Exploding Rate Expectations; Ukraine Risk

by Paul Hoffmeister, Chief Economist

• Expectations of rate hikes this year have exploded higher.

• Correlates with the jump in statistical inflation to a new, higher range since October.

• Russia to pursue largest military land operation since 1945?

• While Russia annexed Crimea in February-March 2014, gold prices jumped more than 10%.

Expectations of how much the Federal Reserve is going to raise interest rates this year have exploded higher. According to the Chicago Board of Trade, the December 2022 fed funds future is suggesting that the federal funds rate, which now trades around 8 basis points, will be nearly 137 basis points in December. This implies that the FOMC will raise the overnight lending rate by a quarter point at least 5 times in the coming months.

What’s especially notable about these expectations is how quickly they’ve changed during the last three months. In early October 2021, the December 2022 fed funds future indicated that the market was only 1 quarter point increase this year.

What’s behind this major shift? In our view, it’s partly due to the recovering economy following the global shutdown in Q2 2020. Prior to the pandemic, according to the Bureau of Labor Statistics, the U.S. unemployment rate was 3.5%; today, it’s 4.0%. But even more, statistical inflation began to break out in October 2021. Specifically, the core Personal Consumption Expenditures Index according to the Bureau of Economic Analysis began to rise from a 3.6% year-over-year increase to 4.9% today.

Since the breakout of inflation in October to a new, higher range, the Federal Reserve has communicated a series of hawkish policy changes ahead. For example, on November 3, the FOMC announced that it would reduce the pace of bond purchases, which suggested that its quantitative easing program would end by mid-2022. On November 30, Chairman Powell acknowledged that “it’s probably a good time to retire [the word transitory] and the bond taper may need to conclude a “few months sooner”. On December 15, the FOMC announced the plan to conclude its bond buying program in March. Then, on January 26, the FOMC statement read: “With inflation well above 2 percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate.”

A rate increase in March, following the FOMC’s March 15-16 meeting, seems to many to be a fait accompli. Underscoring the speed in which expectations have changed recently, the prospect of a March increase was highly unlikely based how fed funds futures were trading last October.

Ukraine: Senior U.S. military and state department officials briefed the House and Senate in closed door meetings last Thursday. According to the New York Times, lawmakers were informed that Russia has assembled 70% of the forces necessary to mount a full-scale invasion of Ukraine, which “would constitute the largest military operation on land in Europe since 1945.” Some officials believe that were Russia to invade, it would not occur until the second half of February, so as not to antagonize China’s leadership, who will be overseeing the Winter Olympics in Beijing. Furthermore, it would allow the ground to freeze even more, making it easier to move heavy equipment and vehicles. Officials outlined 5 provocative scenarios that President Putin could undertake in Ukraine, from a coup or limited incursion to a larger scale invasion to take over most of the country.[i]

President Biden has ordered 3000 troops to Eastern Europe in countries bordering Ukraine, but he insists they will not go into Ukraine.[ii] And, according to the New York Times, American and European officials have warned of “sanctions on Russia’s banks, trade restrictions on semiconductors and other high-tech items and the freezing of the accounts of Russian oligarchs and leaders.”

What does this mean for investors? We don’t believe this issue will be resolved anytime soon and will likely linger for a long time. Furthermore, geopolitical variables can be enormously complex and unpredictable, and similar periods of time can be useful for investors to navigate markets amid uncertain variables like these. When Russia annexed Crimea in 2014, the S&P 500 returned over 5% between in February and March, but we’d emphasize that stocks were then coming off a very weak January. Additionally, gold prices jumped from approximately $1250 in early February 2014 to more than $1380 in March 2014.

[i] “US warns of grim toll if Putin pursues full invasion of Ukraine,” by Helene Cooper and David Sanger, February 5, 2022, New York Times.
[ii] “Biden moving US troops in Eastern Europe won’t prevent Russian invasion, experts agree,” by Caitlin McFall, February 5, 2022, Fox News.

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Paul Hoffmeister is chief economist and portfolio manager at Camelot Portfolios, managing partner of Camelot Event-Driven Advisors, and co-portfolio manager of the Camelot Event-Driven Fund (tickers: EVDIX, EVDAX).

Camelot Event-Driven Advisors LLC | 1700 Woodlands Drive | Maumee, OH 43537 // B313

Disclosures:
• Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended by the adviser), will be profitable or equal to past performance levels.
• This material is intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept for any particular advisor or client. These materials are not intended as any form of substitute for individualized investment advice. The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own. Before participating in any investment program or making any investment, clients as well as all other readers are encouraged to consult with their own professional advisers, including investment advisers and tax advisors. Camelot Event Driven Advisors can assist in determining a suitable investment approach for a given individual, which may or may not closely resemble the strategies outlined herein.
• Any charts, graphs, or visual aids presented herein are intended to demonstrate concepts more fully discussed in the text of this brochure, and which cannot be fully explained without the assistance of a professional from Camelot Portfolios LLC. Readers should not in any way interpret these visual aids as a device with which to ascertain investment decisions or an investment approach. Only your professional adviser should interpret this information.
• Some information in this presentation is gleaned from third party sources, and while believed to be reliable, is not independently verified.
• Camelot Event-Driven Advisors, LLC, is registered as an investment adviser with the United States Securities and Exchange Commission. Registration as an investment adviser does not imply any certain degree of skill or training. Camelot Event-Driven Advisors, LLC’s disclosure document, ADV Firm Brochure is available at http://adviserinfo.sec.gov/firm/summary/291798

Copyright © 2021 Camelot Event-Driven Advisors, All rights reserved.

Will Rate Hikes Break the M&A Boom?

by Thomas Kirchner, CFA

• 70% of mergers are all cash.

• Large cash hoards reduce need for debt financing.

• Regulations bigger concern than interest rates.

2021 set a new record of M&A activity, with global volumes reaching $5.1 trillion and U.S. mergers increasing 50% to $2.5 trillion from the prior year. Volumes in Europe and Asia continue to lag U.S. activity with $1.5 and $1 trillion, respectively . So far in 2022, the year is off to a strong start thanks to Microsoft's deal to buy Activision for $75 billion, which will make it one of the 10 largest U.S. mergers of all time. As always, the numbers are skewed heavily by a small number of mega mergers. Only 64 deals had over $10 billion in size, representing 0.4% of the number of mergers. However, these 64 mergers represented 24% of deal volume by dollars. [i]

SPACs flame out

SPACs contributed about 10% to global M&A volume and thus constitute a significant portion of the total. Of the 199 SPAC mergers completed last year, only 15 shares trade in positive territory. Only 8 have outperformed the S&P 500 [ii]. This performance is in line with past experience. As we wrote previously, the long-term performance of SPAC mergers is poor. Their poor performance was foreseeable when we wrote this in April 2021. SPACs are best viewed as a poor substitute for venture capital, where most investments result in a complete loss, with only a small fraction providing strong returns. Venture capital funds are successful only if the small minority of winners has such a phenomenal performance that it more than offsets the losers. Given these challenges, it is not surprising that despite all the hype, only the top quartile of venture capital funds beats the S&P 500 [iii].

Regulation is back

After four years of generally lax anti-trust enforcement – although the final years of the Obama administration also were not particularly tough – merger regulation is back. The appointment of Lina Khan as head of the FTC signals the implementation of President Biden's “whole-of-government” approach to regulation. The traditional anti-trust analysis involving consumer welfare is replaced by a broader review of the impact of mergers on the environment, labor and equality. These extra layers of bureaucracy will prolong the timeline of larger mergers.

A plethora of new regulations will, in the aggregate, impact merger activity negatively even though each new rule, taken in isolation, is not a big deal. For example, early terminations of the HSR waiting period will no longer be granted. It used to be standard practice that when the DOJ or FTC determined that a merger had no anti-competitive threat, they would let the merger go ahead immediately by terminating the statutory HSR waiting period early. This will no longer be done. Of course, this makes no sense: the regulators have determined that a merger poses no anti-competitive threat, yet it cannot go ahead until a pre-determined waiting period has expired, during which nothing is done. Clearly, this measure is more political messaging than tough regulation. It certainly is not smart regulation.

Similarly, the government now has the ability to extend merger review processes indefinitely. The underlying philosophy of anti-trust regulation was to minimize disruption to business activity by forcing regulators to act quickly or, if they can't get their act together promptly, drop merger challenges. The FTC is now keeping investigations open beyond the usual time periods and warns merger parties that if they go ahead and close a deal, they do so at their own risk.

Cash is king

70% of all mergers (by size) last year were all cash, only 9% were all stock, with the remainder having a combination of cash and stock [I]. With credit spreads still low by historical standards and corporate cash balances at all time records, we expect cash to continue to be the preferred form of M&A payment for the foreseeable future.

Moreover, private equity funds are sitting on over $1 trillion in dry powder [iv]. This committed capital needs to be put to work irrespective of the level of interest rates.

While rising interest rates will make cost of debt financing more expensive, the enormous aggregate amount of cash available means that buyers, on average, can reduce the amount of debt financing employed in M&A and simply use more cash when the cost of debt becomes too high.

Therefore, we do not believe that rising interest rates directly will impact M&A volumes. However, there is an indirect risk: should financing become unavailable due to higher rates – for example, if banks were to tighten lending standards or regulators were to clamp down on leveraged acquisitions – then an indirect impact would be sharply reduced M&A activity. We have last seen such an outlier in the 2008 credit crunch. However, for a credit crunch to occur, you need major components of the financial system to implode. Therefore, we highly doubt that a sharp reduction of M&A activity is on the horizon. A bigger concern than interest rates is the increase in regulation and enforcement, which quite clearly is designed to reduce M&A activity. U.S. business has benefited from large improvements in efficiency over the last 20 years, some of which was driven by the cost cutting that follows when duplicate overhead is eliminated as a result of M&A. If the government regulates such efficiency gains away, it will have negative long-term consequences for the economy overall.

[i] Camelot calculations based on Bloomberg data.
[i] Nikou Asgari, Patrick Mathurin and Chris Campbell: “Spac wizards run out of magic as returns prove weak” Financial TImes, January 22, 2022.
[iii] David Siegel: “Ventureball: A Primer on Venture Capital for Hedge-Fund Investors.” Data Driven Investor, January 15, 2020. However, we would like to point out that while the statistic about the top quartile is quoted frequently, there is a strong debate about its accuracy.
[iv] Kaye Wiggins: “Cash-rich private equity pays record premiums to snap up public companies” Financial Times, October 7, 2021.

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Thomas Kirchner, CFA, has been responsible for the day-to-day management of the Camelot Event Driven Fund (EVDIX, EVDAX) since its 2003 inception. Prior to joining Camelot he was the founder of Pennsylvania Avenue Advisers LLC and the portfolio manager of the Pennsylvania Avenue Event-Driven Fund. He is the author of 'Merger Arbitrage; How To Profit From Global Event Driven Arbitrage.' (Wiley Finance, 2nd ed 2016) and has earned the right to use the CFA designation.

Camelot Event-Driven Advisors LLC | 1700 Woodlands Drive | Maumee, OH 43537 // B311

Disclosures:
• Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended by the adviser), will be profitable or equal to past performance levels.
• This material is intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept for any particular advisor or client. These materials are not intended as any form of substitute for individualized investment advice. The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own. Before participating in any investment program or making any investment, clients as well as all other readers are encouraged to consult with their own professional advisers, including investment advisers and tax advisors. Camelot Event Driven Advisors can assist in determining a suitable investment approach for a given individual, which may or may not closely resemble the strategies outlined herein.
• Some information in this presentation is gleaned from third party sources, and while believed to be reliable, is not independently verified.
• Camelot Event-Driven Advisors, LLC, is registered as an investment adviser with the United States Securities and Exchange Commission. Registration as an investment adviser does not imply any certain degree of skill or training. Camelot Event-Driven Advisors, LLC’s disclosure document, ADV Firm Brochure is available at http://adviserinfo.sec.gov/firm/summary/291798

Copyright © 2021 Camelot Event-Driven Advisors, All rights reserved.

Fed Policy: Threat of Phillips Curve Rate Hikes

by Paul Hoffmeister, Chief Economist

• Hawkish Fed minutes: 2% inflation goal reached.

• Economy at or near full employment.

• Philips curve logic to drive rate decisions.

On Wednesday, January 5, the FOMC released the minutes from its December 14-15 meeting, providing important insight into their views about the trajectory of monetary policy during the coming year. In our view, the minutes seemed especially hawkish, and their policy framework is somewhat concerning.

The Committee’s median projected timing for the first rate increase was pulled forward from Q1 2023 to June 2022, and many members believed that it was appropriate to start balance sheet runoff sooner after the initiation of the first rate increase than during the last rate-hiking cycle. Many believed it should transpire faster as well; in the previous cycle, the balance sheet runoff began almost two years after the policy rate lift-off commenced.

Note, at the time of the December meeting, the unemployment rate had declined from 4.8% in September to 4.2% in December, and core PCE price inflation (core personal consumption expenditures) had increased 4.1% year-over-year. Participants were generally constructive about the environment, with the minutes noting that “progress on vaccinations and strong policy support, indicators of economic activity and employment had continued to strengthen.”

With the relatively sanguine economic environment, some committee members noted that certain measures of inflation had reached decade-high levels and the percentage of product categories with substantial price increases continued to climb. Rising housing costs and rents, wage growth due to labor shortages, and supply constraints were also cited. Some participants expressed concern that “the recent elevated levels of inflation could increase the public’s longer-term expectations for inflation to a level above that consistent with the Committee’s longer-run inflation objective.”

To us, the following is one of the most important sections of the minutes:

Participants agreed that the Committee’s criteria of inflation rising to 2 percent and moderately exceeding 2 percent for some time had been more than met. All participants remarked that inflation had continued to run notably above 2 percent, reflecting supply and demand imbalances related to the pandemic and the reopening of the economy. With respect to the maximum-employment criterion, participants noted that the labor market had been making rapid progress as measured by a variety of indicators, including solid job gains reported in recent months, a substantial further decline in a range of unemployment rates to levels well below those prevailing a year ago, and a labor force participation rate that had recently edged up. Many participants judged that, if the current pace of improvement continued, labor markets would fast approach maximum employment. Several participants remarked that they viewed labor market conditions as already largely consistent with maximum employment.

Our interpretation of this is that a significant contingent of FOMC members believe that the economy is at or near full employment, and that inflation is excessive and must therefore be addressed. With inflation running at nearly 5% year-over-year and unemployment currently below 4% (near pre-pandemic levels), the Federal Reserve appears to be setting the stage for anti-inflation monetary policy in 2022. This means that it’s likely to pursue a prolonged rate-hiking campaign, which by definition seeks to limit economic growth.

While inflation is a major economic negative and can be pernicious in its effects, the Federal Reserve’s use of interest rates to modulate growth is arguably a poor tool to control inflation and has in the past led to major downturns that then required policymakers to backtrack on their respective rate increases. Furthermore, as clients have heard us say in recent years, we belive the view that too many people working is inflationary (and bad) is flawed. This framework of inflation is called the “Phillips Curve” and is highly disputed, and in our view, led to the excessively aggressive and mistaken rate hiking cycle of 2017-2018. Arguably, more people working and greater economic activity increases the demand for money and therefore can be deflationary.

Unfortunately, Phillips Curve-focused monetary policy is back.

As an aside, while we’re optimistic that currently high readings of inflation will abate over time, we believe that the Fed’s forecasts are too optimistic that they’ll hit their 2% inflation objective so quickly. The minutes stated: “PCE price inflation was therefore expected to step down to 2.1 percent in 2022 and to remain there in 2023 and 2024.”

We do not anticipate housing and energy-related prices to materially abate. As a result, a 2.1% PCE reading seems unlikely, in which case, this could only support inflation hawks on the Committee and the campaign for higher rates and a policy aimed at slowing economic growth at the margin. Is aggressive and perhaps misguided monetary policy a major, immediate macroeconomic risk? It may not be for the near-term. But this is something to closely monitor during the coming 12-24 months.

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Paul Hoffmeister is chief economist and portfolio manager at Camelot Portfolios, managing partner of Camelot Event-Driven Advisors, and co-portfolio manager of the Camelot Event-Driven Fund (tickers: EVDIX, EVDAX).

Camelot Event-Driven Advisors LLC | 1700 Woodlands Drive | Maumee, OH 43537 // B298

Disclosures:
• Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended by the adviser), will be profitable or equal to past performance levels.
• This material is intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept for any particular advisor or client. These materials are not intended as any form of substitute for individualized investment advice. The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own. Before participating in any investment program or making any investment, clients as well as all other readers are encouraged to consult with their own professional advisers, including investment advisers and tax advisors. Camelot Event Driven Advisors can assist in determining a suitable investment approach for a given individual, which may or may not closely resemble the strategies outlined herein.
• Any charts, graphs, or visual aids presented herein are intended to demonstrate concepts more fully discussed in the text of this brochure, and which cannot be fully explained without the assistance of a professional from Camelot Portfolios LLC. Readers should not in any way interpret these visual aids as a device with which to ascertain investment decisions or an investment approach. Only your professional adviser should interpret this information.
• Some information in this presentation is gleaned from third party sources, and while believed to be reliable, is not independently verified.
• Camelot Event-Driven Advisors, LLC, is registered as an investment adviser with the United States Securities and Exchange Commission. Registration as an investment adviser does not imply any certain degree of skill or training. Camelot Event-Driven Advisors, LLC’s disclosure document, ADV Firm Brochure is available at http://adviserinfo.sec.gov/firm/summary/291798

Copyright © 2021 Camelot Event-Driven Advisors, All rights reserved.

Thinking about Inflation

by Paul Hoffmeister, Chief Economist

• Inflation is always and everywhere a monetary phenomenon.

• What could keep a lid on Inflation.

• Energy prices are biggest inflation risk.

Historical View of Money and Inflation

Milton Friedman famously said, “Inflation is always and everywhere a monetary phenomenon.” This is the fundamental idea behind the monetarist school of economics that focuses on controlling the money supply to control the price level.

If there is inflation, then there is an excess supply of money in the economy; and the central bank can extract that money (by selling bonds) to appropriately balance the supply and demand for money. If there is deflation, then there is too little supply of money; and the central bank can add money (by purchasing bonds) to appropriately balance the supply and demand for money.

Over thousands of years, civilization ultimately identified precious metals as the most stable store of value and unit of account. Prices of many goods and services would generally fluctuate around a specific ratio of gold. Rather than bartering and trading specific goods, humans could use gold or other precious metals as the means of exchange because the price in terms of precious metals did not significantly change. Commercial transactions were far easier to perform with precious metals.

When the concept of money or currency emerged, central banks sought to maintain a stable price of gold in their respective currency. If a British pound note or US dollar represented a fixed price of gold, then commercial transactions were even easier to perform than carrying gold coins. To keep its currency value stable, the central bank would add or subtract currency on a regular basis by keeping its eye on the gold price of the currency. If the gold price rose (indicating inflation), then the bank would reduce money supply, and vice versa. By keeping the currency value stable with respect to gold, then prices of goods and services should generally be stable in that currency as well.

The objective of central banks of maintaining a fixed gold price and the basic operations to meet that objective is the spirit of the idea that inflation is always and everywhere a monetary phenomenon.

Inflation Since 1971

Unfortunately, things have gotten a little more complicated with the advent of the modern monetary system. In August 1971, President Nixon abandoned the gold standard, and for the first time in history, humans began to transact within a fiat monetary system where not one major currency was tied to something real. Since then, no central banks have officially managed their money supplies with the objective of keeping a stable currency price in terms of gold. This has led to violent currency swings and extreme inflations and deflations (see chart 1). And it has made the inflation discussion more complex.

Under successfully run fixed monetary regimes where the currencies were stable with respect to gold, prices for goods and services would change relative to gold. But when they did, it was typically not a monetary phenomenon. Instead, it was a signal to the market that there was too much or too little of that good or service. As a result, producers would then respond accordingly to properly align supply and demand. For the most part, the price changes under fixed monetary regimes were tame, in comparison to periods when there was no monetary standard.

Today, unfortunately, price swings can occur because of monetary error as well as specific supply and demand effects for a given good or service. Price signals are much more complicated or distorted. A rise or fall in prices might be due to too much or too little money supply, supply disruptions or sudden changes in demand.

Thinking about Inflation Today

The global economy is currently experiencing a surge in prices. For example, as of last month, the CPI was rising 6.8% year-over-year; whereas in June 2020, the US CPI had risen 0.1% year-over-year. How much of this increase is monetary, economic, or product-specific? And, are we on the verge of a breakout in inflation, or even hyperinflation?

In our view, it’s more the latter than the former. Indeed, gold has risen from $1200 per ounce in 2018 to just nearly $1800 today (see chart 2). This indicates inflationary monetary error and will contribute to a broad price level rise in coming years. However, the prospect of, let’s say, 15% inflation is highly unlikely today. Between 1976 and 1980, gold sky-rocketed from nearly $100 to more than $850; at which time, year-over-year growth in CPI had jumped from approximately 5% to 15% (see chart 3). This is why we’ve been saying that we’re not concerned about a major outbreak of inflation, unless gold were to start exploding higher past $2000-$3000 per ounce.

This leads to focus on supply and demand for goods and services in the economy. With the nearly sudden shutdown of the global economy in 2020, the demand for goods and services plummeted, causing the year-over-year growth in CPI to fall from 2.1% (in December 2019) to 0.1% (in June 2020). Demand collapsed and producers were forced to slash prices.

With the resurgence in demand thanks to the relatively quick reopening of the global economy as well as supply chain constraints and supply shortages, prices have surged, which is reflected in the 6.8% year-over-year growth in CPI.

What Could Keep a Lid on Inflation

A few things are working in favor of CPI now.

First, some of the pressure on port operators and logistics providers appear to be improving. Drewry’s global benchmark freight rate is down about 11% since its September high. According to Freightos, the cost of shipping goods from China to the West Coast is down nearly 30% from its high. According to the Port of Los Angeles, the number of container ships waiting to dock has fallen by nearly 50% in recent months. And, railroads are now picking up shipments within 2 days, compared to almost 13 days during the summer.

Second, the reality of the CPI statistic is starting to favor slower growth. The bottom in the CPI Index data was the second half of 2020. As a result, the year-over-year comparisons in the coming year will be more favorable, and no longer compared to the low prices during the period of inventory liquidation of 2020.

For the most part, the inflation outlook is not great, and as it naturally tends to do, hurts the most vulnerable members of the economy whose wages are not keeping pace with their cost of living. But the CPI data will unlikely misbehave as it has during the last 12 months.

Biggest Concern about Inflation Outlook

My biggest concern, however, is the continued rise in energy prices, and this goes back to earlier comments about prices keeping their historical ratio with gold over the long-term. Since 2001, the oil-gold ratio has generally traded around 17.1; meaning that 17.1 barrels of oil traded per ounce of gold, on average. With gold at nearly $1800 and oil near $70, recently, the ratio trades at approximately 26 (see chart 4). If oil traded at a more normal ratio with gold, then this would translate to $100+ oil. This would lead to a significantly higher CPI and hurt the most vulnerable even more.

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Paul Hoffmeister is chief economist and portfolio manager at Camelot Portfolios, managing partner of Camelot Event-Driven Advisors, and co-portfolio manager of the Camelot Event-Driven Fund (tickers: EVDIX, EVDAX).

Camelot Event-Driven Advisors LLC | 1700 Woodlands Drive | Maumee, OH 43537 //  B290

Disclosures:
• Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that the future performance of any specific investment, investment strategy (including the investments and/or investment strategies recommended by the adviser), will be profitable or equal to past performance levels.
• This material is intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept for any particular advisor or client. These materials are not intended as any form of substitute for individualized investment advice. The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own. Before participating in any investment program or making any investment, clients as well as all other readers are encouraged to consult with their own professional advisers, including investment advisers and tax advisors. Camelot Event Driven Advisors can assist in determining a suitable investment approach for a given individual, which may or may not closely resemble the strategies outlined herein.
• Any charts, graphs, or visual aids presented herein are intended to demonstrate concepts more fully discussed in the text of this brochure, and which cannot be fully explained without the assistance of a professional from Camelot Portfolios LLC. Readers should not in any way interpret these visual aids as a device with which to ascertain investment decisions or an investment approach. Only your professional adviser should interpret this information.
• Some information in this presentation is gleaned from third party sources, and while believed to be reliable, is not independently verified.
• Camelot Event-Driven Advisors, LLC, is registered as an investment adviser with the United States Securities and Exchange Commission. Registration as an investment adviser does not imply any certain degree of skill or training. Camelot Event-Driven Advisors, LLC’s disclosure document, ADV Firm Brochure is available at http://adviserinfo.sec.gov/firm/summary/291798

Copyright © 2021 Camelot Event-Driven Advisors, All rights reserved.

Have Chinese Tech Stocks Bottomed?

by Thomas Kirchner, CFA

• Tech clampdown helped President Xi's grab power.

• No need for further aggressive action.

• Chinese tech stock likely have bottomed.

It has been about a year since President Xi's clampdown on tech companies began. With Xi having won prophet status in the Sixth Plenum of the CCP, we believe that the worst is over and that Chinese tech companies present a good entry point.

President Xi's Power Grab

We believe that the main motivation behind the tech clampdown is President Xi's power grab. Many tech entrepreneurs are affiliated with the Shanghai clique around former Premier Jiang Zemin. President Xi himself rose up through the CCP ranks as a member of this group but has since split with his own group of supporters. Weakening tech companies meant a weakening of the remnants of the Shanghai clique. For example, Jiang Zemin's grandson Jiang Zhicheng is said to be behind Boyu Capital, a fund that would have made substantial gains from the IPO of Ant Financial. By blocking the IPO, reported the Wall Street Journal, Xi prevented Jiang's clique from making billions of dollars in gains. Boyu has since relocated to Singapore.

The CCP's Sixth Plenum earlier this month put President Xi on an equal footing as a key leader in the continuity of Mao and Deng, as has been reported widely. But more importantly, it also overturned one of the core tenants of Deng's reforms: collective leadership. This opens the door to a Mao-style dictatorship under President Xi. Collective leadership has been a key characteristic of the post-Stalin Soviet Union as well as post-Mao China. Its abandonment is bad news for the freedom and life of anyone not completely subservient to Xi as it signals a return to brutal repression. Xi will seek a third term at next fall's Communist Party conference. All signs point to him winning

The Great Leap from Common Prosperity to Common Poverty

President Xi's policy of “common prosperity” through stone-age communism risks creating “common poverty,” warns one of the few pro-market voices allowed to speak openly, economics professor Zhang Weiying. Social media distribution of Zhang's article was blocked; but interestingly, the article itself remained available on the internet.

Clearly, as much as the CCP spreads an image of harmony and consensus, China is large and opposition still exists within the Party. President Xi may want to create an absolute dictatorship but if he were to pursue overly suicidal economic policies, it will eventually hit CCP officials' personal wallets. After all, many Party officials have accumulated substantial wealth, and not just through amazingly well-timed land or real estate investments, but also in other industries. The technology sector may have been in cahoots with Jiang Zemin's clique, but it remains key for future growth. Even more so if the real estate sector is in decline and less likely to contribute as much to future economic activity as it has done historically. In addition, technology is also crucial to produce modern weapons, which Xi will need to project Chinese power globally.

Therefore, it is unlikely that the clampdown on tech will go much deeper. While there is room for tough regulatory action at the margins, such as with Didi recently, further generalized action against the sector will have more negative effects on Xi's power than it will help.

Mafia state

The counterargument to this optimistic view is the already high degree of violence with which CCP officials dispose of rivals. This allows the party to stifle any complaints about economic policies that turn out to be a disaster without suffering adverse consequences.

Disappearances have become widespread and are no longer limited to officeholders who are little known outside of a narrow circle of bureaucrats. They happen to world-famous businessmen, pop culture idols or tennis players. The recent re-appearance of disappeared tennis star Peng Shuai was contrived so transparently that we wonder whether the actual message the propaganda sent was not that she is fine, but that the CCP has absolute power over the disgraced. Any dictator can murder a dissident, but coercing a disappeared to fake their own re-appearance, that is dictatorship 2.0.
An obviously fake re-appearance is similar to the message Zimbabwe's then-dictator Robert Mugabe sent in January 2000 when he won a lottery that was believed to be incorruptible because its drawing was transmitted on live TV: Mugabe showed that he is so powerful that he can even manipulate a lottery in front of millions of viewers. Clearly, Mugabe did not care for the $2,600 prize, but for demonstrating his absolute control and discourage any wannabe-opponents. Peng's odd re-appearance has a similar feel to it.

Almost forgotten is an account by China Daily from 2011, which pointed out the unusual frequency with which Chinese billionaires die untimely deaths: one died every 40 days on average in the prior eight years. Of 72 billionaires, 14 had been executed after a trial. The others died, in descending order of suspiciousness, of murder (15), suicide (17), accidents (7) and illness (19) [i]. Those who died from illness averaged only age 48, so we may have to reorder that list.

In short, China is run like a mafia state, and hence President Xi has few constraints in implementing and perpetuating economically harmful policies. Further actions against tech companies would be practicable under this scenario even if they turn out to be counterproductive.

Sanity will prevail

On balance, we believe that economic sanity will prevail even while substantial room for abuses remains. Just a few days ago, Bloomberg [ii] reported an upcoming clampdown on Variable Interest Entities (VIEs), something we had warned about a few months ago. However, China Securities Regulatory Commission promptly denied that VIEs were to be banned. The denial leaves open the possibility of other regulatory action short of a ban. We suspect that the Bloomberg report was leaked deliberately to prepare the market for measures that will be less stringent than the worst-case scenario of an outright ban.

We believe that this playbook will repeat more broadly across the tech sector. Therefore, investments are not a binary yes/no decision, but a question of price. And in particular in light of the recent weakness in price and the likely slowing in the clampdown, we believe it is a good time to re-up investments in Chinese tech companies.


[i] Ray Kwong: “Friends Don't Let Friends Become Chinese Billionaires” Forbes, July 15, 2011.
[i] “China to Close Loophole Used by Tech Firms for Foreign IPOs” Bloomberg News, December 1, 2021.

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Thomas Kirchner, CFA, has been responsible for the day-to-day management of the Camelot Event Driven Fund (EVDIX, EVDAX) since its 2003 inception. Prior to joining Camelot he was the founder of Pennsylvania Avenue Advisers LLC and the portfolio manager of the Pennsylvania Avenue Event-Driven Fund. He is the author of 'Merger Arbitrage; How To Profit From Global Event Driven Arbitrage.' (Wiley Finance, 2nd ed 2016) and has earned the right to use the CFA designation.

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