most recent one and it doesnt take a genius to
see this has been cold. It hasnt been as bad as it
could have been for the simple reason that we make big
bets when we are doing well and small bets when we
arent. We allocate increasing amounts of capital to
winning trades and cut losing trades rapidly. Weve
been cutting a lot recently. The good news is that this
has minimised our drawdown. The even better news is
that our returns have improved lately; it looks as if we
are entering a hot spell, and we have begun to re-
allocate significantly more risk capital to our
endeavours.

So what makes me think we are heading hot at the
moment? Let me tell you about the character of Bob
Ryan, from the US cable TV show Entourage. The
show chronicles the workings of Hollywood and Ryan is
a legendary movie producer credited with a string of
box office winners. His problem is that his success was
rather a long time ago. So no one is certain of his skills
anymore. His reaction is to make seemingly absurd
promises think along the lines of "...what if I were to
tell you that this movie will cost peanuts to make, will
earn you four Oscars and will gross $100m...is that
something you might be interested in?" In some walks
of life (well, mine anyway) such is the popularity of the
show that the expression has entered the modern
lexicon as a catchphrase for offering up fantastical, if
not actually impossible, ideas. With that in mind, what
if I were to tell you that I have adopted a tactically
bullish outlook? Is that something you might be
interested in?

Last bear standing? Not any more

I know what you are thinking. You are thinking that the
last bear is capitulating. It isnt a good sign. Maybe it is
that simple. But I think it is a little more complicated.
We, and I accept we arent the first here, sense that US
monetary officials may now be willing to subordinate
the demands of their own economy to the perils
confronting emerging market economies. If that is the
case, the great peril is not that the Fed finally tightens
monetary policy and US stock prices suddenly tumble
from what are very obviously overpriced levels. Would
that it were our curmudgeonly portfolio structure
(think dynamic volatility targeting and stop losses)
works well with big stock market reversals. Instead the
greater peril is that the current backdrop will turn out
to mark a rapid acceleration in the ongoing move to the
upside. A hint that this might be the case comes from
looking back through the 113 years of price data for the
Dow Jones Industrial Average. We have done this (so
you dont have to), searching along the way for the
comparable periods that fit most tightly to the last 500
trading days. What is clear is that periods of trading
similar to the one we have seen over the last two years
dont often seem to end quietly: they boom big time or
they crash. Which is it to be this time? Looking at the
markets of 1928, 1982 or even 1998, all of which have
scarily similar looking historical charts to todays, we
wonder if it wont be both. Starting with the boom bit.


















Let's look at what happened in 1998. All sorts of market
moving events were shifting the sands. There was the
fall out from the Asian Tiger crisis. There was Russia's
local currency default. And there were the event risks of
the collapse of LTCM and the Y2K scare. Together these
things ensured that US monetary policy was set far too
loose for the US economy itself. And the result? A
parabolic trend to the upside in equities that destroyed
anyone who chose to stand in its way. This is what I fear
most today: being bearish and so continuing to not
make any money even as the monetary authorities
shower us with the ill thought-out generosity of their
stance and markets melt up. Our resistance of Fed
generosity has been pretty costly for all of us so far. To
keep resisting could end up being unforgivably costly.

Made a mistake once? Why not make it again

You will wonder what makes the Fed so concerned that
it is willing to risk another bubble and another crash?
100
110
120
130
140
150
160
170
100
120
140
160
180
200
220
0 100 200 300 400 500 600 700 800 900
Trading Days
Dow Jones Industrial Average
Dec 1995 to Dec 1997
Dec 1997...
Last 500 Trading Days (RHS)
Manager Commentary, December 2013
W
hat if I were to tell you I was turning
more bullish? Is that something you
might be interested in?
You are here?
Sources: EAM, Bloomberg.
Meet Bob Ryan (Link)
E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E
E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E
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2
Manager Commentary, December 2013
The answer rests in the dominance of neo-mercantilism
as the most successful economic orthodoxy of our time.
For those new to this, the text book definition will
suffice. Neo-mercantilism is a policy regime borrowed
from 19
th
century Kaiser Germany. It encourages
exports, discourages imports, controls capital
movement, and centralises currency decisions in the
hands of a central government (to reduce reliance on
flighty foreign capital). The point is to increase the level
of foreign reserves held by the sovereign government,
allowing for an accommodating domestic monetary
policy. It also looks like it works you can make a good
case for it being responsible for the superior growth
rates seen across Asia since the 1980s. However it
comes with what I think is about to be a major problem.
It has made domestic monetary policy in most Asian
countries very pro-cyclical and we havent really yet
tested this pro-cyclicality to the downside. What
happens when the rest of the world becomes unwilling
to raise its indebtedness further in order to buy Asian-
produced products and facilitate Asian growth? And
what if that is about where we are right now?

To date, the experiment with economic growth in Asia
has succeeded as an almost direct result of the re-
leveraging of the American economy since interest rates
began to fall in the early 1980s.

















The Japanese authorities blazed a trail on this for
everyone to follow. It kicked off with (yet) another
credit cycle gone wrong. In the 1970s there was a
bubble in lending to Latin American governments. That
was popped by Paul Volkers tightening of US monetary
policy. Latin American currencies tumbled and sound
currencies soared. Except the yen. Japan had a central
plan for economic self-sufficiency - one that required a
positive current account and endless rounds of
domestically funded investment. They did not want a
strong currency, low cost imported goods and a
consumer boom or anything else that might have risked
future trade deficits. So they worked to keep the yen
from appreciating too fast, too soon. How? The Bank of
Japan created yen and bought Treasuries. This money
found its way into the local banking system (as new
money does) where it was soon turbo-boosted by
foreign capital inflows: overseas investors were
attracted by the corporate profits produced from the
loose policy and pretty pleased with the way in which a
persistently undervalued exchange rate made asset
prices cheap to foreign investors. Chuck in fractional
reserve banking, and risk-seeking bankers and it was
inevitable that asset prices would surge. The rest is
history. Equity prices, ignoring all qualitative objections
to bubble valuations, quadrupled. Then they crashed.

First Japan. Now China.




























However Kindleberger was writing pre-neo-
mercantilism. He would have expected the follow-on
from this to be higher consumption as a result of the
wealth effect of higher asset prices (people who feel rich
spend more) and of the boost to spending from a rising
currency giving falling import prices. Hed have looked
at 2004 China and expected every member of the
middle class to be driving a cheap BMW by 2006. That
didnt happen. Instead currency interventions held
down the yuan and, at the same time, the planners
need for cheap credit to finance their investment
projects meant the real returns from bank deposits

To understand todays story
we have to leave Japan
(reluctantly well come
back to it), and travel 20
years later to China, where
the same pattern has been
repeating itself. Back in
2004, China's cheap land,
cheap labour, cheap money,
cheap everything, produced
high returns on capital and
trade surpluses with the rest
of the world which
encouraged investment
inflows into the country.
That, as Charles Kindle-
berger, the intellectual
godfather of macro investing
and author of the
unsurpassed classic Manias,
Panics & Crashes, noted, is
the kind of combination that
"almost always" leads to an
increase in the country's
currency and domestic asset
prices.


Source: EAM.
Kaiser Wilhelm II
Japan
managed
FX
US had low
debt to GDP
= spend >
save
Produced
investment
boom
Provided
Japan with
exports
A Virtuous Circle
Producing Dollars For A
Richer China
Japan
low ROI =
consumed <
save
Required
more
exports
In the beginning
E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E
E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E
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3
Manager Commentary, December 2013
were forced to stay firmly negative (if you are going to
invest in worse than useless investment projects it
mitigates matters somewhat if you insist on the debt
being cheap). Negative deposit rates might make
residents of countries with developed welfare states
more likely to spend. They appear to make the Chinese
more likely to save. You will hear much about the rise of
a consumer boom in China in no end of bullish papers.
But the truth is different. It is that China is unique in
the extent to which it has prevented ordinary people
being exposed to cheap BMWs; despite the massive
growth in the economy, consumption has persistently
fallen as a share of GDP. The Kaiser would have
approved.


















Mercantilism needs a donor. That donor has
been you.

The key point about Japanese and now Chinese
mercantilism is that the creation of domestic growth in
this way has always required a donor country the one
hosting the consumption boom needed to finance the
investment spending back home. In the latest round,
cash is injected into Treasuries by China (this is what
Bernanke referred to as the glut of savings). It is then
captured by the US banking system (someone has to
sell the Treasuries to the Chinese and manage the
proceeds). Then the loop repeats. Chuck in (again!) the
fractional reserve banking and your usual bullish
community of loan officers in the US and you soon see a
rise in economic activity and of course in leverage. Then
stock and property prices boom. But it doesnt end
there. Oh no. The boom boosts wealth in the US. They
borrow more and spend more bringing what should
be tomorrows consumption forward into today. That in
turn boosts demand for imports and shovels more
dollars into China, something that forces it to print
more yuan to keep its currency down and to buy more
Treasuries. This cash enters the banking sector... and so
on. All this needs more and more Chinese productive
capacity (more steel plants, more concrete, more
factories, more ships, more roads, more property,
more, more, MORE) to meet the additional foreign
demand. China is the host. The US is the donor. The
host effectively offers vendor financing to help the
donor consume. In return the host gets high domestic
investment rates and full employment both things
that help when you are after social obedience and
international influence (its easy to have a strong
foreign policy when your would-be enemy owes you
money). And everyone gets rising asset prices. Which is
nice. In theory this is an expansion without limit. That
sounds like a joke. Its more an observation.

Limitless prosperity or limitless instability?

This has been our world for some time now. Thats a
problem for the likes of us. Why? Because when the
psychology of the price discovery mechanism becomes
more dependent on money creation than economic
growth, as in Japan during the 1980s and in China for
the last decade, asset prices become an abstraction.
They separate from our qualitative perception of
reality; they are more susceptible to wild price trends
that in theory have no limit; and they display a two-way
causality.

This isnt how it is supposed to work. In a more normal
world you can think of finding value in terms of the
one-way causality of a thermometer and room
temperature. If we doubt the veracity of the
thermometer we can always produce an independent,
second, thermometer to determine the proper
temperature. The temperature is what it is. Just as in
investing the fundamentals are what they are. But what
if it wasnt like that? What if by warming the mercury in
the thermometer, we could also raise the room
temperature? This is what happens in the wacky world
of neo-mercantilism. Here "fundamental" investing has
little or no merit. There is one reason for being long and
one alone: sovereign nations are printing money and
you can see that prices are trending. Thats it. Nothing
else matters. Think of a neo-mercantilist market as if it
were a mouse with the toxoplasma virus. The virus
hijacks its immune system and makes it fearless. It dies
in the end. But not before it does some pretty nutty
stuff. Theres no more point in yelling watch out for
the cat at a mouse hijacked by toxoplasma than there
is looking at valuation measures in a market hijacked by
mercantilism.

Me and my immune system

My investing immune system has been in pretty good
shape recently. But thats the main reason why Ive
Source: IMF and BCA Research Geopolitical Strategy.
*In 1990 international Geary-Khamis dollar/rebased to 1870 = 100.
**At purchasing power parity/rebased to 1995 = 100.
100
200
300
400
500
600
700
21st Century Asia
GDP**
China
USA
Japan
100
150
200
250
300
350
19th Century Europe
GDP*
Germany
UK
France
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4
Manager Commentary, December 2013




























America fights back

Back to our story. What happens when the donor cant
take it any more? This happened in part in March 2009
when the US rejected Asia's neo-mercantilism. Two
destructive, domestic boom/bust cycles within a decade
had left gross debt almost four times GDP. The
domestic economy had become unresponsive to even
record fiscal expansion and almost zero overnight rates.
Something had to be done to regain the initiative. Polite
requests for the Chinese to allow their currency to
revalue higher versus the dollar were rebuffed and in its
absence expansionary American fiscal and monetary
policy only served to make China richer. Not ok. So
America fought back. With QE.

If the Chinese were never going to revalue their
currency themselves, the US would effectively do it for
them. QE would target higher prices in China,
something that would revalue the renmimbi in real
terms and, with a bit of luck, produce the consumer
boom that its bureaucrats had so steadfastly sought to
prevent. This would transform China into the donor
country and also generate the prosperity America
needed to recover from the clutches of its debt
deflation. And so the sands shifted again. The Fed
kicked off its Treasury purchase program in 2009 in the
full knowledge that the lack of demand for productive
investment in the moribund US economy would create
a surplus of speculative flows into faster growing
regions of the world. It also knew that such flows would
force the foreign exchange targeting emerging market
central banks to print even more of their own
currencies to keep a lid on their exchange rate
appreciation as the dollar debased itself. The Fed then
recognised how the chain reaction we have chronicled
above would go. Emerging market asset prices would be
bid up, something that would in turn be met by more
central bank printing of local currencies which would
then be leveraged through the emerging market
banking system into even higher local asset prices and
so on and so on and so on.

The Fed starts winning

This works. Well it works for the Fed. We estimate that
total emerging market debt now surpasses $66trn.
Thats almost two and a half times emerging market
GDP and double its level at the start of the Feds QE
extravaganza. At the same time car sales in China have
surpassed those of the US and property prices are on a
rip. Housing transactions are up 35% year on year and
new home prices are rising across the nation by
between 15% and 20%. Looks like a consumer boom
doesnt it? So from the Feds point of view this is going
well. So well that since July 2008, the renminbi has
appreciated by some 30% against the euro. But while
the Fed might be pleased the Chinese probably arent.

When the monster stops growing, it dies. It cant stay
one size.

The Grapes of Wrath, John Steinbeck

The mercantilist plan has always been to push overseas
trade expansion via the perpetuation of an under-
valued currency. It isnt working out. Look at Europe.
Europes nominal GDP was supposed to be much
higher by now (partly on the back of Chinas helpful
2009 bout of credit expansion). But it has only
surpassed its previous highs by 2%. And denominated
in renminbi, its much much worse: the European
economy has nose-dived by 25% since March 2008. Try
being a small labour intensive manufacturer in some
coastal Chinese city renowned for its export prowess
but struggling with fast rising wages selling into that!

The German philosopher and experimental
psychologist scientist, Gustav Fechner, once proposed a
rule that can be expressed as follows in order that the
intensity of a sensation may increase in arithmetical
progression, the stimulus must increase in geometrical
progression. That seems to describe China pretty well.
The huge disappointments in growth elsewhere mean
produced mediocre invest-
ment performance. Ive been
sensible. But in doing so I
have imposed qualitative,
one-way causality arguments
onto a market that just
doesnt care. I need to be
more like the mouse (just
without the bit where it dies)
and that means I have had to
put aside qualitative analysis
and be in this trending
market. I had thought it
would be worth staying
bearish and accepting
underperformance for the
fun of being right in the end
- becoming what the British
call a vexatious litigant,
someone who fights for the
sake of it. But Im not sure
any of us can wait that long.
Playing it safe, as my good
friend Chris Cole wrote last
year may be the greatest
risk of all. So the mouse it
is.

Danger Mouse

E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E
E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E
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5
Manager Commentary, December 2013
that for Chinas GDP to
make arithmetic prog-
ression, a geometric
intensity of effort with
no theoretical end - is
required. The monster has
to grow. Note that since
the Fed turned the tables
with its QE policy in 2009,
China has had to consume
more concrete in its roads,
rail projects, bridges,
factory construction and
new buildings than the US
did during the entire 20
th

century. Yet despite this
xx
















Herculean effort its structural growth rate has fallen by
30%. This is all fascinating. But Ill tell you what it isnt.
It isnt stable. It is what China expert Michael Pettis
would call a volatility machine.

Markets predicting deflation get asset inflation

Something happened in April of this year that I think
may have marked a turning point. Before I go into that I
want to be sure we all understand something. You want
to believe that Chinas growth rate over the last 30
years has been a triumph of superior state planning and
the irrepressible force of urban migration, a one way
causality if you like. Id like to too. But we have to
accept that it just isnt true. Instead it is the result of a
system of foreign exchange suppression and so
anchoring our expectations to it is a very bad idea. With
that in mind, Im going to ask you to consider the US
Treasury Inflation Protected Securities (TIPS) market.
As you know, we allocate a lot of time and risk capital to
equities. Their malleability allied with low transaction
costs and liquidity make them an excellent way for us to
invest in our macro narratives. But we find it hard to
buy and sell equities based on valuations. Doing it like
this is just too imprecise. So we prefer the certainty of
inflation expectations: you should be long equities if
inflation expectations are trending higher or more
specifically for us when the 10-year inflation
expectation, derived from the TIPS market, is greater
than its 200 day moving average.

Over the last decade you could have done this and
nothing else and escaped most criticism. A simple
trading rule where one is long S&P futures when the
condition is met, and flat otherwise, has produced a
return of 75% since the 1st of January 2003 (around the
bottom of the TMT crash). A long-only strategy has
produced better gains - almost 95% - but using the rule
would have lowered your maximum drawdown from
56% to just 20%. So once you adjust for volatility you
can say that you would have done better investing
guided by trend inflation expectations than not. The 10-
year expectation moved below its 200 day moving
average in April this year. And yet we have taken a
resolutely contrarian message from this signal. Dont
sell equities. China's pledge to maintain high GDP
growth rates by ploughing on with capacity enhancing
supply additions to its fixed capital formation, even at a
time when the still risk averse banking system in
Europe and America is failing to produce a consumer
boom in the West, is fast building global deflationary
pressure. That's the resounding message from the TIPS
market. And in a world of two way causality, that could
continue to prove immensely bullish. Why? Because the
Fed uses this criteria as its principal benchmark for
determining whether to taper or not.















So imagine the virtuous loop that runs through asset
prices today. The Fed begins QE to thwart neo-
mercantilism and capture more of its own domestic
expansion. The Chinese witness a shortfall in their GDP
growth rates as their overseas expansion moderates.
This robs them of the ability to loosen policy in the
West. They counter by embarking on more fixed capital
formation to maintain a floor on domestic GDP growth.
This adds to the global supply equation that drives
break-even inflation expectations lower and leads the
Fed to once more embark on yet looser monetary
conditions. It is a reflexive cycle that can drive mice to
be madder and madder. Or braver and braver. Depends
how you look at it. But either way, only a foolish
investor would stand in the way of this bull market. Itll
crash of course, just not for a while.

Want to make real money? Make it in Japan

What if I were to tell you that you could buy something
for $300k and it might be worth $5m in a couple of
years? Is that something you might be interested in?

Japan has never been very far away from my thoughts.
I've grown old as its economy and stock market have
1.5
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2.3
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US 10yr Breakeven Inflation
with 200 Day Moving Average
Sources: EAM, Bloomberg.
Gustav Fechner
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E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E
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6
Manager Commentary, December 2013
languished from the aftershocks of their equity price
bubble in the 1980s. My first year as an investment
analyst in Edinburgh was spent conducting research on
Japanese stocks in the year immediately after the
bubble had popped. I remember the denial on the part
of my superiors that the show had ended. Its hard to
accept you have luck not talent.

Later I remember being struck by how the Dow Jones
Industrial Average had broken its 1929 price high 25
years later in 1954. That really captured my
imagination. I don't know why. Perhaps even then it
was the notion of an economic life cycle savings
hypothesis. That people make consumption decisions
based on their current stage of life. That we have
roughly 25 years or so to accumulate savings and a
pension to see us through our less industrious later
years. It made sense to me that regardless of the stock
market bubble in the 1920s, 25 years should be
sufficient to take out a nominal price established so
long ago. I reasoned that even low rates of inflation
compound to quite a large number over so many years.
And that the nature of social democracies is that they
dislike prolonged hardship. If things get so bad then
sooner or later they are going to vote for politicians who
will address their concerns.

So I started looking around to see whether I could find
other asset classes that complied with this pattern.
Gold caught my attention. The price high of January
1980 struck me as being similar in magnitude to what
took place on Wall Street all those years previously.
Gold flew from its shackles of $35 an ounce in 1970 to
sell briefly for more than $800 in January 1980; and
then it crashed. But the nominal price high was taken
out 27 years later on the 28th December 2007. The
silver market had been cornered at the peak making its
price high that much more difficult to surmount. It
needed 31 years to re-establish the old price high. The
oil market took just 24 years to break the $40 handle
last seen in March 1980. Interesting isnt it?

I then became fascinated by the 7th of December 1941.
Yes it was the date of the attack on Pearl Harbour but it
also represented an incredibly rare occurrence: the
Dow Jones traded at its 50-year price moving average.
John Templeton bought his "penny" stocks and the rest
was history. This brings me to Japan. The TOPIX stock
price index has recently traded as low as its 50-year
moving average and better still, next December will
mark the 25th anniversary of its great price peak.

Maybe this doesnt mean anything. But it is our
contention that Japan's long spell in the sin bin has left
its society particularly vulnerable to the charms of a
radicalisation of monetary policy. We reckon that with
the pro-growth shocks of neo-mercantilism essentially
having run their course, Japan will struggle to produce
the incremental GDP necessary to service and repay its
gigantic sovereign debt load. This will provoke
inflationary price targeting by a politicised central bank
that should send Japanese stock prices heavenwards
once more. Im not eulogising about Abenomics and its
golden arrows here. Instead Im expressing a more
negative kind of bullishness: the fear of persistent
policy failure that leads to fiat money printing without
limit.






























Back in 2008, with world equity markets in turmoil, I
purchased a one-touch 40k Nikkei call option for which
we paid $300k. I could envisage the yen strengthening
substantially and triggering a corporate shock as
Japanese household names buckled under the duress of
currency appreciation. I also bought a lot of credit
protection. And sure enough, in 2011 and for the
majority of 2012 the yen strengthened. Japan recorded
its largest manufacturing bankruptcy and a number of
prominent household names, the giant electronic
businesses, saw the cost of insuring their debt sky-
rocket. For instance, Sharp rose from a spread of
around 100 in January 2012 to over 5,900 in October of
the same year. The Japan iTraxx Index for five-year
protection, however, only flared to 220 (from around
0
500
1000
1500
2000
2500
3000
TOPIX Total Return Index
With 50yr Moving Average
Sources: EAM, TSE and Bloomberg. TOPIX Total Return Index. Shows monthly averages.
?
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400
600
800
1000
1200
1400
1600
1800
2000
Gold (USD per Ounce)
With 50yr Moving Average
Sources: EAM, CRB and Bloomberg. Shows monthly averages.
27 Years
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7
Manager Commentary, December 2013
100 in 2010) and so our hypothesis that much of
corporate Japan would buckle under the weight of yen
strength proved unfounded.

That was a shame but nevertheless, this crisis-lite was
sufficient to produce the political intervention that we
had envisaged. The most senior policy makers at the
Bank of Japan were unceremoniously removed from
office and monetary policy was set, instead, very
loosely, propelling yen asset prices higher. The stock
market leapt by 60% on the news and the currency
weakened by 20%. And, as the chart below of the
Japanese five-year break-even inflation expectation
reveals, one should be long their stock market. We still
value the one-touch at our purchase price today, and
with the market approaching 16k and trending higher,
who is to say where it will trade in April 2018? If it
touches 40k, Ill get $5m.














Where will it all end?

Remarkably, the aftershocks of Japan's volte-face
seemed to catch American policy makers out. In May,
the Fed, convinced that its QE program had succeeded
in re-distributing global GDP away from China and
towards the US economy, began signalling its intent to
taper its easy money by autumn. However, with 10-year
Treasury rates having moved from 1.75% to 3% and its
fourth largest trading partner having devalued by 20%
since the previous November, the anticipated vigorous
domestic American growth never actually materialised;
it was captured instead by the new and even looser
monetary policy of Japan. Yet again the reflexive loop
had worked to sustain the monetary momentum that is
feeding global stock markets. And the not so all-
knowing Fed? It had to shock market expectations in
October by removing the immediacy of its tighter policy
and stock markets rebounded higher. Where will this
all end? Can it ever end?

There are multiple possible outcomes. The one markets
are most vulnerable too is the re-emergence of bullish
bankers. They could lend such that the consumer boom
in the US and Europe finally sparks and in doing so
provoke the Fed to finally tighten policy. That would
spook developed market equities but not as much as
you might think - they will have the palliative of the
stronger GDP growth. Emerging market equities are
closer to the edge of a bubble and could prove more
susceptible to a greater drawdown owing to the
fragilities of their debt fuelled economies. But for now,
the re-emergence of risk-seeking bankers fuelling a
lending boom in the West seems remote. We arent too
worried about it. In Europe for instance the banking
system has an estimated 2.6trn euros of deleveraging
(circa 30% of GDP) still to complete, having shed 3.5trn
euros already.

So we are happy to run a long developed market stock
position with a short hedge composed of emerging
market equity futures. We are running an unhedged
long in Japanese equities as our wild bullish card (we
have, of course, hedged the currency).

It seems then to us that the most likely outcome is that
America and Europe remain resilient without booming.
But with monetary policy set much too loose it is
inevitable that we will continue to witness mini-
economic cycles that convince investors that economies
are escaping stall speed and that policy rates are likely
to rise. This will scare markets and emerging markets
in particular - but it wont actually materialise: stronger
growth in one part of the world on the back of easier
policy will be countered by even looser policy elsewhere
(the much fabled "currency wars"). So market
expectations of tighter policy will always be rescinded
and emerging markets will recover rather than crash.
Developed markets just keep trending positively
against this background and might accelerate.
Remember what we said about 1928 and 1998 at the
beginning.

Just be long. Pretty much anything.

So heres how I understand things now that I am no
longer the last bear standing. You should buy equities if
you believe many European banks and their sovereign
paymasters are insolvent. You should buy shares if you
put a higher probability than your peers on the odds of
a European democracy rejecting the euro over the
course of the next few years. You should be long risk
assets if you believe China will have lowered its growth
rate from 7% to nearer 5% over the course of the next
two years. You should be long US equities if you are
worried about the failure of Washington to address its
fiscal deficits. And you should buy Japanese assets if
you fear that Abenomics will fail to restore the fortunes
of Japan (which it probably wont). Hey this is easy

-1
-0.5
0
0.5
1
1.5
2
Japan 5yr Breakeven Inflation
with 200 day moving average
Sources: EAM, Bloomberg.
E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E
E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E E
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8
Manager Commentary, December 2013
This document is being issued by Eclectica Asset Management LLP ("EAM"), which is authorised and regulated by the Financial Conduct
Authority and registered with the SEC as an investment adviser. This document is being issued by EAM. No representation, warranty or
undertaking, express or implied, is given as to the accuracy or completeness of, and no liability is accepted for, the information or opinions
contained in this document by any of EAM, any of the funds managed by EAM or their respective directors. This document does not constitute a
financial promotion or form part of any offer to issue or sell, or any solicitation of any offer to subscribe or purchase, any securities. Recipients of
this document who intend to apply for securities are reminded that any such application may be made solely on the basis of the information and
opinions contained in the relevant prospectus which may be different from the information and opinions contained in this document. Past
performance is no indication of future results. All charts are sourced from Eclectica Asset Management LLP. 2005-13 Eclectica Asset
Management LLP; Registration No. OC312442; registered office at 6 Salem Road, London, W2 4BU.
And then it crashed

I have not completely lost my senses of course.
Eclectica remain strong believers in the most powerful
force in the universe - compounding positive returns -
and avoiding large losses is crucial to achieving this.

We have built a reputation for getting the calls right in
the difficult space that is macro investing, which has
served us and our clients well during both trending bull
markets and times of crisis. Today, of course, the
market is "golden" which is to say that the 50 day price
trend is above the 200 day. But remember that during
those forays into the "dead-zone", years like 2008 and
2011 when equity markets crashed, Eclectica performed
handsomely. I like to think therefore that I own an
alpha crisis management franchise that has rewarded
our investors at times of stock market stress.

This commitment remains as resolute as at any time
over the last 11 years that I have managed the Fund. But
what if I could produce a consistent alpha return profile
with the in-built crisis hedge to your wealth... is that
something you might be interested in?