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Dear Colleagues,

I have been meaning to exchange my views with you for quite some time, but so much has been written, said and broadcasted on the unfolding events, that I stood idle and preferred to firm my view before sharing some ideas, on which I greatly welcome your feedback.

I will not expand in great depth the considerations that went into my analysis, doing so would mean writing a long and possibly boring essay, which many of you have no time to read nor me to write.

Arguably unoriginally, I believe that we find ourselves in an environment where assets are overvalued. This is a consequence of the extensive reflation that has been engineered by central banks and policy makers globally over the last 10 years.

This overvaluation occurs in a period of widespread excess capacity that will have to be worked trough. Unemployment will not abate in the western world.

It comes also in a period where unprecedented debt levels plague western economies at the individual, corporate and sovereign level.

True, some corporations have very strong balance sheets and order books, but these are just some.

The coming years will see a pick-up in defaults. Signs of corporate stress are appearing, many companies managed to refinance only thanks to the great bond bull market of the last 3 years: A phenomenon driven by the search for yield in disregard of credit fundamentals.

This overvaluation also coincides with an impaired global banking system, garnished with all the systemic implications that this status bears; Particularly so in an environment where regulators and lawmakers seemingly react in order to increase uncertainty, complicate things and obviously increase their grip.

It also looms in a period where the ability of policy makers to respond effectively is limited, and where Wall Street & Co. have either developed a credo, or are trying to convince us about the contrary. Where and which policy makers have earned such a demonstrable track record?

More to the point, if the sustainability of valuations depends on the actions of policy makers, then may the force be with us!

The thesis of strong growth in the emerging and developing markets is real and strong, but due to the social, political and structural characteristic of these economies, growth will not be linear, it will add volatility. Until strong internal demand develops, social security systems, functioning courts of law and human rights establish themselves in the day to day lives of these economies, they will be forcefully impacted by the unwinding of the western credit super-cycle and vulnerable to other exogenous events.

This month S&P took a brave step by timidly pointing to the unsustainable conditions of the balance sheet of the US government, which promptly retaliated with an investigation on the agency. In the meantime the financial world was busy pointing at the euro as the cause of all evils, the FX market still seems to disagree.

During periods of stress human beings notoriously revert to behavioural patterns that have proved successful in the past. One pattern known as flight to quality is now very observable; Herds are looking for a safe haven in US treasuries…

The most widely repeated quote amongst financial commentators this month was Churchill’s; after having tried everything else, you can trust Americans to do the right thing! I think they are still early in the “everything else” phase.

Monetary systems are also being questioned; the status (role) of paper money as a means of trade will not be put in doubt, but the one of store of value is being vigorously challenged.

Possibly few of us will disagree on the notion that a period of slow growth looms ahead of us: In times of low growth the ability to repay debt diminishes. Some will disagree and deny the grave implications of this last observation.

Of course a buyer of last resort with deep pockets may present himself with QE7,8 and 9 and kick the can one more yard down the road. On the other hand debtor countries may default, restructure and devalue; this hypothesis includes the US.

When all this is going to unravel and how, is not given for us to know, what we know is that at the moment we are not paid sufficiently by the markets to own assets. Political intervention risk also denies many short trades.

We live in interesting times, faced with challenges that our generation of investors encounters for the first time. Our fiduciary duty and our business acumen should point us to lengthening decision making horizons and to an unprecedented alignment of interests with our clients, to preserve their wealth and our revenue streams.

The coming years will be rich in opportunity, patient and prudent managers which will succeed to preserve their calm, their independence of thought and keep ample dry powder, will render a good service to their clients and collect interesting returns, in a structurally different playground.

Despite some temporary upside risk, I say good luck to market timers and bottom pickers and I advice to keep out and watch events unfold.

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