Game Over?

[DK Matai]

We are grateful to Mark Lapolla, global investment strategist at
Knight Capital, which executes more trades than any other US firm, for
his response to the ATCA briefing, "What could trigger the next
financial crisis?" Thomas Joyce, Chairman and CEO of Knight Capital
Group, is a long standing distinguished member of the ATCA 5000. Mr
Lapolla writes:

The Game is Over

The simple story is this: We believe the structural and cyclical terms
of global trade have finally reached their tipping point. This will
catalyze a wholesale change in sentiment and a historic repositioning
of risk assets. The emerging market global growth story is over.

In meetings with strategic allies and clients throughout October, we
began emphasizing our growing concerns about the nearly ubiquitous
confidence the financial markets -- and for that matter, global
leaders and their body politic -- have in China; and by extension, the
rest of the emerging market story, commodities, and the long-term
direction of foreign exchange cross-rates.

Not surprisingly, our concerns were met with varying degrees of
resistance; but the overall consensus clearly favoured a very bullish,
asymmetric outcome over both the near and intermediate terms. When
pressed as to our own sense of timing and specific catalysts for broad-
based trend reversal, candidly we were unclear. Our sense then was
that the higher and faster the commodity markets pushed, the sooner
the reversal would occur. But we have now clarified our view.

In just the past several weeks, we believe the data and government
action out of China, the back-up in US interest rates, intensifying
pressures across the EU, broadly rising commodity prices, intensifying
efforts to control hot money flows, and the market’s strengthening
belief that somehow China and the United States would be able to
engineer and a currency re-alignment without breaking the global
growth story, have finally pushed the global terms of trade to their
tipping point.

And now, as is evident by the flight to safety, and growing evidence
that China will soon try and effect price controls in addition to
raising interest rates and significantly changing the rules for their
vast network of TLGVs, the writing is on the wall. The game is over.

The simple story is this: We believe both the structural and cyclical
terms of global trade have reached their tipping point which will
effect a wholesale change in sentiment and a historic repositioning of
risk assets.

So what do we consider the “terms of global trade”?

Structurally, they are the intersection of:

A. Government Policy (rule of law, market systems, trade law, etc);
B. Resource and Industry (natural resources, labor/demographic pools,
industrial advantages, import dependencies, etc); and
C. Economic Security (sovereign’s competitive standing, the relative
power/needs of the citizenry, the mandate/control of the government,
etc.)

And cyclically, the terms of trade are defined by the intersection of
foreign exchange rates, commodity prices, and the cost and
availability of trade finance. And in our assessment given:

1. The structural breakdown of the credit and labour markets in the
developed world and the anaemic outlook for nominal GDP growth;
2. The immaturity of the developing world and their vulnerability to
credit shocks and uncontrollable inflation;
3. China’s dependence upon non-economic, and unsustainable credit
expansion to maintain growth far beyond natural export and domestic
demand; and
4. Asia’s dependence upon imported energy and agriculture:

the game is over!

Presently, we believe that the broad-based resurgence of investor
confidence in the emerging market and secular bull market in
commodities will end badly; proving that the rally which commenced in
Q2 2009, was in fact an “echo bubble” facilitated by massive -- and
unsustainable -- stimuli from the Chinese Government.

And although such cataclysmic shocks rarely result in rhythmic,
straight line fractures, the chain of price adjustments should be
relatively clear. Accordingly, we expect a shockingly powerful rally
in the dollar, broad-based weakness across the commodity sector, a
dramatic widening of emerging market credit spreads, and what could
prove to be a stampede of hot fund flows out of the emerging markets.

We appreciate both the gravity and the brevity of this note; but then
again, the story is simple!

Thanks



Mark

Mark Lapolla is Managing Director at Knight Equity Capital Markets.
Mark Lapolla joined Knight with the acquisition of Sixth Man Research,
which he founded in 2007. Mr Lapolla brings years of experience on
both the Buy and Sell Side and has established mindshare with high
profile institutional fund managers worldwide. At Sixth Man Research,
he created a distinctive approach to analyzing emerging market trends
and imbalances regardless of asset class or geography while serving
some of the world’s largest mutual funds, hedge funds and commercial
banks. Prior to Sixth Man Research, he started Petros Capital, a long-
short equity hedge fund that primarily served university endowments
and charitable foundations. Before Petros Capital, he was with Friess
Associates, managers of the Brandywine Funds, in which assets under
management grew from $2.2 billion to $15 billion during his tenure.
He was also responsible for managing $1.5 billion directly, as well as
overseeing the fund’s largest positions which aggregated another $5
billion. In 1990, he began managing money as an analyst covering
technology and retail stocks. Mr Lapolla launched his career in 1983
as an equity trader at Goldman Sachs and has held various trading
positions at leading sell-side firms. He graduated from the College
of William & Mary in 1983 with a BA in Economics.

[ENDS]

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All the best


DK Matai

Chairman and Founder: mi2g.net, ATCA, The Philanthropia, HQR, @G140

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