Monthly Archives: May 2012

Market Comment 29 May 2012

(sorry I meant to post this yesterday, looks a bit optimistic by now!)

May has been a painful month, but the last week showed a degree of improvement, at least in equities. The S&P 500 Index in the US rose 1.7%, and the Eurostoxx 50 Index rose by almost 1%. Russia slipped a further 1%, but ended the week well off its lows, and China did the same. The currency market was more volatile, as the euro lost nearly two percent against the dollar, and gold lost 1.3%. The crisis continues unabated, but this week there are grounds for tactical optimism as markets are heavily oversold.

The immediate driver is Greek news, where the less radical parties appear to be gaining popularity. If the population is starting to see the choices as either exit the euro or continue with austerity, then there is clear ground to hope they will vote for the latter. Despite the rhetoric and the understandable angst, most Greeks remember that the drachma was not a kind currency to them. Greece has seen great gains since joining the euro, even despite its current troubles.

Finding profitable investment opportunities remains tricky. Emerging market stocks have been sold down to distressed levels. Investors understand that the a financial panic will bring far more selling, but in less catastrophic scenarios, these are appealing entry levels with exciting upside potential.

Russia is now trading at less than five times expected earnings for this year. Considering the recent improvements in dividend commitments (the index is now close to 4% dividend yield), the market should be trading differently. Russian stocks could go lower, in a global credit freeze, but there is little reason for them to stay lower. We would recommend picking up a few dividend stocks as a hedge against the European crisis stabilising in the short term. (Call us for some suggestions.)

China too is looking attractive. It’s earnings ratio is below 10, compared to a five year average of more than 15. Again, the market could go lower, but it already looks cheap. It is important to remember that, contrary to in the 2008 cycle, this time the Chinese economy is slowing because the government wants it too. And, in fact, policy has begun to reverse – the last actions were aimed at stimulating more growth.
Short-term equity targets make sense in this market, focus on quality stocks with low valuations and/or healthy growth paths. Gold targets also make some sense if you holding is less than 10%. The metal has well demonstrated its weakness as a safe-haven, but the risk-return profile is shifting more positive.

Best regards,


That Infamous IPO

The IPO of Facebook, at 100x earnings in the middle of a period of extreme financial stress has unleashed a cacophony of criticism. How quickly we forget the basics of finance, or is it that our industry is still home to too many that never grasped them anyway? Here are some guiding points:

1. The valuation was not pulled out of thin air, nor was it set through an entirely democratic bidding process (had it been, the final multiple would likely have been far higher). As is usually the case in IPOs, especially those of nascent industries with less obvious track records, the Facebook valuation was essentially negotiated with a small group of very large institutional investors. True, Facebook wanted the highest price possible, but the largest institutional investors also wanted returns. These two parties sat across from each other and negotiated what they thought was a reasonable valuation level.

2. The underwriter took risk, which is why they had to intervene to stabilise the stock in early trading.

3. The buyers took risk, because this is a nascent industry, there is no telling if the market will accept their idea of what a fair valuation is.

4. The sellers took risk likewise, because the market may ultimately decide that a fair valuation is far higher.

5. The share price is now 18% below IPO level. But it won’t stay there. Reasons for selling so far include: the technical failures of the Nasdaq in early hours, which mean that investors want to get out rather than risk being stuck; disappointment that the stock didn’t leap at the open; and overall market conditions.

6. It is no coincidence that the S&P Index doesn’t accept companies until they have established a stabilising history. New companies are often volatile.

The sharp fall in Facebook does not represent an IPO failure, only a disappointment for lazy speculators who hoped to make easy profits from a massive, risky and technically difficult share issuance. There is a reason that Facebook management has not responded publicly to what has happened: It is not so unusual, and thus far does not represent a failure of management or even the underwriter.

We will have to wait for the early trading to calm, and possibly for the company to prove its worth before we can judge the success or failure of Facebook’s IPO.

Market Comment 21 May 2012

It was another painful week on markets. In the absence of any clear drivers, the easiest route for prices was down. The S&P 500 Index in the US lost 4.3%, the Eurostoxx 50 lost 4.9% and Emerging Markets lost 6.6%. (Russia lost 12.3%, on low demand as oil fell 4.6%.) The EURUSD continued to edge down. The bright spot was gold, which rose nearly 1% on the week – in last week’s letter we had noted that it was becoming more attractive after a sharp correction.

There is other good news too: Trading volumes were high globally, a sign that we may be entering a new phase of the sell-off.

Markets are reacting to some extreme risks, but so far economic activity doesn’t seem to have collapsed to the extent that equity prices imply. This makes the market look cheap, and at a time when politicians are finally getting serious about putting growth on the agenda.

The path ahead is of course highly uncertain. Will Greece leave the Eurozone? The next election will take place in mid June. None of the political parties wants to leave the single currency. And Europe has expressed willingness to help with growth measures, so behind the rhetoric there is hope for a compromise. But, the EU will not give ground on core concerns, and will implement contingency plans to protect member states from contagion if Greece does go.

The future looks brighter then. We have highlighted many times that the Eurozone needs to have growth on the agenda, and possibly even less stringent austerity conditions. This week there is a European Summit which will consider exactly this point. It is concerning that Spain’s financial reporting is under the spotlight, but even so we could see something of a rebound in the days ahead.

It is unclear whether any price recovery would hold – the technical indicators still look weak. But, I would expect more resistance to falling prices this week. If I’m wrong, and we see further sharp selling, it may be a good opportunity to buy more. Market prices are already reflecting worse outcomes than we might reasonably expect. As before, we would focus on globally exposed and high dividend stocks. There are quality businesses available at low prices.

Best regards,


The Thing About The UK Economy

After spending a considerable time watching the UK political debate at this crucial juncture, I feel compelled to address several deceptions, largely being expounded by Labour, but certainly with broad appeal throughout the media regardless of political leaning:

– The deficit-cutting policy was right. It has given the UK government a degree of credibility that wouldn’t have been there had it launched on spending despite having the largest deficits in Europe. Now, if things worsen, then the UK can increase spending, with market support. There will be claims that this is a U-Turn, it is not. Rather it will be a reaction to the changing circumstances, only made possible by responsible responsible fiscal planning over the last two years.

– Comparing the UK to the US is not realistic. The US is the biggest economy on the planet, and has global reserve currency status. They have the freedom to pursue more expansive fiscal policies due to their global importance. The world could and would have turned away from the UK in a flash had it done the same thing. Not only because the country’s finances were in a far worse condition. Also because it is simply a smaller and less important currency. The coalition has succeeded to maintain the pound as a safe and appealing global currency, an essential pre-requisite to attracting investment.

– The banks are not responsible for failing to lend. They could go out and lend tomorrow. Everyone knows that bankers like making money, and they do that by lending money. Why are they not lending? Because their regulators demand they reduce their lending levels. If they lend now, they breach regulatory constraints. The banks are not choosing to constrain money, the system needs to adjust to allow lower capital constraints at the bottom of the cycle, or to get to new capital adequacy standards more slowly.

Luckily, the public is increasingly aware that Labour is failing to take a stance on what to cut and what not to cut. It’s no good just saying all cuts are bad. Labour still ranks as untrusted on the economy. Small wonder.

When this government took power they said it would be a long slow and difficult path. It’s harder than anyone wants, but why is the everyone so surprised that it is not easy?

– NB I am not a party member nor an active voter. I am an apolitical economist.

Market Comment 14 May 2012

Markets performances were mixed last week, the S&P 500 Index in the US lost 1.1%, mostly on European related fears, but the Eurostoxx 50 Index was essentially unchanged, after five days of volatile movements. More general indicators of global nervousness, the EUR/USD exchange rate, gold and the price of oil all continued to fall. The European bond market also sent a clear negative signal.
The key issue, as we highlighted in our previous letter, was Greece, where the key political parties are struggling to construct a coalition government. If they do not succeed in the next few days, a fresh election will be called, and parties will likely campaign on clearer political platforms: Stay in the euro and continue with austerity, or leave the euro and pursue expansive policies.
The former idea is painful, but the latter will be even more damaging. How did Greece get into this position? Largely through the inability of its leaders, and those of the Euro Area, to reach a quick enough consensus on how much austerity was needed. Many say that austerity is no solution. But the case of Latvia (recently raised back to investment grade by S&P) shows otherwise. Austerity can work, but it takes a sharp and determined effort. In Greece, the process has been slower and so more painful, dragging on for several years. It is little wonder the population is exhausted.
For us as investors, it matters which path Greece follows. Markets are pushing against strong resistance levels, which demonstrates the global concern. New elections would likely see markets breaking down further, even though many assets are very cheap already. On the other hand, if Greece forms a government of stability, then market prices should stabilise and begin to rise.
In such an environment, I look for investments that are less dependent on Greece itself. Gold has sold off dramatically, and is becoming attractive at current levels (remembering that it is a volatile speculative asset class rather than a safe-haven). The dollar too has scope to benefit further too – the US economy is relatively healthy, and the dollar is a safe haven. As markets sell-off, I also like high dividend stocks, and global businesses that offer the chance to benefit from strong Emerging Market dynamics.
Best regards,

Market Comment 7 May 2012

It should not be a major surprise for our regular readers that markets have been weak since our last letter. The core European equity index lost 4.1% last week, the US lost 2.6% and EM markets lost 0.6%. The key market mover was oil, another dynamic that regular readers will have been prepared for. The world has been producing a million barrels per day of excess capacity for weeks now, coupled with lower than estimated risks of war in the Middle East, and weaker than expected growth globally, it was only a matter of when the oil market would reverse, not if it would.
The current week is also likely to exhibit considerable investment uncertainty. Over the weekend, political change has been confirmed in European economies, accelerating the euro decline that started some days ago. Whilst the media attention is on the French election, it is arguably more important for investors to look at Greece. True, political change always causes uncertainty, but the new French president remains committed to correcting France’s deficit.
In Greece, there is a rising interest to review austerity agreements to stimulate growth. Unless the Greek politicians manage to frame this argument in a way that doesn’t reverse the path of fiscal repair, there is a danger of that country returning to the forefront of the risk agenda.
News from the US was also less than positive, as jobs data missed estimates, but it is far from disastrous. The US has still added an average of 200k jobs per month this year. Recovery is not as strong as many want it to be, but it continues to show healthy momentum.
Where does this all leave us? The risks are certainly lower than last year. There is no nation in the same condition that Greece then was, the market has a clearer understanding of steps the ECB can and will take to respond to market breakdowns, and European politicians are moving their emphasis toward pro-growth reforms. Recent political developments can only serve to accelerate this process.
Downside risks are more contained then, so we stand ready to buy as markets are coming down. What you do next depends on your existing exposure. If you are significantly underweight equities in your portfolio, this week is a sensible time to make first purchases. However, it is likely too early to rush in with strong conviction. In these volatile markets, it is better to wait for signs of a turn before shifting from risk aversion to increasing optimism.
The US remains a clear preference to Europe. And the key message is short-term caution, markets are getting oversold and close to technical resistance, once they get there, we will see if they manage a tactical rebound.
Best regards,