Managing Money Is Not So Easy Anymore

Return figures for the first half of 2010 did not make for inspiring reading.  Government bonds performed rather well and some high yield and emerging market credits much better still. The main story however was one of renewed volatility and flatlining or declines by most asset classes.  July has so far been a different story however, with several key markets and risk assets turning sharply back up.

This patchy narrative is, frankly, not much of a surprise, given the nature of the economic conditions through which we are living.  Volatile markets moving sideways amidst continuing uncertainty about economic trajectories is very much what the “new normal” is meant to be about. It has not made managing money any easier however. Of more than 2700 UK funds monitored by Trustnet, for example, the median return year to date is just 2%.

According to the latest quarterly survey by Asset Risk Consultants, the average manager of sterling or dollar based private client assets gave back all or more of the gains that were eked out in the first quarter. For many hedge funds, the year has been a virtual washout, despite the fact that on paper volatile markets are meant to be the ones in which they should be thriving. Those dumb, derided retail investors who poured their money into bond funds for the moment look smarter than the pros.

Standing back from the fray, is it possible to see what is going on? While equity markets were clearly due a pause after their powerful recovery last year, investors remain mired in the fog of a seemingly unending struggle between powerful ongoing global deflationary forces and concerted Government and central bank attempts to head off the consequences through monetary expansion and (whisper it not too loudly) competitive currency debasement. 

The inflation/deflation argument seems to ebb and flow from month to month, mainly in response to news flow and shifts in investor sentiment, with little regard to fundamentals. One paradox is that while sovereign debt has been the outstanding news theme of the year to date, it has so far failed to make much of a dent in the performance of government bonds outside the most obviously indebted crisis areas. 

By the same token the argument whether or not the US economy is heading into a double dip recession may have become more shrill, but it is hardly nearer resolution. The evidence on either side, as far as I can see, is so far too inconclusive to award a victory to either side. Leading indicators are pointing down, but that is consistent with a slowdown as well as a new recession. The one certainty seems to be that the Federal Reserve will continue to err on the side of monetary laxity, with a second bout of QE on its way at the first sign of any market panic at deteriorating economic data.

In his latest investment bulletin, the fund manager Jonathan Ruffer likens the current economic environment to a dangerous downhill road. At the wheel sit the drivers of economic policy, desperately lurching from one side of the road to another in a furious attempt to keep their economies out of the ditch. Deflation is the ditch on the left, inflation the ditch on the right. Unfortunately, the faster and more furiously they yank the steering wheel from one side to the other, the more dangerous and erratic the descent becomes.

Mr Ruffer’s view, like mine, is that the final destination of this bumpy ride can only be the ditch of inflation. At present there is “an overwhelming dynamic”, he writes, away from “do-nothing deflation towards the soothingly-delayed consequences of monetary compromise”. Although we are trapped in a period when “the fundamentals of economic forces are willed into quiescence by politicians and bankers”, the only good news is that it cannot last indefinitely.

But if quality real assets are the ones which investors need to own to prosper from the eventual inflationary outcome, the choice is not so simple for those who either lack that clear-cut conviction or feel professionally constrained to outperform over shorter horizons. How soon we reach the final inflationary destination is impossible to predict with precision. (Mr Ruffer, whose funds set out to make positive returns in all conditions, still owns lots of bonds for that very reason).

All we know is that the journey ahead will be full of heart-stopping moments when one or other ditch looks like claiming a new victim. For hazards in today’s financial markets, read spikes in volatility and bonds whose capital value must, as a matter of mathematical inevitability when yields in general are so low, leap around in extravagant response to every minor twist and turn in the ongoing inflation-deflation debate. Markets that are hooked on monetary stimulants will tend to be bipolar in nature.

It is only small comfort to argue that the one sure way to make money in these difficult market conditions is to play currencies, the instruments through which the global game of competing monetary disorder is being played out. Having no intrinsic value and defying fundamental analysis, currencies are the ultimate zero sum game. Seeking to elevate them into an asset class is a sign of how hard conditions for managing money have become while the current “monetary disorder”, as Mr Ruffer calls it, persists.

Read more...

A Route Map To The Future?

The technical analyst Robin Griffiths, now working for the blue chip firm of Cazenove, was in more than usually ebullient form at an Investment Research of Cambridge seminar in London last week. With the precision that never ceases to amaze me about technical analysts, he laid out the dates when he expects the next turning points in the market to occur.

As someone who lacks any belief in the mumbo-jumbo theories that typically accompany most chartists’ projections, I nevertheless find the insights of the best technical analysts helpful in forming broad market views (by best I mean those who understand how markets behave in real life and allow their charts to inform, rather than dictate, their views).

The scenario which Robin outlined is certainly a plausible one that makes a lot of intuitive sense in a period when markets continue to yo-yo between fears of inflation and deflation. His starting point is the unarguable one that the big indebted countries, such as the US and UK, are on a different route map to those of the fastest growing developing economies. While the former are still toiling their way through a secular bear market, the latter are in a clear secular uptrend.

In practical terms what he thinks this means is that the US stock market will head down again from its current technical rally, with the S&P index falling from 1100 now to around 940 by late October, which is when he reckons President Obama will introduce a new set of stimulus measures, including a second round of Quantitative Easing. That will give the market one more short term boost before capitulation finally sets in and the market falls back to test its March 2009 lows some time towards the end of 2011, with both yields and p/es down to around seven, a typical end of bear market level.

Although that will probably mark the end of the secular bear market that began in 2000, it will still take some years, in Robin’s views, before the US embarks on its next sustained bull run. That is not likely to be in full swing until the next cohort of young in the American population reaches the economically influential age of 30-35 some time in the period 2015-2020.

For the best developing countries, such as Brazil and India, he argues, the short term pattern will be similar, but more volatile. The key difference however is that these two markets, unlike the US and UK,  remain in a secular bull market and so the medium term picture, helped by a vastly superior demographic profile, will be much brighter.

Robin sees the Sensex index in India (his favourite long term market) first testing resistance levels at 15,000 or 16,000 this autumn before revisiting the former peak at 21,000 next spring and falling back to its current level when Wall Street bottoms towards the end of 2011. After that however, it will be onwards and upwards, with the Sensex index powering on to a succession of new highs while the indebted developed world still stagnates in relative terms.

China and Russia, in contrast, are on quite different trajectories, which makes lumping them in together with the other BRICs less sensible. Robin’s view is that the Chinese market, which is already down 70% from its peak, has further to fall in the short term, but will then move on the higher ground once the current tightening has run its course. Russia has a terrible demographic profile – life expectancy is falling rather than rising, he believes - and is a market that most investors will want to avoid.

My View: I don’t know if the equity markets will retest their 2009 lows, let alone when, but a big setback is certainly still a possibility at some point in the next 18 months, as the ebb and flow of inflation/deflation news will continue to drive short term trading patterns in the market for some time. The consequent volatility will muddy the waters for many market participants.

My best guess for now is still that the markets will move higher towards the end of this year. While large cap equities and the best emerging markets both look extremely attractively priced for the long term,  the risk of a severe correction next year will deter the faint-hearted who cannot face the possibility of another testing down year like 2008.

UK and US Government bonds face the reverse of this outlook: periodic potential gains in the short term, driven by risk aversion and reaction to news flow, offset by the prospect of long term penury for those who buy and hold – rather than trade - them at their current historically low yield levels.

Read more...

Heading Into The Equity Grind

Sometimes a good graph can be worth a thousand words. I am grateful to Robert Buckland of Citigroup for this helpful illustration of stock market behaviour after the largest market falls of the last 30 years. This shows in his words how equity markets typically move through a phase of strong recovery in the 12 months after a market plunge (the “equity surge”) to a period of more consolidation or gradual improvement (the “equity grind”).

Of course this time it could be different, and if you care to follow the warnings of Professor Nouriel Roubini and others, we could be in for a further gruesome period for equities as a double dip recession in developed countries starts to bite. However there is a reason why the phrase “this time it’s different” was described by Sir John Templeton as the four most dangerous words in investment. It is that believing the adage will often lead you to a dangerous conclusion. (Pedants might say it is five words, but that is another matter).

There is no doubt that the technical position of the equity market has deteriorated in recent weeks. Earnings upgrades, as noted earlier, are starting to run out of steam. There is certainly no shortage of negative news around. But that does not mean that equity markets cannot move higher over the balance of the year and that I still suspect is what they will do. In the short term equity markets look oversold, and many professionals I rate highly tell me they are finding bargains at current levels. That won’t make the pace of equity market recovery any faster, but it does provide a measure of comfort.

Read more...

The Budget: A Start Down The Road

There was nothing in George Osborne’s emergency Budget on Tuesday to contradict the idea that the transition from Labour governments to Conservative (or in this case Conservative-led) ones tends to be good for the investing classes. The fall of the Callaghan government in 1979 was followed after an initial period of uncertainty by the start of an 18-year bull market that was resilient enough to survive two nasty recessions, the 1987 crash and our undignified exit from the ERM in 1992. There were similar bull markets for shares in the mid-1930s, following the formation of a Conservative-dominated National Government, and in the Eden-Macmillan years in the 1950s.

This time round, the stock market response is again likely to be positive, once it has had time to digest unpalatable items such as the rise in capital gains tax for higher-rate income tax payers. Raising the top rate to 28% rather than 40% or higher is less of a sop to the Lib Dems than many Tories had feared. Osborne’s measures are generally a boost for the private sector. Indeed, by leaving the onus on the private sector to lead the UK out of economic recovery, he has firmly rejected neo-Keynsian solutions in favour of hitching the administration’s fortunes to those of its natural constituency.

The proposed year-by-year cut in corporation tax down to a record low of 24 per cent, and the commitment to ‘simpler rules and greater certainty’ for companies generally, are all to the good. At the macroeconomic level, his vigorous assault on the fiscal mess that Labour left behind is what markets had expected. The devil is in the detail however and the numbers will be rigorously scrutinised for fault lines. It will take time therefore before we can judge whether the results succeed in confounding the jeremiahs of the economics profession, who insist that keeping the public spending spigots open for longer is essential to avoid a second recession, as Geoffrey Howe’s famous 1981 budget was eventually able to confound the nay-sayers of the day.

Prospects for those whose investment horizons do not extend beyond home shores are certainly better than they were under Gordon Brown, but not yet as good as those whose do. UK companies which have succeeded in surviving the debt crisis have rarely been in better shape financially, and in many cases shares look reasonable value. If what Keynes called the corporate sector’s “animal spirits” can be roused, and sterling remains competitively priced, then there is room for profits and investor returns to exceed expectations.

But the fortunes of the UK will remain constrained by the burden of public debt and the painful side-effects for employment and growth of Osborne’s campaign to diminish it. At best it will be a case of two steps forward and one step back for UK plc, forced to compete in international market against less constrained rivals. The weakness of the euro is already doing wonders for German industry, for example.

Fortunately, twenty years of free-moving global capital flows have significantly increased the correlation between the performance of the main asset classes in different countries. Innovation has also greatly increased the range of markets in which private investors can readily invest. That cuts both ways: almost half BP’s dividends before the current disaster were being paid in dollars to investors outside the UK. No UK investor any longer has to place a binary bet on the success of Osborne’s strategy however.

Despite gloomy headlines about possible meltdown in the eurozone and fears that the US economy may be heading for a second recession, the global economic news has been good. The annualised rate at which global industrial production has been recovering since the darkest days of the credit crisis has been unprecedented. Giles Keating of Credit Suisse points out that car sales in the three largest economies (Germany, Japan and the US) are still well down on pre-crisis levels, yet in the eight largest emerging markets they are growing strongly. Taken together, global sales of cars in these 11 economies are already back above their pre-2008 average.

Indeed, so well are low-debt and emerging economies doing that some are already starting to confront the problems of too rapid growth, through interest rate rises and tighter monetary control. China’s attempts to control its real-estate bubble have captured most of the headlines, but the Chinese are not alone. Brazil grew at an annualised rate of 10 per cent in the first quarter and interest rates there are heading up; so too in Australia and Canada. The evidence to date has confounded the many who doubted that there might be a V-shaped economic recovery.

In the absence of serious mistakes by governments and central bankers, not something that can alas yet be discounted, the odds on further recovery are improving, but with the indebted developed world continuing to lag the developing world. It is true that many investors remain to be convinced. Risk aversion explains why, although share prices are still handsomely above the lows of early last year, yields on government bonds remain stubbornly low.

So too, with the notable exception of gold, are the prices of most commodities. That is not a pattern you would expect to see if sustainable economic recovery was now a universally accepted fact. Banks in the eurozone remain vulnerable and will need to be recapitalised, while the blundering way that the EU and ECB have handled the Greek debt crisis is not an encouraging omen.

Experience shows that a good investment strategy has several elements: an understanding of value, since buying cheaply is the only thing that guarantees good returns; diversification, to protect against mistakes and unforeseen risks; a longer-term focus, for consistency and the avoidance of pointless trading costs; and a strategy that matches the investor’s temperament and tolerance for risk. One Budget can make only so much difference. 

Looking back to 2000, no more than half a dozen good strategic calls, some running contrary to consensus opinion at the time, would have ensured a profitable decade. One was to buy and hold government bonds, which have been in a more or less continuous bull market since 1981. Another was to buy and hold commodities, which despite recent stalling, remain in one of their generation-long cyclical upswings. A third was to be out of equities when valuations rose above historic norms, as they were in 2000 and 2007, while increasing (for those with the tolerance to ride out short-term volatility) the proportion in emerging markets.

Property remained a good bet for the first half of the decade, but killed anyone with excessive leverage when the credit crisis hit. Sterling, surprisingly perhaps, ended the decade at almost the same price in dollars at which it started, and needed no long-term strategic call. Wine and art had a terrific decade.

Anyone who got those calls right could easily have trebled their wealth over the period — not bad in a decade when mainstream asset classes and allocations produced disappointing returns. The credit crisis of 2008 underlined how the diversification value of so-called alternative assets such as hedge funds and private equity proved illusory when trouble hit. Many turned out to be nothing more than debt-leveraged equity holdings that proved difficult or impossible to sell. 

Looking forward to the next decade, some of these trends, including the rise in emerging markets, are set to continue. Current prices for emerging-market equities still leave room for long-term gains. So too do prices of many large dividend-paying companies in developed markets. Equities in general are certain to enjoy a better decade than the one just finished: there has never been an example in history when a decade of flat equity returns failed to produce above-average returns in the next one.

Other trends will reverse completely. For the first time in nearly 30 years government bonds in the main issuing countries look extremely unattractive on anything but a short-term view. Bonds issued by stronger, more politically stable emerging countries look better value. However firmly the new government wrestles with the public finances, all historical experience will have been defied if higher inflation is not part of the eventual solution. Unfortunately inflation-linked bonds, one obvious hedge, are currently dear.

The factors behind the global commodity upswing remain in place. Expect higher prices over at least the next five years not just for gold and silver, which are bulwarks against the monetary debasement now being practised around the world, but also for oil, timber, industrial metals and agricultural commodities. Although the UK’s ability to devalue has given us a helpful jump-start over eurozone competitors, the longer term implication is that the dollar, sterling and the euro (if it survives) may continue to weaken over the next decade relative to the currencies of faster-growing or resource-rich developing countries. The UK’s fortunes are looking up after this week’s Buidget, but economic miracles sadly need more time to gather real momentum. It is a start, but no more

Read more...

May Can Be The Cruellest Month Too

MAY TURNED OUT to be one of the worst months on record for world equity markets, reports Andrew Lapthorne, the head number-cruncher and quant in Soc Gen Asset Management’s award-winning strategy team. The MSCI World Index dropped almost 10% in dollar terms, making it the worst May for this index since it began in 1970, and the worst monthly performance since February 2009, which turned out to be the final death throes of the great credit crisis bear market, the darkest hour before the dawn.

The worst country casualties, unsurprisingly, included the Eurozone countries whose debt problems have been so much in the headlines; Greece down 19%, Ireland 13% and Spain 11% in local currency terms. It turns out however that the falls in Asia were much greater: China’s Shanghai B market was down 16% and the Nikkei 225 down over 11%. The best performing markets year to date, as at the start of the month, more surprisingly, are mid and small cap stocks. Both the Russell 2000 and the FTSE 250 are still ahead year to date.

What is easily overlooked, of course, as with any short term data set, is that the recent falls in equity markets followed an exceptionally long and sustained period of market gains from February to April, with the S&P 500 rising for something like ten consecutive weeks, a most unusual trend. To use the jargon of the technical analysts, markets had become highly oversold. To that extent May’s falls were no more than a necessary and overdue correction.

However it seems clear that, just as Anthony Bolton predicted six months ago, equities are likely to be pushing against headwinds for some weeks yet. News will continue to be dominated by crises of one sort or another. The earnings upgrades that have helped to drive the markets higher are petering out. Valuations appear to have priced in a lot of future recovery already, with the MSCI World index trading on a p/e of 13 and a dividend yield of 2.7%.

Nevertheless the scale and strength economic recovery around the world continues to impress seasoned market-watchers. Few fund managers have navigated the crisis of the last three years better than Jonathan Ruffer and his team at Ruffer Investment Management. To quote a recent note of theirs: “One of the by-products of the tumultuous events and the private sector bail-outs of the last two years has been a massive transfer of risk from the private to the public sectors”.

“In part it is precisely this factor which has enabled equity markets over the past year to display a raffish insouciance in the face of so many outstanding problems and risks; with risk being largely socialized and a negligible cost of money, the measures that the corporate sector has taken in terms of inventory liquidation, labour shedding and capital spending cuts means that its present rude financial health stands in stark contrast to the groaning public sector deficits on view across the globe”.

They go on: “While we never try to time markets, it does not seem outlandish to say that the next few months will see risk assets move into the departure lounge from the ‘sweet spot’. Improving economic conditions, which we fully expect, will bring into sharper relief the need for ‘exit strategies’, with a likely reduction in liquidity available for investment in financial assets”.

“Further sovereign bond crises, accompanied by default risk, may erode the valuation basis for equities. Meanwhile, even if the UK is an acute case, inflation is regularly outpacing forecasts and will prove indeed to be part of the solution. After the relative ease of the last twelve months, protecting capital and generating real returns is about to start getting more difficult again”. We shall see.

A LOT of headlines have been generated by the European School of Management’s report into hedge funds.  The main findings are that hedge fund investors chase recent past performance and merrily buy into investment styles that have been working well recently regardless of the huge differentials in risk that different styles entail. 

The researcher, assistant professor Guillermo Baquero, concludes: “These results raise serious concerns about investors’ ability to make the right allocation choices and suggest that increasing investor protection and curbing unnecessary risks and speculative activity of hedge funds should be a priority for regulators”. 

I am not so interested in the regulatory issues. It has always been my view that hedge funds are not appropriate for retail investors, and should remain what they once were, namely largely unregulated vehicles for professionals and consenting wealthy adults. There is plenty of evidence to suggest that a small minority of hedge funds, if you are lucky enough to find the ones with real talent, are proven and consistent wealth-generators.

The majority, however, charge too much for what they in practice deliver, and their risk profile is skewed far too heavily in favour of the managers to make them prudent investments for most investors. Illiquidity too can be a problem, as became all too evident during the credit crisis. It is no real surprise that there has been a lot of pushback on the level of fees since the crisis. To blame them for causing the crisis is quite wrong however.

What these new research findings do show clearly, as many of us have long suspected, is that hedge fund investors are really no different from investors in general. They may be richer, and more sophisticated in other ways, but at heart they make just the same old mistakes - too greedy for results, too short term, too hyper-active, too blind to risk.

A SURVEY by the Association of Investment Companies names the top 20 investment trusts of the last decade, as measured (a) by their absolute returns and (b) by the consistency of their performance. Top of the list on both scores, gratifyingly, comes a trust that I own, Blackrock World Mining, which has returned an impressive 811% over the past decade and outperformed the average investment trust in eight of those ten years.

It is followed in the rankings by Fidelity European Values (once run by Anthony Bolton, but for most of the period in question by his successor Tim McCarron) and HgCapital, the private equity fund that spun out of Mercury Asset Management some years ago. (This is another fund which I happen to own, having bought some shares last year). The table of supporting data is worth looking at, although purists would argue that it suffers from taking no account of risk, gearing or volatility. A table of risk-adjusted returns would show some significant differences, as indeed would a table constructed on the same basis 12 months ago.

As a long term investor in investment trusts, the main message that I take from the survey is that identifying the big long term themes in the investment world and letting them run their course through a shrewdly managed, low cost vehicle is a much easier way to make money than furiously trying to pick winners over shorter periods of time.  Blackrock World Mining is a play on the commodity cycle. A good number of the other trusts on the list are essentially beneficiaries of emerging markets in one form or another, which has been the other big story of the past decade.  In a decade when the equity markets have produced little return overall, it is also noticeable how well some smaller company funds have continued to do.

AT A ROUND TABLE discussion I chaired for Spectator Business magazine last week, to be published shortly, a key theme on which all the participants agreed was the need for the new coalition government not to make a mess of the recovery by bungling the proposed Capital Gains Tax changes. As it happens, there is a powerful blast on the subject in this week’s Spectator from Art Laffer, inventor of the notorious Laffer curve. Economists may not be able to agree whether or not the Laffer curve is valid, but the general conclusion seems compelling to me. The way that the government crafts its CGT proposals is going to be a critical test of how far the new Government is hampered by the need to make concessions on tax to its own coalition partners.

THE THOUGHTS of Canadian investment strategist and commodity bull Don Coxe on the markets (from a recent conference call with clients): “No new bear market — we are going to have a correction here, but the global economy is still growing, but not as fast as the optimists would have hoped, and I don’t believe we can have a true bear market as long as liquidity is being supplied by the central banks at virtually zero cost. So much of that liquidity was misallocated before, but gradually as the economy grows it will be able to absorb it in actually productive activity”. I hope Don is right. Marc Faber dug out this apt quote from the US founding father Thomas Jefferson for his most recent monthly market commentary: “I predict future happiness for Americans if they can prevent the government from wasting the labours of the people under the pretext of taking care of them”.

Read more...

Q and A: Richard Oldfield

Richard Oldfield, the subject of our latest Q and A, is the founder and chief executive of Oldfield Partners, a privately owned investment management firm with $2.8 billion under management, invested wholly in equities “on a concentrated, value-focused, index-ignorant basis”. He is largely unknown outside the professional world, but highly regarded within it.

Before founding Oldfield Partners in 2005 he was for nine years chief executive of a family investment office. He is chairman of the Oxford University investment committee and of Keystone Investment Trust plc, and the author of Simple But Not Easy, a “slightly autobiographical and heavily biased book about investing”, first published in June 2007, which I strongly recommend and praised in The Spectator.

How generally do you see the equity markets at the moment?

We are torn between the extreme gloom about the problems of the public sector and enthusiasm for the new strength of the private sector, with strong cash flow and balance sheets and evidence of much improved demand, and valuations which are not too high. On balance we think it is positive for equities (which is a bias, but not an invariable bias, of ours).

Is the crisis in the eurozone over yet?

I think the outcome is resting on a knife-edge. On balance my sense is that the crisis will pass, and the euro will survive, at least for now. The stakes are too high for governments to let it go. I have always said however that the euro was unlikely to survive for more than 15 years, and I stick to that.

All that talk of the euro becoming a new reserve currency can be discounted. It isn’t going to happen. Central banks are not going to be rushing to buy more euros if they think they might be getting drachmas instead. On that basis that the euro does survive for now, however, that should mean we get a decent market rally.

What is the best approach to adopt in this kind of market?

The cushion of comfort is very important: risk is high. Investors need to be sure they have enough in low-risk assets so that they will not fret too much about the higher-risk ones. But once this cushion of comfort is determined, a different figure for every investor reflecting not only circumstances but temperament, investors shouldn’t be too shy of holding equities.

The answer I think you are begging with this question is “buy and hold is dead – do we need a trading strategy instead?” I am not too sure of that. The time to be skeptical of buy and hold was, in hindsight, in 2000 before equities gave a negative return for ten years.

Now, on the contrary, buy and hold may be a little hairy – hence the importance of the cushion of comfort – but the odds of an average to above-average return over the next ten years seem to me to have risen, particularly with quality stocks which really are for tucking away for the long term.

What opportunities do you see? Are there any striking valuation anomalies?

Not many major anomalies at the higher level – sectors or country. Japan though is cheap and maybe now the catalysts to this cheapness getting recognized have increased – a weaker yen, and a government determined to stimulate consumption. Quality equities, by which I mean major companies with low debt, strong cash flow, relatively unvolatile earnings, and high return on equity, do look good value.

There are plenty of anomalies, we think, at the stock level. Some excellent companies are becoming extremely cheap. The only question is whether the good companies in the private sector are going to get crushed by the public sector. On balance I still think that is unlikely.

Please give some examples of stocks you have been buying and why?

The most recent purchases this year have been Fiat and Hitachi, both based on the sum of their parts. Hitachi has been a dismal story, but there are signs at last of management change to sort out this amorphous conglomerate, and the stock is extraordinarily cheap.

Fiat is only the fourth car company we have bought in 30 years. Car companies are terrible – high debt, highly cyclical, usually union power – but in return for their terribleness there is occasionally huge upside and we think we have it here.

What would you avoid (or go short of) and why?

We would continue to be wary of China.

What are your thoughts on gold, bonds and property?

Gold: having been a bull for the last ten years, I am now wrongly somewhat more skeptical. The conditions still appear classically good for gold, but everyone is already there. On bonds, I am afraid, we are entirely consensus in being negative. Property – no clear view.

If you had just one moneymaking tip for this environment, what would it be?

But we don’t (and, seriously, we don’t believe in having one good idea; we think a portfolio should have a lot of decisions at play in it). Don’t stray too far from your comfort zone is the most important thing.

Read more...

Too Early To Panic (Though Some Are)

After another turbulent week in the markets, it seems a good point at which to stop and take stock of where we are. Equity markets are now oversold and will certainly have a bounce soon, for sure. Readers of Independent Investor will know that Jim Rogers thinks this is just a normal market correction, after the strong run from February to April.


Crispin Odey thinks the trend is still upwards. Ken Fisher does so likewise. Sanjeev Shah, Anthony Bolton’s successor at Fidelity, also thinks the market is oversold and has bought some more units in his own Special Situations fund – always an encouraging sign.

In a short Q and A last week, Richard Oldfield, the founder of Oldfield Partners, a specialist equity fund manager which has no public profile but is much admired by those who know it, is keeping his pro-equity bias in place, though he also said that he has learnt to ignore at this peril technical indicators such as Investors Intelligence’s bullish/bearish sentiment indicator, which has been flashing a clear warning sign.

So, at the very least, even if you don’t dare to be bullish, don’t be fooled by dramatic media headlines into thinking that the equity market rally is necessarily yet over. The crisis in the eurozone is real enough, and has been confounded by the unimpressive response of Europe’s political leadership to date. There is no doubt that there is an element of investor panic out there in the response to the unfolding eurozone crisis.

You can see this in a number of different indicators. The VIX index, which is often used as an indicator of fear in the market, has risen sharply in the last two weeks.

More worryingly, so too has the Libor rate, the key interbank lending rate which can also be interpreted as an indication of how willing banks are to lend money to each other.

This underlines the fact that behind the worries over the eurozone is the fear of further banking collapses. The rescue of the Spanish bank this weekend underlines how weak many lenders in the eurozone still are.

If banks start to stop lending to each other again, and liquidity dries up again because of fears over bank solvency, we will heading back towards a new crisis.

The technical condition of the stock market has deteriorated in the last few weeks. Richard Russell, the doyen of all technical analysts, now in his ‘80s, reports from his San Diego home in dramatic tones that the stock market has entered a primary downtrend.

All this may help to explain why Philip Gibbs, the financial expert at Jupiter, moved a lot of his funds out of equities and into cash earlier this year, fearful of the impact that the new crisis over sovereign debt might have. Against is the fact that Jupiter has announced last week its intention to float on the stock market, not something the firm would presumably try if the hugely influential Mr Gibbs was as bearish as he was in the run up to the 2008-09 banking crisis.

The risk of a new financial crisis, as has been noted here before, has never gone away, but the odds against it happening have been lengthening. Now the odds have taken a hit back in the opposite direction. A new crisis can still be avoided, but investors need to be aware that the possibility remains, even if it is still more likely that the equity market will start to pick up, as it was clearly beginning to do on Friday before news of the Spanish bank rescue.

While I remain confident that the case for equities remains robust, therefore, it is clearly sensible to remain alert to the danger of a new crisis, and be prepared to act accordingly if the market fails to bounce back. The next couple of weeks will give us more clues as to whether another dramatic stock market crisis is imminent.

Read more...

Election Reflections

It was a long night and still early days in the complex games of manoeuvre that will inevitably follow confirmation of a hung Parliament. What if any investment conclusions can be drawn at this moment?

A Tory-Lib Dem agreement is the only one that can effectively guarantee the stable and effective government that all parties say they now want. However it is far from a certain outcome.

An agreement between Labour, the Lib Dems and assorted other parties looks on the face of it more doable, but is also riddled with complications that will incur costs (eg bribes to the Celtic countries) that are directly inimical to the urgent crisis measures that the growing debt crisis demands.

Time is short. As the unfolding drama across Europe has shown, political hesitancy in tackling issues can be costly. But it will be costly too if the crisis measures that are eventually agreed lack the popular support needed to be implemented effectively.

All of these factors point to a continuation of sterling weakness until an outcome becomes clearer. The fact remains however that the UK is still a sideshow in the broader market and Eurozone debt crisis that has been raging all week.

Jim Rogers suggested yesterday that, putting aside the rogue market action on Thursday as an aberration, the sharp fall in world equity markets over the past week has actually been no more than a necessary correction after a very strong equity market rally since the start of February.

That is true, to the extent that what has happened in the last five days is perfectly consistent with a sharp but normal reaction to the unprecedented ten weeks of continuous advance on Wall Street and other markets that preceded it.  With hindsight, both the Eurozone crisis and the UK election may still however prove to look like an overlay on this normal cycle of market action, rather than its cause.

You cannot read into what has happened therefore the certainty that the bull market, or bear market rally (call it what you will), is over. However it would be no surprise if the equity markets were now in for a period of consolidation short term. Risk has returned to centre stage in the global financial system and investors who have been persuaded themselves to step back into the arena could easily be pushed back into their shells again.

This is not to say that dramatic warnings about the consequences of the Greek crisis are without foundation, merely that the collapse of the Eurozone and/or debt default is not a high probability in the short term. For now my favoured strategic stance remains fixed on above average equity exposure (through “quality” companies), minimal exposure to government bonds and healthy holdings of both gold and cash, with some property now being gradually added to the mix. The longstanding bias in favour of commodities also remains.

It is worth remembering Sir John Templeton’s timeless advice that the place to look for the best investment opportunities is never where the prospects are brightest, but where they look the most dire. That is the argument behind looking at shares in BP, for example, whose external reputation can rarely have sunk any lower than it is today.  

Read more...

Andrew Dalton’s Market Review

Equity markets rose last week until Friday, when they fell sharply with the announcement of the SEC’s suit against Goldman Sachs.  The picture that emerges from the suit is nasty, plausible but, probably, difficult to prove.  Goldman Sachs was not alone in manufacturing these types of synthetic transactions.  Nonetheless, it appears that the SEC intends to follow the profile of the particular Goldman Sachs transaction known as Abacus 2007 – AC1. 

  If the case is eventually proven, the path for compensation for those who lost money would be much easier.  The timing of the SEC’s case is important politically, because regulation of the investment banking community is under active discussion in the US Congress.  It is important, however, to realise that much of what is in contention is already history and the impact on world equity markets, therefore, is likely to be short-lived. 

Of more importance has been the progress of first quarter earnings reports from the United States, which has been good.  As of April 16^th, 38 companies in the S&P 500 have reported, representing 12% of total market capitalisation.  The upside surprise ratio stands at 78.9%.  The earnings growth of companies reporting thus far is up 31.8% year-on-year.  The reported earnings growth rate excluding financial sector is 41%.

Elsewhere the Greek situation rumbles on.  The latest IMF/EU delegation expected in Athens today has been delayed by a week because of volcanic ash that prevents flights.  However, it now appears likely that the Greeks will seek to draw down official pledges of assistance from other European Union countries.  This had the effect, at the end of last week, of pushing German government bond yields higher and Greek government bond yields higher still.

In the United Kingdom, the Liberal Democrat leader, Nick Clegg, appeared to do well in the three way debate on UK television between himself and the two other party leaders last Thursday.  The most recent opinion poll even suggests that the Liberal Democratic party has more electoral support than any other party in the UK general election, which is to be held on 6 May.  Even that level of support, though, would be insufficient to give the Liberal Democratic party a majority of seats in the UK House of Commons, although it could double the number of seats they currently hold, making a ‘hung’ parliament more likely.  Sterling weakened.

Part of the difficulty on Friday was that Goldman Sachs did not issue its rebuttal until this morning.  In that rebuttal, Goldman was anxious to ensure that attention should be focussed on this one transaction, which involved two professional institutional investors, IKB and ACA Capital Management.  They pointed out that this particular transaction has been the subject of SEC examination and review for over 18 months and that, based on all that Goldman itself had learned from this examination, the firm’s actions were entirely appropriate. 

Goldman further pointed out that the institutions were very experienced in the CDO market, extensive disclosure was made in respect of each of the securities in the reference portfolio, similar in detail and scale to those disclosures required by the SEC in public transactions and that the offering documents provided all the information needed to understand and evaluate the portfolio.  In essence, the transactions at issue involved a static portfolio of securities, which was marketed solely to sophisticated financial institutions. 

IKB, a large German bank and leading CDO market participant and ACA, the two investors knew about the associated risks.  Goldman pointed out that they were among the most sophisticated mortgage investors in the world, they understood that a synthetic CDO transaction requires a short interest for every corresponding long position.  Goldman Sachs insisted that it never represented to ACA that Paulson was going to be a long investor.  As normal business practice, they asserted, market makers do not disclose the identities of a buyer to a seller and vice versa.  Clearly, Goldman is going to fight it all the way and suits against major broker dealers have been difficult to win.

More generally, the US economy has clearly ended the first quarter on a stronger note than originally anticipated and the second quarter has started even more strongly.  The April manufacturing PMI probably increased to 61.5% and ISI’s company surveys last week were at 46.7 versus 45.4 in March.  Strength in the Empire manufacturing employment index, published on Friday, fits with an improving picture for household employment, which has risen by almost 1.4 million over the past three months.  Credit markets are improving.  ABX prices (ie housing related securities) have surged in the past few weeks from 35.5 to 44.0 and CMBX prices (ie commercial real estate related securities) have risen from roughly 86.0 to 91.5.  Junk bond yields declined last week to 8.05%.

The range of investors’ views is, though, extraordinarily wide. ISI last week tested the views of their clients in a survey and the range of views was wider than at any stage that they can recall.  The expectations for real US GDP growth in 2011 range from 0% to +6%, the range for house prices from -10% to +15% and the level of the S&P index at the year end from 950 to 1450.

One way or another these views will eventually converge.  To our mind, sharply rising corporate profits, strong growth in emerging markets and rapidly recovering world trade argue for higher business spending, still further rises in commodity prices and equity market strength.  It may be that some of this strength has made some investors even more nervous.  Over the last 301 days, the GSCI measure of commodity prices has risen 80.4% - the most ever in an economic recovery. 

Even the most deadbeat areas of economic activity in the United States seem to be catching the mood.  California’s manufacturing PMI for the second quarter increased to 61.7, which is an outstanding figure, and Californian employment data reported last Friday showed that Californian employment over the last three months was actually up 35,000.  New York was up 43,000.

Technically, markets may have been rather overbought in the middle of last week with rises in each of the last seven weeks.  Friday’s action helps to correct that situation but, in our view at least, does not affect the primary uptrend.

Andrew Dalton is the Founder and Chief Investment Officer of the Dalton Strategic Partnership, and previously spent 30 years at Mercury Asset Management in a variety of senior investment positions. His market review will appear weekly in Independent Investor’s newsletter.

Read more...

The SEC and Goldman Sachs: Danger Ahead

The SEC’s action against Goldman Sachs is just the kind of dramatic and unforeseen event that could stop the equity market’s strong rally in its tracks. By chance the day before yesterday’s SEC announcement hit the news wires, I spent some time discussing the state of the markets with Richard Oldfield, a highly regarded investment manager who runs the successful boutique firm Oldfield Partners, and among other things sits on the Investment Committee for Oxford University’s endowment. (He is also the author of a splendidly readable book, entitled Simple But Not Easy, which explains in plain language some of the home truths about the business of investment management that you won’t hear from most practitioners).

Discussing how far and how fast the markets have turned round over the past 12 months, Richard noted how whereas being bullish a year ago was patently a minority view, more recently it has become mainstream, even if volumes remain light by historical standards. Although you can justify the market’s current levels on valuation grounds, given the positive surprises about earnings and economic recovery that continue to come out of the United States, we are reaching a stage where markets become vulnerable to an adverse movement in sentiment. With Wall Street already looking somewhat overbought on technical grounds, it might not take much, he thought, to stop the rally. 

Among other telltale indicators that Richard tracks, he has learnt to keep a close eye on the Bullish/Bearish adviser sentiment index tracked by the technical analysts at Investors Intelligence. When the proposition of bullish advisers exceeds 50% it is a classic warning signal. “I have ignored it in the past and usually come to regret it” , he told me. With the most recent reading at 49% bullishness in the US adviser community against just 18% bearishness, we are approaching just such a point when it leaves the market vulnerable to an unexpected piece of bad news. Barely 24 hours later we have just such a potentially damaging story hitting the headlines.

Why could today’s Goldman Sachs story be that news? Partly of course because Goldman is the pre-eminent investment bank in the world. If the SEC succeeds in proving a case against them for its part in the subprime mortgage scandal, it could well be the trigger for actions against other participants as well. It also signals the strength of the political imperative for the authorities to be seen to taking action against those who were prominently involved in the subprime disaster.

More importantly, try as hard as it might, Goldman has been unable to refute convincingly the unsavoury suggestion that it was effectively playing both sides of the trade as the subprime mortgage market collapsed – helping to create the CDOs that hedge fund managers such as Jim Paulsen wanted to short and then selling them to others of its own clients. The apparent conflict of interest is not only unseemly but potentially, if proved, highly damaging to Goldman’s brand name and franchise.

The 12% drop in the investment bank’s share price yesterday is not an encouraging omen, implying as it does that the market is all too aware of the potentially adverse implications of the SEC’s action. Needless to say, immediate market reactions are often wildly overstated and it may be that Goldman will be able to fight back successfully and contain the damage as we move forward. If the share price recovers quickly, the story may well disappear and the market can continue its upward momentum. I have certainly learnt many times the importance of not over-reacting to dramatic sounding market news, especially when as now equities are due a pause after a strong run.

Nevertheless, to my mind this has all the makings of a red flag which could in time turn out to have wider market implications, of the kind that Richard Oldfield raised as a possibility. Against a still positive outlook for equities, a note of caution is called for.

Read more...

Ken Fisher: Liking What He Sees

Ken Fisher, the West Coast money manager, has been one of my professional correspondents on the markets for over a decade. His directness and knowledge of US market history are always stimulating. He is not always right, but he is never shy of nailing his colours to the mast. Of his many books, the one I find most useful is The Only Three Questions That Matter, which is a treasure trove of useful ideas on market behaviour. These are his latest views, courtesy of his regular column in Forbes magazine.

“I like what I see: improving fundamentals plus skepticism: the classic ingredients of the second phase of bull markets. It's a year since the bull market began, and I remain firmly bullish. I'm often wrongly called a permabull. I'm not one. In 25 years of Forbes columns I turned bearish for three extended periods: in 1987, in 1990 and between 2000 and 2002. Yes, I completely missed foreseeing the 2008 bear market. But that doesn't make me a permabull”.

“When in doubt I am biased toward owning stocks. Stocks rise more often than not. Since bear markets are always followed by bull markets--which is a basic rule some investors seem unable to accept--it seemed to me basic to be bullish once the 2008 bear market was well under way. One year into the current bull market I like what I see: globally improving fundamentals plus strong societal skepticism. Snarky, cranky sentiment and better fundamentals are the classic ingredients of the second phase of bull markets”.

“Economic numbers globally and almost consistently keep coming in up and better than expected, while being largely dismissed in terms of significance. In part this is because the fastest recoveries from the recession are happening in the 25% of global GDP found in emerging markets countries. Maybe it's unnerving that China and Brazil are leading us. Americans are way too U.S.-focused”.

“My Feb. 8 column cited the "pessimism of disbelief," the tendency to see all news as bad, or, if good, as something likely to morph into something bad. (Typical formulation: Stimulus efforts either won't work or will cause inflation.) You can see this pessimism in mutual fund flows: For three years there has been a migration into bond funds--mostly into government bonds for safety--just in time for long-term U.S. government bond funds to return a --17.5% in 2009. That's fear”.

“For more on market sentiment, visit market blogs anywhere. The scepticism is wise-guy thick. Anyone posts something positive and they get pounded by the wiseacres. I love it. This is the wall of worry bull markets classically climb. So be bullish while the sentiment's sour--and keep buying good companies at reasonable prices”.

My Comment: This effectively has been my stance for most of the last 12 months. We have had a market mired in pessimism as a result of the credit crisis in which the majority of investors have been unable or unwilling to credit the strength of the potential global economic recovery.

On fundamental grounds, the case for buying equities at today’s levels has now become fairly weak. The prospective 10-year returns for any investor returning to the market for the first time today are mediocre at best. However it is quite likely that momentum will now carry this bull market phase higher, as more investors come to regret having missed the boat, and for those with the appetite for that kind of risk it is worth staying for the ride.

However, while remaining fully invested,  I am now more cautious and on the lookout for early warning signs of a cyclical downturn.

Read more...

Andrew Dalton's Market Review

Andrew Dalton is the Founder and Chief Investment Officer of the Dalton Strategic Partnership. This is his latest global market review, as at March 30th 2010. These reviews will be posted regularly on the Independent Investor website and in the forthcoming new subscription-only publication.

As we come to the end of the first quarter, it is worth reflecting on what has happened in world stock markets. Generally equities are higher, despite a sharp correction between mid January and mid February. Asian markets have been mixed but North American equity markets, by contrast, have shown considerable strength. The great surprise has been the Japanese equity market, which has done well both in absolute terms and in currency adjusted terms. The impact of currency movements has been considerable. Both the pound and the euro have fallen sharply against the US dollar.

In effect, the UK has seen a major devaluation from its 2008 peak and that process of depreciation continued in the first quarter of this year. As a result of this devaluation, UK industry and business has become more internationally competitive. Markets, of course, have worried about the size of the UK government’s deficit and the outcome of the general election likely in May this year. The euro, meanwhile, has been overshadowed by the problems of Greece and the fear that these problems are both more fundamental and likely to have a more widespread impact elsewhere in Europe too. So far these problems have been contained and Europe, as a whole, has benefitted from a modest rerating of the euro. It is an open question as to how much further this has to run.

Throughout the period, we have remained as fully invested as possible in equities, taking the view that equity markets remain in a primary bull trend. We have taken this view since early May 2009, and had been building up towards that position over the six months prior to that.

Over the quarter, there have been some significant shifts in our asset allocation between equity markets. For a fully invested equity portfolio, we have ratcheted up our exposure to North American equities further – such that at the end of March, our total exposure in this area is around 46% of net assets compared with a 34% exposure at the end of last year. Our Japanese exposure has also risen to around 7% of net assets, for a fully invested portfolio, compared with 2% at the end of December.

This has been possible as a result of a relatively low exposure to Continental European equities (around 5% at the end of March) and by squeezing our exposure modestly in Asia ex-Japan. The latter accounted for 14% of net assets at the end of March, compared with 17% at the end of December. We have avoided bonds, partly because our risk budgets have been fully absorbed holding equities and partly because we remain concerned about the deterioration in government finances in various parts of the world. Our sense is that government bonds are in a low grade bear market. Thus far the selling pressure has mainly been felt in the peripheral euro area bond markets.

The UK budget last week provided a snapshot of the UK’s fiscal position. The UK Chancellor’s budget judgement was relatively conservative. The UK Chancellor revised lower his forecast for the UK fiscal deficit from this fiscal year and the subsequent five years by an average of £9.2 billion a year with the biggest downward revisions in the first two years. In essence, the UK government locked in the gains from the recent better-than-expected deficit prints.

Where previously the UK government had been looking to halve the deficit in four years, it now expects to more than halve the deficit over that period. As a result, the UK government expects to restrict the debt incurred by the end of 2014-15 by a further £75 billion or to 75% of GDP. This decision to save the benefits from improved economic performance contrasts with the Pre-Budget Report where the Chancellor ‘spent’ most of the benefit from positive revisions.

The UK government generally stuck to its GDP growth forecasts. Growth is still expected to be in the region of 1.0%-1.5% for this year which, as it happens, is broadly in line with market expectations but, for next year, the Chancellor nudged his forecast lower by 25bp to 3.0%-3.5%. On the revenue side, the Budget forecasts show a robust 6%-7% recovery in receipts each year from April this year. The main news on the revenue side was the decision to phase in fuel duty in three stages from April to January instead of a bullet 3p increase in April.

No doubt this gradualist approach reflected the imminent general election. There were no changes in VAT, income tax or capital gains tax rates. However, the higher income tax rates and national insurance rates announced in the Pre-Budget Report in December will go ahead as planned.

The UK government’s spending plans were kept deliberately value. However, there will be sharp spending cuts after the general election and there are indications that government departments are well advanced in preparing options for the incoming administration. Meanwhile, so called ‘efficiency savings’ have been stretched to the limit of credibility.

Within our North American equity portion, we have had substantial exposure to Canadian equities which, of course, have a bias towards natural resources. This has been helpful. Canada is a major beneficiary of strong resource prices. Rising commodity prices have helped its currency to rise steadily in recent years. Somewhat more effective regulation has helped Canadian banks to avoid the massive losses that caused havoc in the US and European financial sectors. The fiscal picture also is the best among the major developed countries and the Canadian economy’s performance compares favourably to that of most other developed countries.

The likely strength of the cyclical recovery in the US has been central to our view of the world for the last nine months and that view appears to be working out. The US now has a competitive currency, competitive labour costs, robust corporate balance sheets and economic data confirms that the country is on a solid recovery path. This has been and is likely to continue to be positive for equities. The prospect for US dollar bonds is less obvious. As US economic and financial conditions continue to normalise, real yields should also normalise. Indeed, yields on US Treasuries have been rising - recently US Treasury bond auctions have been received tepidly and 10-year swap spreads have turned negative. In this sense, markets are making a return to the mean move.

In the event, the EU heads of government provided some sort of back up undertaking to Greece last week. There was no commitment to concessionary terms and a role was provided for the IMF which, frankly, is the only institution with the experience, people and processes in place to implement a package and then to enforce the fiscal discipline that will be necessary within a relatively concentrated three year timetable to close the Greek government’s fiscal deficit. This will be painful, as the latest Irish GDP numbers issued last week demonstrate.

We now know that Irish GDP fell by 2.3% quarter-on-quarter in the fourth quarter of 2009. This was far weaker than t he 1.0% quarter-on-quarter contraction expected. At the same time, the third quarter reading was also revised down to -0.1% quarter-on-quarter from a previously reported increase of 0.3% quarter-on-quarter. The contraction in the Irish economy has been led by declining investment (-9.7% quarter-on-quarter, after -10.3% quarter-on-quarter in the third quarter) – indeed, Irish investment has now fallen by a staggering 52% since the peak in the first quarter of 2007.

On the output side, that is reflected by ongoing weakness in industrial gross value added. Elsewhere on the expenditure side, private consumption in the fourth quarter fell by 0.3% quarter-on-quarter and government spending was down by 0.8% quarter-on-quarter. Net trade had little impact in the fourth quarter, with exports edging up by 0.1% quarter-on-quarter and imports falling by the same magnitude. As a result, the Irish economy has now contracted by 12.6% since its peak in the first quarter 2007 (and 18.7% in normal terms). Not surprisingly, asset values have taken the biggest hit. Household wealth has declined sharply.

All of this reinforces our view that European growth faces real headwinds in the months ahead as some deflationary forces are unleashed.

Read more...

Philip Gibbs Goes Back Into Cash

Having navigated his way successfully through the worst of the global financial crisis by moving heavily into cash and Government bonds, Philip Gibbs at Jupiter has once again moved his flagship Financial Opportunities fund into ultra-defensive mode, with more than half the fund now in cash or cash equivalents, according to the latest monthly factsheet.

In an interview with Citywire last week, Philip made the following points:

• The UK financial sector has halved in the last two years and it has left valuations looking attractive. HSBC and Barclays remain the top two long positions in the Absolute Return fund.
• However there is a warning in these ratings as the economy in the West is being artificially sustained by governments. It is “complacent” to put too much in the UK when there are better opportunities in countries with stronger growth prospects. 
• He has a negative view on both UK and Japanese government debt because there are better opportunities in corporate debt. “At the moment, I am long corporate and short government bonds thanks to the yield differential” .
• The economies of indebted nations are going to suffer as debt levels are addressed. Nations such as the UK, US and Japan face high and growing deficits, and without the fiscal firepower to tackle them, the situation will deteriorate if yields rose and debt finance costs rise.
• He is bearish on the outlook for both sterling and the euro because of the fiscal situations in the UK and Europe.
• He prefers emerging market debt, given the more positive economic outlook in the region. Some Western government debt bucks the trend, pointing to Norway as a good opportunity.

My comment: It remains very hard to make a case for Government bonds at current yield levels, and there are good grounds for believing that the great Government bond bull market that began in 1982 is finally breaking down, which will create an entirely new backcloth for investment decision-making over the next 10-15 years. A return to deflation, which would prevent such an outcome, cannot be ruled out entirely, but to my mind now looks good odds against.

Read more...

Crispin Odey: Bullish Again

Crispin Odey has yo-yo-ed in his views about markets, as hedge fund managers are prone to do. He thinks we are in a trading market, but makes some good points in his latest monthly report (see below).

In keeping with my view that this is a trading market, I find that I have again changed my mind and feel rather bullish about the prospects for stock markets over the next six months. Partly this reflects that markets make up their minds in the spring and the fall.

It is now too late for the markets to get bearish. And yet, people are wanting these markets to go down. For all of the fall in the percentage of cash held by institutions signifying that they have become more enthusiastic, the numbers merely reflect that equity markets are up over 50% from their March 10 lows of a year ago whilst cash, (and most people!) are unmoved. There is the first signs of retail investors tickling their way back into equities but again in this season of ISA’s it is worth remembering that over 80% of ISA’s are in cash.

My own optimism for stock markets has a dark side too, but it is based on the fact that equities, at least in Europe, are still so cheap against bonds and property. Ten year government bonds are yielding just over 4%, prime UK property is yielding through 6% whilst the FTSE is on a gross earnings yield of 10%. There is no good reason for the bigger, better, quality equities yielding anything more that high quality property.

The changes in the UK which imposed rates on empty commercial property makes the case for equities stronger, whilst the bigger stocks have the advantage of liquidity. If, and I know that it is a big if, the dangers to this massive build-up in government debt do not make themselves manifest immediately, the strongest trend around will be the arbitraging of bonds, property and equities.

That arbitrage could return over 30% even from here. The dark side is that a period of respite that allowed equities to re-rate, would also mean that when we meet again with inflation, equities will fall just as far and fast as other asset classes. As a trader that makes me excited too!

My view is that while the markets continue to look for direction, there is as yet no reason to think that an end to the market rally is imminent. Although more people are coming round to the case for equities, they are not yet such a majority as to justify a contrarian change in stance.  

Read more...

Andrew Dalton On The Markets

As someone who is required to read a huge amount of written material about investment, I have spent many years looking for experienced professionals who can write both clearly and with integrity about the the changing dynamics of the markets. By that I mean experts who are not just easy to read and understand, but who have the judgment and experience to be able to distinguish between “noise” and substance – to pick out what matters from the daily torrent of information and data that is now available to all market participants courtesy of Reuters, Bloomberg, the Internet and traditional news media.

One of the few who meets this demanding set of criteria is Andrew Dalton, who spent 30 years as one of the key senior management team at Mercury Asset Management before setting up his own fund management firm, the Dalton Strategic Partnership, seven years ago. He is going to be contributing his weekly market reports on a regular basis in future for Independent Investor. This is his take on the events of the week ending 7 March 2010.

The rally which began in mid February has continued last week. The pressure associated with Greece lifted slightly. The Greek government completed a €5 billion bond issue, albeit at 35bp of yield above the market. This provided modest relief to the Euro on Friday. From a technical point of view, equity markets maybe slightly over-bought on a short-term basis. However, there has been a notable decline in selling pressure over the last three weeks, together with signs of greater buying power.

Markets have broadened, particularly in the United States, where it is now clear that mid cap and small cap indices are above their early January highs, even if the S&P itself is not yet there. Economic statistics, coming out of the US have been complicated by severely bad weather conditions in February. Nonetheless, the US Federal Reserve Beige Book gives some comfort that economic conditions continue to improve albeit at a relatively gentle pace.

The US non manufacturing ISM index rose to 53 in February, which was above consensus expectations. The details included solid gains in the employment and new orders components. The ISM indices typically are not particularly susceptible to storm related distortions, which are likely to have a bigger impact on payroll and consumer spending data.

Reports from the 12 US Federal Reserve districts contained in the Beige Book indicated that while economic activity remains at a relatively low level, conditions have improved modestly since the last review and those improvements are broadly spread geographically than in the last report. Ten districts reported some increased activity or improvement in conditions, while the remaining two reported mixed conditions. In the last Beige Book eight districts had reported increased activity or improving conditions. Most districts reported that consumer spending in the recent 2009 holiday season was slightly greater than in 2008 but still well below 2007 levels.

Retail inventory levels remain lean in nearly all districts. Auto sales held steady or increased slightly since the last Beige Book in most districts. Non financial services activity generally improved in districts that reported on this sector. Manufacturing activity has increased or held steady since the last report. Among districts reporting on near term expectations, the manufacturing outlook was optimistic but spending plans remain cautious.

This is all good news from the equity investor’s point of view - a positive story but not overblown. There is still enough weakness to reassure the banks that interest rates are not likely to go up soon. Towards the end of 2009, home sales increased in most districts, especially for lower-priced homes. Home prices, this time, appear to have changed little since the last Beige Book and residential construction remains at low levels in most districts. Commercial real estate was still weak in nearly all districts with rising vacancy rates and falling rents.

In essence this reaffirms that while there are clearly some divergences of opinion between FOMC members, the Fed will not feel any pressure to tighten policy or withdraw liquidity (beyond what is already scheduled). Elsewhere, notwithstanding the strength of the Japanese yen, Japanese exports are recovering quite sharply. Japanese exports have risen 46.8% from a year ago while imports are up 34.7%. The trade surplus in February was ¥99.4 billion, up from a deficit of ¥141.5 billion a year earlier. On a seasonally adjusted basis, exports have accelerated steadily from 0.6% growth (a month) in July last year to a record 8.6% month-on-month rise in January. Meanwhile, the Japanese stock market is cheap still.

The problem is to identify who will be the buyers. In Japan, foreign investors were net buyers of Japanese stocks for the third week in a row last week by a ¥82.5 billion margin (down from ¥100.5 billion the week before). Japanese trust banks, though, were net sellers of ¥86.6 billion shares. Individuals were net buyers but only by a ¥1.0 billion margin, although this compared to being net sellers of ¥49.0 billion the previous week. The press commenting on the Japanese Ministry of Finance’s latest corporate statistics report are still pessimistic and focused on the weakness of current corporate fixed investment spending instead of the 102% rise in profits. In fact, Investment spending has fallen 17.3% from a year earlier.

Our guess is that it will pick up. Anyway, Japanese corporate profits bottomed in 2009 January to March quarter, albeit at a historically low level. Looking at the four previous corporate earnings upcycles excluding the current one), on a simple average basis they have lasted 13 quarters, which suggests that the recovery will continue quite some more time. Capital expenditure has continued to fall but, historically, capital expenditure bottoms out approximately six months after capacity utilisation bottoms out, which has already happened. We remain modestly positive about Japan.

Read more...

A Powerful Argument For Global Equity Income

I have felt for some time that one of the biggest current risks for investors is that they become so bemused by the gloomy news coming out of the United States that they will miss the strength of the potential recovery in US equities this year. There are several reasons why the two trends – gloomy economic news, positive corporate prospects – are even more than usually out of synch with each other. I am grateful to Guy Monson, the CIO of Sarasin, for providing more powerful evidence of this important divergence, which has big implications for investors.

The most important reason for the divergence is that even though both the consumer and the public sector remains mired in debt, the US corporate sector has come out of the credit crisis and recession in extraordinarily good shape. In fact, as Guy points out, well established companies, especially those with a global market presence, have rarely faced better conditions – minimal domestic inflation, a super-competitive dollar, strong balance sheets and falling unit labour costs.

In fact, while it is true that the banking system remains extraordinarily fragile, and domestic demand is constrained by high unemployment and personal debt issues, for those companies looking beyond domestic boundaries the world has never looked better.  The critical point is that while there is no doubt that economic leadership is shifting from the West to the emerging markets, led by China, this trend provides an exceptional business opportunity for competitive exporters with strong brands, global distribution and access to the fastest growing markets.

This happy state of affairs is already reflected in two highly visible trends – the rebound in corporate profits in the US, which is as sharp as the decline that preceded it and the recovery in the US trade balance, which has already been halved from its peak and is likely to continue that way, absent a further sudden shift in the value of the dollar. Meanwhile, measured against bonds (admittedly a narrow valuation measure), equities still look more favourably valued than at any time since the 1970s, despite the rebound we have seen from the lows in March 2009, according to Ned Davis Research.

For investors one of the most important implications is that the case for thinking we could be facing a rerun of the Nifty Fifty years of the 1960s, when large global companies led the global markets higher, looks well founded. Just as importantly, these conditions greatly increase the attractions of global equity income as a home for investable cash – whether you choose to access that emerging trend through a fund or directly through investments in individual corporate equities.

For UK investors in particular, this looks a much more attractive option than conventional UK Equity Income funds, which increasingly reflect the lopsided and highly concentrated nature of the UK stock market, with its dominance by just a few companies in 2-3 highly exposed sectors, principally energy and drugs companies.  Just five stocks now account for more than 40% of the total dividend payments of the FTSE All-Share index. The two largest oil majors, BP and Shell, account for 25% just on their own.

UK equity income funds are where the money is tending to flow as investor confidence slowly returns. Guy’s argument is while equity income in general is a sound place to be looking, the lopsided profile of the UK market is exposing investors in those funds to a degree of concentration risk with which, did they but understand it, they might well entitled to feel uncomfortable. According to Sarasin’s analysis, Glaxo and Vodafone between them make up more than 10% of the value of eight of the most popular UK equity income funds. All but one of them have more than 30% of their portfolios in just eight of the largest UK stocks.

As a firm that specialises in global thematic investing, it is no surprise to learn that Sarasin is currently pushing its global international equity income funds as an alternative. One needs to lay off for a degree of talking their own book. However self-interest does not mean that they cannot be right and the evidence in any event speaks for itself. (By way of disclosure I am sufficiently persuaded of the merits of the argument for switching to global equity income that I own units in one of Sarasin’s international income funds and have looked at those of other providers as well).

The key points to take away are not open to challenge. The UK stock market has always been more concentrated than most other leading markets, because of its dependence on banks, oil companies and pharmaceuticals. In the US the 10 largest companies account for less than half the proportion of the market that they do in the UK. The universe of potential dividend-paying stocks outside the UK is therefore both more diversified and less vulnerable to dividend cuts than its UK equivalent.

More importantly, whether or not you like the idea of the Nifty Fifty (the craze for which, it is worth pointing out, eventually ended in tears in the 1970s),  there remain good reasons for thinking that large companies with strong fundamentals and global reach are liable to perform well in the shifting global environment we now face. They certainly look a better bet in relative terms than anything you can find in the bond market, in which for all their diversification value, it is surely only a matter of time before the secular bull market of the last 25 years finally runs its course.

Read more...

The Great Wall of Worry (FT Column)

If my experience is anything to go by, few recent events in fund management have aroused as much interest as Anthony Bolton’s decision to return to full-time investment management with a new China fund for Fidelity. By doing so he seems to be breaking Jeremy Grantham’s golden, and all too well evidenced, rule that the biggest dynamic shaping the fund management business is career risk (avoidance thereof).

Why on earth is such a celebrated stockpicker taking a chance with a new venture that could so readily backfire and jeopardise the remarkable reputation that he has spent 30 years acquiring? After all, when Mr Bolton retired at the end of 2007, his track record was second to none. His Special Situations fund outperformed the FTSE All –Share index by an extraordinary 6% per annum over a period of 28 years. The European fund he ran for 13 years until 2003 also beat its benchmark by a handsome margin.

Having timed his exit from fund management with impressive prescience, handing over his Special Situations fund just in time to avoid the savage 2007-09 bear market, it is certainly a high risk strategy to come out of retirement and launch a new fund whose mandate is to invest in what many believe to be an already overvalued emerging market on the other side of the world of which he has only limited knowledge and experience.

Mr Bolton speaks no Mandarin or Cantonese and by his own admission has always been terrible at foreign languages. He won’t be learning the mother tongue of the country in which he will now be spending his time looking for investments. By any stretch of the imagination, this is what Sir Humphrey of Yes Minister fame would have called a “brave decision”.

The prospectus for the new closed end fund will be published this week. The target Fidelity has set for the launch is raising $1 billion. This makes it not only one of the biggest investment trust launches of all time in the UK, but ensures that if it fails it will do so in the most visible way – career and reputational risk, in other words, on a grand scale.

Nobody who knows him will assume that Mr Bolton is taking on his new venture lightly. It is a safe bet that the timing of his China fund launch has been carefully considered. The idea that he is moving to Hong Kong solely to take advantage of a lower tax regime, however appealing that may be to a citizen of the near bankrupt UK, does not stand up to scrutiny. Nor, despite the huge marketing push behind it (Fidelity is paying trail commission to intermediaries for the first time on an investment trust launch), is it credible that he has been somehow bullied into running the new fund to boost his employer’s flagging UK sales.

Having first taken an interest in the Chinese equity market several years ago, there is no question in my mind that Mr Bolton’s enthusiasm for the stock picking opportunities in China is genuine. While he has only committed himself to two years running the new fund, something that makes many advisers nervous, it is inconceivable to me that he would abandon the fund in the event that the Chinese stock market were to crash, as many sceptics seem to think is likely.

Having interviewed him recently for Independent Investor, I suspect that Mr Bolton regards talk of a bubble in Chinese stocks not as overdone – clearly, it could happen any time – as somewhat beside the point. It is inevitable that Chinese stocks, like all emerging markets, will be more volatile than developed markets, but that is part of the price you pay for potentially exceptional returns. If the market does fall a lot, it can also rebound even more strongly. By choosing a closed end structure, Fidelity is presumably guarding against such an outcome.

For all the talk of a bubble, the Chinese market remains at barely half its all-time high; its economy is poised to reach the level of GDP at which historically an emerging economy makes a decisive shift towards consumerism; the stock market is far from efficient; and the currency over time is a near certainty to appreciate, providing a built-in safeguard for UK investors. All these are positives for any investor prepared to look beyond the very near term.

In advance of the prospectus, it is impossible to judge how well the new fund will perform. What can be said for sure is that Mr Bolton is staying true to his own principles. 30 years ago he concluded that the only way to outperform the market was to do something different from the market. That, after all, is what being a contrarian means. Whether it succeeds or fails, the new fund guarantees that his name will be remembered long after many lesser mortals have taken their consensus thinking and risk aversion to the grave, lamented by few.

Read more...

The Case For The Doubters

Those who read the Q and A with Sebastian Lyon of Troy Asset Management last July will be familiar with his conservative, hairshirt style of investing. At recent meetings for investors in his funds, which now include the Personal Assets investment trust, formerly managed by Ian Rushbrook, he updated his views on the market outlook.

These are some of the key points in his presentation:

As a result of the global financial crisis, investors are living in "a phoney world" characterised by zero interest rates and asset prices that are distorted by quantitative easing, among other things;

The consequence is that few investors, even professionals, know what to think. Picking a path through this unprecedented set of conditions is like "being in a dark room looking for a black cat that isn't there";

In Sebastian's view, the secular bear market which began in the year 2000 continues, meaning that the UK stock market is likely to follow a similar parth to that of the Dow Jones index between 1966 and 1982, rising and falling within a trading range (that range, in the case of the FTSE 100 index, being 3500 to 6500);

Most likely that means the equity market will experience one more low before a new secular bull market begins in a few years' time. The trigger for the new setback is likely to be a sustained rise in bond yields;

The current cyclically adjusted equity market p/e ratio, though down from its peak, is still in the top quarter of historical experience and the dividend yield, following ten months of rising markets and many companies announcing dividend cuts, is "nearer poor value than good value";

Given his mandate to preserve the real value of his investors' money, and faced with this unappealing outlook, Sebastian has been buying stocks such as Diageo and Nestle, which have impressive records of growing their dividends (sevenfold in the last 20 years in the case of Nestle);

The companies he is avoiding like the plaque are those such as Cookson and British Airways, whose CEO Willie Walsh has to spend his time firefighting successive crises rather than planning for the future (BA has not paid a dividend since 2001);

Another big holding in both Personal Assets and Troy's flagship fund is gold, something that most investment trusts have never held and many investors hate. Yet gold, which J.P.Morgan described as "money and nothing else", is the ultimate store of value and the only sensible protection against inflation and policy errors in an era of fiscal excess;

Sebastian was keen to point out, finally, that despite the cautious mandate of his funds, he was by no means a "perma-bear", as his successor Ian Rushbrook had never been either. He looks forward to the time (2015?) when the secular bear market has ended, gold is no longer needed in the portfolio and the funds are able to gear up to particpate in the next equity bull market. That time however is not yet here.

Comment: I am a fan of the Troy approach to fund management, not least for its emphasis on low turnover and reraswonable management fees, although I think there is a serious risk that the rebound in the US economy may well surprise this year by being stronger than cautious investors such as Sebastian expect. My own portfolio includes gold and defensive equities for similar reasons to his.

This quotation from Gerald Loeb, author of a classic book on the stock market, with which Sebastian finished his presentation is also very apt: “Profits can be made safely only when the opportunity is available and not just because they happen to be desired or needed...Willingness and ability to hold funds uninvested while awaiting real opportunities is a key to success in the battle for investment survival”. In other words, there is nothing wrong with staying in cash when no clear-cut opportunities for stock market profit appear to exist.

Read more...

Politics Is Back In Vogue (FT Column)

If you are not a fan of forecasting, and have no reason to be sure what is going to happen over the next 12 months, it makes a lot of sense to start the year, not with a set of predictions but with two lists – a wish list and a watch list. As well as being good for the spirits, positive thinking is helpful from a risk perspective. It is much easier psychologically to take precautions against a wish not happening than it is to assume that a public prediction will turn out to be wrong.

This, in any event, is very much the way that many fund managers seem to operate. I have lost count of the number of times over the years that active fund managers are heard to say that what we are facing is a stockpickers’ market – or, to put it another way, a range-bound market that will reward those with suitable skills. As far as I can see, this more often than not is also wishful thinking.

Even if it is true in one year, it rarely is in the next. In 2009, did you need stockpicking skills to spot and ride the market rally? Not really. The most important thing was to be in equities at all, and then the best thing to do was chuck away your analytical sensitivities and pile into high beta stocks regardless of merit.

With the market having rallied so strongly since its lows in March, it is easy to say that 2010 will be different. The so-called “dash for trash” may already have run its course. Large cap quality stocks must be the better long term bet at today’s values, but that does not make it a sure thing that the rotation will persist throughout this year. 2010 has started with a bad January for equities and risk assets, which if you believe in such things, bodes ill for the rest of the year.

However these are early days,and although sentiment has clearly taken a turn for the worse in the last three weeks, with the hedge funds mounting a concerted assault on the risks of Government bond defaults in the Eurozone, it is still premature to write off the rest of the year. The Bank of England’s decision to call a halt to quantitative easing is a valiant statement of intent that it wants to return to more normal conditions, but it may yet be derailed by a return of investor nervousness. 

Meanwhile, whether or not you buy into Pimco’s “new normal” hypothesis, what is undeniable is that politics has returned with a vengeance to centre stage, and with it the parameters of risk are changing. With unemployment (or the fear of it, as in China) still running high, new political battle lines are already being drawn in many countries. The Massachusetts election result, to give one example, is clearly a potential game-changing event.

For central bankers and politicians alike, operating in unprecedented conditions with the usual inadequate data, the risk of policy errors remains extremely high. The government debt crisis towards which many countries are now hurtling presents plenty of opportunities for false steps, as well as a wonderful scare story for hedge funds to hunt down, as they are doing.

As experience warns us that this kind of environment is one that is full of perils for investors, a measure of caution is undoubtedly justified. In fact, it seems more likely that the markets’ nervous start to 2010 is best attributed to a heightened sense of political risk than to any change in corporate or economic fundamentals, where as far as can be told the recovery in the United States, at least, is so far well up to expectations, with two thirds of companies beating earnings expectations and support from a steep and rising yield curve. The Government debt issue itself is not news, but how well the markets think governments will react to the problem most certainly is.

Top of any wish list for 2010 must be a return to higher interest rates and rising bond yields. Although this prospect is something that seems to terrify many Western governments, faced with spiralling public debt, it is a essential pre-condition of the world returning to normality. A combination of unprecedented public sector intervention and artificially low interest rates, while it may be justified as a short term expedient, is a surefire path to misallocation of capital and economic stagnation. A failed political response to the debt challenge is the corollary for the watch list.

The risk to investors arises from the fact that, while the voters of Massachusetts seem to have recognised the dangers in fiscal irresponsibility, the administration in Washington does not yet appear to share that opinion. Equally concerning is the fact that the Federal Reserve and many other central bankers seem to have become dangerously fixated on low or even negative real interest rates at almost any cost, as if somehow that is a desirable norm, which it most definitely is not.

The point that should worry investors most is that politics is non-linear. The dynamics can change fast and in unpredictable ways. Politicians tend systematically to overlook the second and third order effects of decisions they make today. Given the likely volatility, the odds are that 2010 could be an eventful year, with an emerging story of better-than-expected recovery (as I see it) threatened by shifting investor worries, continued bank frailty and complex but interesting political and policymaking manoeuvring whose outcome is uncertain and imperfectly knowable.

Read more...