MAXIN GLOBAL FUND - USD is a Long / Short Directional hedge Fund incorporated in Luxembourg. It started trading on February,22 2022 and replaces MAXIN ADVISORS' MODEL PORTFOLIO which has been trading since January 1st 2014.
Hedging Our Portfolio In the Midst of a Financial Earthquake
We shall start this article by reproducing an article published on Bloomberg LP today, March 21st 2023, for the record.
“Some of the world’s biggest investors are looking beyond interest-rate hikes, bank failures and the threat of recession to one of the greatest fears of all money managers — missing out on the next big rally. For trillion-dollar investment groups Franklin Templeton, Invesco and JPMorgan Asset Management, the accelerating financial instability seen in Silicon Valley Bank, Credit Suisse Group AG and First Republic Bank are cues to speed up preparations. They’re convinced that an impending slowdown in the US and elsewhere will prompt central banks to switch back to looser policy, triggering a renewed surge higher in equity markets.”
To us, this is one of the most worrying signals when it comes to Western equity markets, the oblivion of some of the largest investors in the world in the face of the deepest, widest and most global financial crisis that is unfolding right before their eyes and their Fear of Missing Out.
In its purest meaning, oblivion is the state of being unaware or unconscious of what is happening around oneself, and its is truly scary to see how greed makes some money managers discard the consequences of what is proving to be the greatest financial crisis in at least a century.
We had been highlighting the risks of a banking crisis in the US a few months ago, but in truth, we thought it would happen later in the year. We have been taken by surprise at how fast it unfolded.
The events of the past week with three major US financial institutions going belly up because of a run of depositors on their banks were a major tremor for the financial markets, actually the worst that could happen in economies that rely on their banking system to function properly. When confidence of depositors is blown out of the window, the whole system is likely to implode.
On Friday, we thought we had reached a temporary selling climax that would open the way for a lower high bounce into April.
The events of the past weekend, with Switzerland, a nation built on the rule of Law, negating the fundamental principle of shareholder’s rights to force the sale of Credit Suisse to UBS at a deeply discounted value, put the last nail in the coffin of financial stability.
Today, regardless of whether this 100 points rally in the SP500 could unfold, we are no longer prepared to trade it and have re-instated our shorts to take our exposure to Neutral, staying structurally long China and short European and US equity markets, as the risks are far too high to gamble.
Panic is setting-in at the helm
To fathom the depth of the crisis, suffice to observe the drastic, uncommon, wide-ranging and potentially hugely costly measures taken on both sides of the Atlantic to calm the panic of depositors and restore confidence.
Last week, in less than 48 hours
. The FDIC extends the blanket of its insurance to the ENTIRETY of the 17.6 Trillion US dollars of deposits in the US banking system, backed by the US Treasury and the FED. This has NEVER happened in the history of the US financial system and is actually way beyond the means of the three bodies concerned.
. The FED provides a new open-ended facility to the banking system and accepts long dated binds as collateral TAKEN AT FACE VALUE, potentially transferring the unrealised losses of the banking system to the Central Bank with no real mechanism of recourse, and, in particular, no real time frame for a normalisation that could take years considering the duration of of the said bond portfolios.
. US President Joe BIDEN addresses the Nation before the opening of the markets of Friday morning, assuring US citizens that their deposits are safe and guaranteed by the State and that taxpayers will NOT bear the costs of the stabilisation mechanisms. This an extremely unusual step, with deep financial commitments made publicly by a sitting President without any backing, debate or vote from the Senate and / or the House of Representatives.
This is happening at a time where the US statutory Federal debt ceiling has already been blown out putting the US Treasury in the highly dangerous position of potentially defaulting on its obligations even before the crisis.
It remains to be seen how the costs associated with the necessary bailing out of regional and niche banks could happen without ultimate costs, or simply temporary outlays for the US Treasury.
. It is also happening at a time where the bloated FED’s balance sheet has EXACTLY the same problem as the banking system and has barely decreased from its 2021 peak. In fact, since the implementation of the new facility, it started racing again.already as smaller banks are rushing to boast their liquidity ratios.
As can be seen above, since 2008, the Fed has accumulated USD 8.6 Trillion of bonds that it acquired over a decade where bond yields were at barely 0.5 % and with extended durations. If the banking system is living with close to USD 1 Trillion of unrealised losses, the FED itself is sitting on US$ 1.29 Trillion of unrealised losses, and has already become a loss leader for the US treasury and US taxpayer with the limited implementation of the quantitative tightening program since March 2022.
US$ 8.6 Trillion already represents 37 % of the USD 23.3 Trillion US GDP, an unmanageable level by any stretch of financial engineering and the FED may be cramped for years if not a decade to come with those liabilities.
. To save yet another regional bank, some major US banks teamed up to pour their own liquidates into deposits with this particular bank, creating a dangerous precedent in terms of transmission mechanism of the systemic risk, potentially draining the liquidity of major banks to service depositors of smaller banks.
All these extraordinary measures were taken in the short space of a single week, testifying of the panic that has set in at the highest levels of the US Governing bodies.
The Crisis is systemic and global by nature
As testified by the panicky fall in European bank shares and the run on CREDIT SUISSE in Switzerland, the financial earthquake is a generalised and global systemic crisis that affects not only a few banks in the Us, but actually the entirety of te US banking system as well as its European and Japanese counterparts for exactly the same reasons.
The issue this time around has nothin g to do with a few over-leveraged banks that overextend themselves in sub-primes and Mortage backed securities as was the case in 2008, but it comes from the very nature of the banking business that uses short term deposits to fund investments in long term assets such as corporate loans, that are illiquid by nature, and into long dated Government bonds that normally provide the liquidity element of their balance sheets.
The problem here is that US banks have spent the past ten years investing in long dated bonds yielding 0.5 %, while they now trade at between 3.5 and 5 %, and in Europe the situation is even worse as banks ahem accumulated long dated bonds with zero or negative nominal yields.
A 10-years German Government bond acquired in 2021 at 100 % today trades at 85 %, leaving its holders with a 15 % unrealised loss on its books unless it keeps it until 2032 where it will hopefully be redeemed at 100 %.
European Banks have not, for now, seen runs from depositors, but the risk and consequences are exactly the same. What makes European banks much safer is that contrary to the US, the banking system is concentrated in less than a 100 extremely large banks, whereas in the US, there are 5’000 small to mid-sized banks and another 5’000 specialised credit unions that have collected almost half of the USD 17.6 Trillion of US deposits.
The run on CREDIT SUISSE, despite its high liquidity and the extension of a CHF 50 Billion lifeline by the Swiss National Bank last Thursday should have been sufficient to appease the panic. But coming on the heels of the US banking crisis, way more than depositors withdrawing a fraction of te USD 600 Billion of assets form Credit Suisse, the danger came form other financial institutions cutting their counterparts lines to the Swiss lender, withdrawing the essence of its day-to-day operations.
The way the CREDIT SUISSE situation has been handled over the week-end is a RESOUNDING ALAM BELL that testifies of the panic that has reached the other side of the Atlantic as well.
For Switzerland, a country where the rule of Law is the founding principle of society, where every pension fund and almost every citizen owns shares in the two largest banks, to negate the fundamental rights of shareholders, and even worse, of higher ranking bond holders, is a step that has never occurred in the past, not even in the USD 60 Billion bail-out of UBS in 2009.
Had it not been under international pressure, Switzerland would have probably engineered a partial nationalisation of CREDIT SUISSE, taking a 40 to 60 % stake in the bank through an share capital increase and one it through the proper legislative and corporate processes.
The fear of global contagion and the need to sort the problem out before the opening of the markets on Monday led to the most damaging solution, with significant consequences for the credibility of Switzerland on one hand, and for the Swiss taxpayers on the other hand. To achieved the deal, the Swiss Government took, under its sole decisions, commitments that potentially amount to CHF 209 billion, or close to CHF 13’000 per Swiss citizen, without the approval of the legislative body, of the Cantons or for the citizens themselves through their normal popular voting process.
It may have been the best possible solution within the extremely short time frame considered, but it will have lasting consequences.
The aftermath tremors of the Financial earthquake have not yet been seen in equity markets for now, but are already visible in the dislocations of the bond and credit markets.
In the US, the extreme volatility of short rem yields have already led to major casualties in the credit markets with significant hedge funds blowing up and massive losses for some leveraged hedge funds or even pension funds.
In Europe, the CREDIT SUISSE situation has probably killed the market for AT1 – Additional Tier 1 Capital – and the “COCO” bond market, that were a major source of liquidity for the European banking system.
On a more general note, banks are now polarised by their liquidity ratios, meaning that they will restrain credits considerably in the months to come, avoiding risk, long term commitments and decreasing the financing of the economy.
This in turn, will act as a significant dampener on economic activity, leading us to bring forward our time horizon for the sharp economic contraction that we were expecting for the second part of the year.
The issue at the core of the problem has NOT been solved.
In the US, now that confidence has been dented, the numerous small and mid-sized banks will see their activities cramped and remain at risk of further bank runs, despite the availability of ample.liquidity. Depositors have been scared and my choose to move their assets to large banks, a phenomenon that has already started, and that can potentially led to many other institutions to close shop.
Furthermore, even at larger banks, large depositors may well decide too shift their assets from bank deposits to short term Government bills, currently yielding attractive 4.7 % returns with far less risks and higher liquidity.
If only 30 % of the 17.6 Trillion bank deposits are moved into Short Term Government Bills, that represents USD 5.3 Trillion of liquidity that disappears from the banking system, which translates into USD 50 Trillion of capacity to provide credits that disappears overnight, further compounding the economic contraction.
Furthermore, it may force banks to either sell their bond portfolios and book major losses, or transfer yet another USD 5 Trillion of money losing bonds to the FED’s balance sheet , further undermining the financial status of the US Government.
In addition, in a globalised banking system, the ELEPHANT IN THE ROOM is actually the USD 40 to 50 Trillion of outstanding OFF BALANCE SHEET exposure of banks to one another which could suddenly be affected if the above withdraws of liquidity were to happen.
Finally, the next shoe to drop for the banking system is the looming real estate crisis that has already started to unfold and will soon hit the banks profitability and liquidity through surging default rates and delayed payments by homeowners, in exactly the way the 2008 Great Financial crisis unfolded. Real Estate related loans represent close to 3 Trillion, or 10 % of the US banking sector assets and are one of the highest margin business with Credit cards.
In sum, brushing off the risks and the aftermath tremors of the current financial earthquake in. the hope that a new equity rally will develop from already extreme valuations seems to us rather light.
We just witnessed the mots drastic and unorthodox, if not plainly illegal, measures taken by the highest bodies of power to contain the loss of confidence and potential contagion.
The issue at the core of the problem has NOT been solved and will hang over the entire banking system for as long as inflation is not tamed and Bond yields do not come down sharply soon.
The only way for both to happen is a major economic contraction ahead and the travails of the banking system are bound to bring forward and accelerate the economic downturn.
Economic contractions are extremely negative for corporate earnings, especially in an environment of high inflation and high interest rates.
Bond markets, Gold and Cryptos have already started to take te measure of the crisis, The risks in equities is at its highest…
As a result, we are not willing to take the risks of a sudden and brutal re-pricing of equities and have re-instated our short positions strategically.
We may see a 100 to 150 points rally in the SP500 into the next few weeks, but the 2.5 % upside is clearly not worth the risks.
We are extremely worried about Europe where monetary policy is still way too accommodative and inflation could rise again.
The FED should rise rates by 0.25 % tomorrow or stay pat. But doing so could send bond yields rising, further undermining equities.
We only feel safe in China that has none of those issues.
New Asset Allocation
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