Having said that, one pervasive post-bubble dynamic that also seems to hang around Japan‚s neck is that of deflation. It took a long time to understand this (and perhaps even longer to do something about it). But one impact of the post bubble has been generations long upwards move in the Japanese unemployment rate, shown below. So where does this take us then? For starters, those who already now look for a substantial improvement in the economic outlook (i.e. a ‚recovery‚Äù) in the US are likely to be disappointed for some time to come. The US, and the Eurozone will have to learn to live with some structural issues ‚ such as higher unemployment ‚ for the foreseeable future. Asian (and we include China) growth will become increasingly inwardly focused, and this is where the true Asian miracle will take place ‚ when they become more consumer oriented economies rather than just export led ones.

Ben Bernanke‚s recent ‚unusually uncertain‚Äù outlook on the US economic prospects should then be seen in this light. The market, while already discounting a potential double-dip scenario, took fright at this and we have seen US Treasuries move rapidly lower over the past 2 weeks in particular. Yes, it‚s hard to believe that the US 10 year yield was a shade short of 4% in April! By July it had reached 3% and today we see it at 2.60%. Talk about a bull market – more like a fear market! We have spoken in the past of imagining what the world would look like if we had 3 Japans ‚ Japan, the US and the Eurozone. This is most certainly a bond-friendly environment if ever, but in a deleveraging world, be careful of extrapolating the trends too far. The next big obstacle will be the deleveraging in the public sector. It is not going to be easy‚Ķ

So what then DO we extrapolate from this scenario? Lower inflation for one ‚ for now. And continued interest in any high yield currencies, with concomitant currency inflows of course. Despite all the doomsayers predicting the imminent demise of the Rand strength, it continues to hold. For one, we do not necessarily advocate that the Rand should continue to strengthen, but rather that the underpin for the current robustness remains. It would be foolish therefore for the SARB to try to change that trend. It is in their interest to keep things as stable as possible. Were we to have the inevitable phase of weakness, there will be the usual analysts saying ‚I told you so‚Ķ‚Äù

So what has happened then in local markets over the past week? Well, did you hear the screeching of tyres or not? That was the bond market car pulling away as the long end in particular dropped away as all resistance crumbled ‚ albeit on fairly light volumes. But the lack of any sellers should be instructive anyway. 2v10 continues to grind away ‚ now falling below 110 bp‚s for the first time since November 2009. So while the market continues to price in substantial risk of a rate cut ‚ 1×4 FRA now at 6.27% – and hence not much move expected further from the short end for the time being, the long end still looks attractive ‚ both from a local as well as global perspective.

The next couple of weeks should be both interesting and instructive. Will offshore flows continue to drive down local yields and keep the Rand strong ‚ and if they do, how low can they go? Will the SARB follow the call of the markets or the analysts ‚ cut or hold? Separating what we think should happen, what we want to happen from what will happen is going to be a tough task going forward.

Close to generational high unemployment rates ‚ The Deflationary Economy

Arno Lawrenz

Albert Botha

Atlantic Asset Management

Willem Swiegers ‚ Masters Student in Economics (Stellenbosch)

Stephen Reid ‚ Master Student in Statistics (Stellenbosch)

Odwa Sihlobo ‚ Final Year Business Science in Actuarial Science (UCT)

Ilse Meier ‚ Honours Student in Management Accounting (Stellenbosch)

Congratulations to all of them. I am looking forward to working with all of you. I hope you enjoy the month at Atlantic

Albert

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Modelling

No, Atlantic has not decided to add another business line employing Minki and Gisele, regardless of how much fun that could potentially be – I am speaking about modelling in the financial sense.

I think that there is a lot of confusion amongst the investing public as to what exactly modelling entails. While looking for a satisfactory definition online, I stumbled upon what may be part of the problem. Modelling has a wide variety of different meanings. It ranges from the everyday fashion model, to the constructed physical model, through model behaviour, the conceptual model, business model, computer model, data model, through several others, and finally the financial model.

When I refer to modelling, it is the ‚creation of a theoretical construct that represents a process by which a set of variables and a set of logic and/or quantitative relationships interact to aid in forecasting‚Äù ‚ which would be akin to saying that the ocean is wet. While it is strictly true, it does not convey the true scope or scale of the ocean in any meaningful sense ‚ so let‚s try again………….

Modelling is a process whereby people (mathematicians, economists, fund managers and many others) try to make sense of the past, present and future. They try to discover the ‚true‚Äù nature of things past and present (inasmuch such a thing can be said to exist), or try to lift the veil and peek into the uncertain future. The best way to describe this would be to use an example.

From the equity universe, an example would be to model the profit of a company. When one looks at a company‚s balance sheet and income statement history, certain trends become apparent. A growth rate in assets, profit margin, leverage and dividends ‚ this combined knowledge of the internal management decisions, knowledge of the industry and other companies therein along with an economic forecast can be used to estimate the next couple of years‚ profit and dividends ‚ from there the share price follows. This is a financial model.

There are various models in the marketplace and they often affect your life, regardless of whether you are aware of their existence. One of the most important is the inflation model, with the most prominent and influential being the one employed by the South African Reserve Bank (SARB). The SARB uses this model to forecast inflation 36 months into the future and they use the outputs from this model to adjust the official short term interest rates.

Often they use the output from the inflation model as an input into another famous model, called the Taylor Rule to adjust interest rates in the economy.

Models are everywhere and have a much larger influence on people‚s lives than they realise. The Treasury models tax income and government department spend, companies model their strategies and even things like traffic flow and congestion is modelled.

The problem and common criticism with modelling is how often their projections turn out to be incorrect, and while the observation is accurate, the analysis is invalid. Comparing the outputs of models with occurred reality is an invalid test and an unreasonable requirement ‚ one cannot expect any model to forecast the uncertain future with 100% accuracy ‚ or even 90% accuracy. The test of a model is whether the outputs from it, improves the prediction ability of the practitioner relative to what it would have been without its help. If it is no better than just using your gut, experience and intuition, then it is no use at all.

All models are, is a tool to help analyse the future ‚ no more, no less. Its‚ analysis is not sacrosanct and it should never be applied uncritically. Some of the biggest financial mistakes in history have been made when people used models as so-called ‚black boxes‚Äù, not understanding the inputs, outputs and internal mechanisms. It needs a human at the end ‚ or at least it should. If that human was Minki or Gisele, so much the better!

Albert Botha

Atlantic Asset Management

Reading about the world’s most talented investors is both exciting and interesting. I am sure you read investment books to gain insight into how these brilliant minds operate and like me, hope that you pick up an investment tip that may help you in managing your own personal portfolio.

I particularly enjoy reading Malcolm Gladwell’s books. He is not an investment manager, but in his most recent book called ‘What The Dog Saw’ he includes a chapter entitled Blowing Up. It’s an article he wrote in April 2002 for the New Yorker. It’s about two of the great names in the investment world being Victor Niederhoffer and Nassim Taleb. It’s a great read and indicates just how different investment styles can be. The link to the artcile in question can be found in our Weekly Commentary or here, and you can find the link to his book here.

Murray Anderson

Check out What The Dog Saw on Kalahari.net

It is an exceptional read and I recommend you all take the time to do so…..

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Will it be with fondness that we one day look back at this time of crisis and remember how we all struggled to make sense of what was happening at the time? And yet, with the benefit of that hindsight, we will then know and see and comprehend the true nature of the crisis. For surely a crisis understood will be a lesson learned? If only that would be true, then we would not have to resort to that time-honoured quote ascribed to Mark Twain of ‚history may not repeat itself, but it rhymes a lot.‚Äù What he did in fact write was: ‚It is not worthwhile to try to keep history from repeating itself, for man’s character will always make the preventing of the repetitions impossible.” (Mark Twain in Eruption: Hitherto Unpublished Pages About Men and Events).

Why is it that we struggle to comprehend, and yet, for sure, we have seen similar crises before? Similar? What is the comparison here? The Great Depression? The Savings & Loan crisis in the 1980‚s? The Asian crisis of 1997-98? These are just a handful at the top of mind. We could go on and on, and yet, there lies the point ‚ such crises come and go, we have seen this movie before. We should not deny that, as Kenneth Rogoff and Carmen Reinhart so pointedly say: ‚‚Ķserial default on external debt ‚ that is, repeated sovereign default ‚ is the norm throughout every region in the world, including Asia and Europe.‚Äù See the chart from Rogoff and Reinhart‚s study below for a reminder of how common crises and defaults are:

So what then is at the core of such crises if we have not our history lesson learned? The deep dirty secret to the life of a crisis lies in denial. For it is in denial that anything is wrong that allows a market or economic dynamic to become disturbed to the point that a disequilibrium is reached. Malcolm Gladwell wrote eloquently of this disequilibrium in his best-selling book, ‚The Tipping Point‚Äù:

The Tipping Point , he says , is “the moment of critical mass , the threshold , the boiling point where the unexpected becomes expected , where radical change is more than possibility but already a certainty. It is when certain ideas, products, messages or behaviours suddenly turn into something of an epidemic, where everyone or a majority of the people all of a sudden gets caught up in it without warning. We know right away that a certain trend has become an epidemic: its spread demonstrates contagious behaviour, little changes had affected its growth tremendously, and it
happened fast .”

Does this sound familiar ‚ it sure does to the Greeks. So in examining the nature of this current crisis we need to ask where the denial lies? Does it lie in the life of the worker who gets up each morning to go and earn their living and goes about their daily life of consumption undisturbed by the market chaos? Does it lie in the corporate boardrooms, where executives go on with their optimistic economic forecasts to determine how best to grow their profits? Does it lie in the backrooms of parliamentary precincts where politicians make their policy choices trying their best to ensure they have a seat at the next election? The answer, sadly, lies in the collective. It is in the collective nature of society that the denial exists. We are all to blame. We should all be pleading mea culpa, and acknowledge that the crisis stems from a collective failure to address imbalances in our way of life, in our business models, and in our policy choices.

So if we were to examine the most recent chapter in this crisis ‚ namely that of the Greek tragedy, it becomes apparent how strong the denial pattern is. All and sundry seemingly recognise that a serious imbalance exists within the Greek economy : It is overladen with debt, this a result of past political policy choices, a population who cared nought for their civic duty of paying taxes, and corporates who enjoyed the fantasy of an extremely low cost of capital. Yet despite this, all deny their role in arriving at the point they are at today. This continues in the reaction to the austerity measures introduced there in order to finally address the crisis ‚ they are resisted by force and massive social unrest. It is denial of the highest form.

But wait, let us not stop there. For this crisis has also engulfed other, less-peripheral European sovereign states, such as Portugal, Spain, Italy and Ireland. There too, similar patterns of denial exist. So then, if crises by nature come and go, we may ask how does this crisis unfold further? The answer is a painful truth. It is when, having exhausted all avenues of denial, of delaying tactics, and of procrastination, that finally, the bitter medicine is swallowed, the pain and humiliation is accepted, and the policy choices (on an individual, corporate and political basis) of the past are rolled back, a new tipping point is reached and the pendulum can begin to swing the other way.

In the Eurozone over the past few weeks we have the biggest or rather the most expensive act of denial we have ever seen. This lies in the massive EUR750bn bailout package announced recently to provide emergency funding for Greece and other Eurozone countries whose debt dynamics have become too large to carry.

The denial lies at two belief levels: Firstly, the belief that by providing access to cheap funding, they will help Greece and the other severely debt-compromised sovereigns; and secondly, the belief that the crisis is singularly a debt or solvency crisis. These two beliefs are wrong: Firstly, making the cost of capital cheaper to a country whose disequilibrium lies in precisely the inappropriate use of debt capital is like giving free sweets to a diabetic. Secondly, what we are dealing with here is a currency crisis. There is no acknowledgement of this. More denial. This crisis would end far sooner if it were recognised that the burden that Europe carries is one that has been carried before, and solved before.

Typically, as Rogoff and Reinhart show in their study ‚This Time is Different‚Äù, a default by a debt-laden sovereign is usually followed by a currency devaluation, allowing for the levers of the economy to begin their recovery work. In particular, a devalued currency allows for the cost of manufactured goods to become internationally more competitive thus providing the basis of an export-led growth recovery. As we know, Greece does not have this luxury of being able to devalue its currency, and therein lies the issue of this being a currency crisis, for it is not only Greece that suffers, but a number of European countries.

The initial painful medicine that would work, and has been shown to work repeatedly in the past, is denied. The result: More pain in the future. One can deny the inevitable only for so long. As it is, the current Euro bailout creates more debt, and calls for growth-reducing austerity measures. As such the debt to GDP ratio increases, not decreases! Postponing the inevitable adjustment (through an ultimate currency revaluation or through actual default) into the future only makes the future more unpalatable. Throw in Europe‚s demographic pitfalls of an aging population and one begins to understand how inevitable the painful adjustment will be on even smaller taxbase. Just in case we believe that Europe alone will have to deal with its denial, we should also point out that Japan most likely faces an even worse situation. Its day of reckoning will come, as sure as the sun rises every morning.

In looking forward, and in understanding the nature of man, what then are we likely to see going forward?

• An increase in coalition politics, (already witnessed now in the UK), as unpalatable and unavoidable policy choices mean that politicians are forced to stand together even when such coalitions may in the past have been anathema. It will be difficult for politicians to be elected on the basis of a painful prescriptive economic policy.
• This will in turn lead to heightened social unrest ‚ especially in countries where the domestic population is not necessarily a homogenous one.
• This will, in turn force politician‚s hands to increase the social safety net at precisely a time when austerity measures to bring budgets into balance will mean increasing demand for such social safety. This makes balancing the budget even harder.
• This will cause policy response to fall into the necessity of increasing taxes in order to sustain revenue outlays. This of course provides a further negative feedback loop into the lot of the man in the street.
• A restructuring of the Eurozone. This will facilitate the currency adjustment that defaulting countries will require in order to escape the debt trap.
• An attempt to keep currencies weak against major trading partners by keeping short term interest rates as low as possible, creating a race to the bottom effect.
• Rising long bond yields as rising risk of defaults requires increased credit risk premium and rising long term inflation prospects (from currency devaluations and increased money supply) feed into increases in the inflation risk premium.
• A sharp rise in the price of gold and silver, as fiat money currencies finally show their true (lack of) colour.

Will it be with fondness that we one day look back at this time of crisis and remember how we all struggled to make sense of what was happening at the time? And yet, with the benefit of that hindsight, we will then know and see and comprehend the true nature of the crisis. For surely a crisis understood will be a lesson learned? If only that would be true, then we would not have to resort to that time-honoured quote ascribed to Mark Twain of ‚history may not repeat itself, but it rhymes a lot.‚Äù What he did in fact write was: ‚It is not worthwhile to try to keep history from repeating itself, for man’s character will always make the preventing of the repetitions impossible.” (Mark Twain in Eruption: Hitherto Unpublished Pages About Men and Events)…

Read more here.

Report to: Managing Director (MD) and Chief Investment Officer (CIO)

Overview: A growing specialist investment management company is looking for an intelligent, self-motivated and highly computer literate individual who will bring order to the highly diverse nature of the day-to-day office activities. This is about being more than just the team’s personal assistant. This position requires someone who is prepared to roll up their sleeves, use their initiative and get things done. This is not a job about having the right experience, but about having the right skills.

Although this job is within a small team, it is highly diverse, requiring interfacing with IT specialists, technology suppliers, accountants, liaising with external investment professionals as well as all the other day to day activities that are required for the efficient functioning of an office, including the running of an investment team‚s diaries and making all the necessary travel arrangements where necessary. The ability to perform minor miracles on a day to day basis would be highly valued! Making sure that everything runs smoothly is your job. But we want it to be more than just a job, but a passion! So, if you know what an HDMI cable and a USB port is, know how to answer a phone professionally and are willing to work hard to be part of a successful and growing team, then maybe you should give us a call. If you have a spunky and confident personality that might just give you an extra edge!

We offer a competitive salary and usual benefits including a 3 month sabbatical for every 5 years of employment to the right person with the necessary skills.

Minimum Requirements
- Highly computer literate, including advanced understanding and use of MS Office.
- Relevant academic studies (degree/diploma)

Inherent Characteristics
- Self motivated and disciplined.
- Innovative .
- Results oriented.
- Ability and willingness to learn continuously.
- Self confident .

Key Performance Areas and Responsibilities
- Develop and execute office processes.
- Procurement & supplier management.
-Website management and IT supplier liaison
- Marketing material development and publishing
- General office administrative functions
- Office maintenance and upkeep

Please contact Arno Lawrenz at :
021-9138942 or 0798768001
alawrenz@atlanticam.com

***Position Filled***

http://www.tradingurus.com/index2.php?option=com_content&do_pdf=1&id=18411

Internships

On another point we are looking for a couple of interns over the June break to help on a project we want to complete.

The first will be an Honours or Master Student in Statistics. The second a Computer Science Major with a solid background in VBA and Excel – the last, an economics/econometrics major also at Honours level or above.

The project will involve a good deal of modelling and programming and preference will be given to people that have accommodation and transport readily available in Cape Town.

If you are one of these people or you know someone who is and you are available from 1 ‚ 30 June, please get in contact with us. Send us a CV and motivation and we will consider your application.

Essays

On a similar note, we are in the process of launching an essay competition within the next couple of weeks. The topic will be pretty general and we encourage students from all backgrounds to participate. More complete details will follow, but so far the following is important.

You must be a current, final year graduate or post-grad student at a higher education facility in South Africa. The essay length must be between 1000-2000 words. And some of the best essays will be published by both ourselves and possibly some other publications. There will also be cash prizes………..

To get in contact with us regarding either of these issues, send a mail to info@atlanticam.com

I hope to hear from you all soon.

Albert Botha

Atlantic Asset Management

On our recent round of presentations Arno Lawrenz used an excerpt from a book ‚The Value of Nothing‚Äù by Raj Patel to illustrate that it is not only Joe Soap and the average man or woman in the street that makes faulty assumptions about the world in formulating their expectations for future investment returns. Even the most highly respected financial practitioners make serious error of judgement. In this case it was Allan Greenspan and the US Federal Reserve whose assumptions about the banking system‚s soundness led to the death of many banks around the world and the effects continue to reverberate in financial markets. See the excerpt that Arno used below. Arno‚s warning is that by using the most recent 20 year period as our reference for our future expectations will be a dangerous path to tread for all of us as investment managers and investment advisers. This book is invaluable in helping one to understand how easily our views are distorted, and how unfettered free market economics is not the system it is made out to be.

At the end of 2009, Greenspan was summoned to the U.S. Congress to testify about the financial crisis. His tenure at the Fed had been long and lauded, and Congress wanted to know what had gone wrong. As he began to read his testimony, Greenspan looked exhausted, his skin jowly and sagging, as if the vigor that once kept him taut had all been spent. But he came out swinging. In the first round, he took aim at the information he’s been working with. If only the input had been right, the economic models would have worked, and the predictions would have been better. In his words,

a Nobel Prize was awarded for the discovery of the pricing model that underpins much of the advance in derivatives markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year because the data inputted into the risk management models generally covered only the past two decades, a period of euphoria. Had instead the models been fitted more appropriately to historic periods of stress, capital requirements would have been much higher and the financial world would be in far better shape today, in my judgment.

This is a garbage-in-garbage-out argument: The model worked just fine, but the assumptions about risk and data, based only on the good times past, were faulty and so the output was correspondingly wrong.

Check out The Value of Nothing on Kalahari.net

Below you will find links to the referenced article, along with another research piece on post-retirement income.

My ‚Atlantic Log‚Äù article, along with the links focus exclusively on income strategies for the retired ‚ I trust you will find them informative.

Ps. I recommend you read the piece on politics, by our CIO Arno Lawrenz, in our quarterly.

Albert Botha

Atlantic Asset Management

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Click here to read the “Atlantic Log”.

Click here to read the Glacier Funds on Friday Volume 517 “Have you thought about doing this with your ILLA?”

Click here to read the Glacier Funds on Friday Volume 518 “Should it be Life or Living?”

But even though we were wrong, we did not lose. In fact we gained quite handsomely from the decision. How did we manage this and why did we allocate assets as we did? In this blog we look at this and the practical effects of the interest rate cut.

In past blogs, articles and weeklies we have stated our view that inflation will surprise on the downside over the next couple of months and in one of the past blogs a 40-50% probability of a cut is mentioned. Given this, we allocated assets so that we could benefit should our views come to pass, while at the same time we also hedged what we perceived as a possible risk (a decrease in interest rates).

The implementation was in the form of a large allocation to long-dated bonds, some of which we sold after the rally in bond yields. Doing so allowed us to ‚bank‚Äù some of the performance. This does not mean we are suddenly bearish ‚ we may re-enter the market again at some point.

While our implementation may seem to be contradictory given our long term view about the dangers of higher inflation, we specifically invested to benefit from what we believed was a short-term opportunity. It does however beg the question of what would have happened had interest rates been kept on hold?

In this case we still feel we would have profited, but the impetus would have been a downside surprise in inflation rather than the drop in interest rates and it may have taken longer to realise the profits.

Regarding the cut in interest rates, we still feel that it was not necessarily justified. There seemed to be an increased focus on the currency, which many found surprising given recent statements. Furthermore, the cut and the justification given could easily still be applicable at the next meeting and may be used to justify another cut – something we would also disagree with.

The cut caught the market by surprise and I agree with a prominent bank analyst when he says, ‚the MPC‚s credibility piggy bank has been broken into and a withdrawal has been made.‚Äù

Albert Botha

Atlantic Asset Management