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Feras Al-Chalabi

Partner | Portfolio Manager

Current Outlook

Central authorities showed their hand in July, with the Stress Tests a minor victory for the technocrats. It is now clear that, for policy makers, fiscal austerity trumps financial reform. The patient is too sick to survive a bout of belt tightening without medication. Therefore rates will remain low and financial regulation will remain light. This is very good news for European equities. To this end, Basel III has been crucial in removing a significant tail risk to this recovery - that of paralyses in the banking system. Basel III, once touted as the poster child for the new world of financial vigilance, has been diluted to such an extent that even the weakest bank has space to breathe and maybe even to lend again.

The implications are significant for the equity market bull case. The discount attached to regulatory pugilism can now dissipate. With the removal of this overhang markets should continue to re-rate and credit markets can function more consistently. Whilst supportive, my central bull case remains one of valuation, with cash yielding zero, equities offer phenomenal carry and the IRR on share buybacks is highly accretive. In the land of low returns compounding is king.

The market narrative over the last six months has been one of slowing growth. With last year's stimulus packages ended and inventory re-stocking largely done, G7 economies are migrating towards a more torporous growth trajectory. Markets tend to stutter as rates of economic growth decelerate. Hence the sideways indices we have seen to date.

However to my mind the market continues to ignore the perpetuity characteristic of the corporate cash flows in which the fund is invested. This provides the opportunity to collect exceptional long duration assets at exceptionally cheap prices - the luxury goods sector, highlighted in previous letters, is as good an example of this. Least we forget global GDP still stands at +4.5%. The positioning of the fund has remained consistent since the start of the year with a positive bias towards undervalued growth and towards franchises who exit this recession stronger, fitter and with expanded market share. I remain bullish.

30th July 2010

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