Merryn Somerset Webb: There’s only one real question to ask at the moment. Is the market in long-term crisis, or is it offering us an amazing buying opportunity?
Tim Price: I think it’s absurdly early to call an end to the consequences of the rolling debacle that has come out of subprime in the States. It seems fairly clear that the contagion has spread far beyond any tiny outpost of the US mortgage market to the credit markets as a whole. Stocks may be no more than drive-by shooting victims of the credit-market, but their volatility, along with the interventions of the central banks, shows just how scared people are. My guess is that there’s plenty of pain and uncertainty to come.
MSW: With all the current talk of Fed rate cuts, do you think the central banks know something that we don’t?
TP: They must feel there is a reason for pumping so much liquidity into the markets. The hedge funds we speak to have all dashed for cash. They’re nervous too. Some of the larger players are now 100% liquid and some are even preferring T-Bills over actual cash, as they don’t want their money in a bank. They don’t want to be exposed to potential corporate failure. I haven’t seen that level of concern in my career before – and that includes 1998.
MSW: Given this, you’d think the gold price would have gone up a bit more.
TP: You would, but the way the market moved last week appeared irrational all round. People weren’t necessarily selling the stuff they didn’t want – just the really liquid stuff that they could sell in a hurry – that’s why the miners got so badly hit and Bristol-Myers, a broadly conservative US pharmaceutical stock that we hold, fell 6%-7% in a day. The same goes for gold, I suppose. Recent market moves haven’t exactly been rational.
Martin Millar: I agree that it’s too early to be sure how all this will end, but so far we are not seeing signs of trouble in the real economy. Across Europe results are continuing to surprise on the positive side. This is still a liquidity event in the financial markets, rather than a real event in the economy.
TP: But you have to ask how much of the economy is driven by finance and financial services. The results from Wal-Mart and Home Depot last week show us that the US consumer is starting to feel the pain. I would argue that this crisis has transcended to the real economy – at least as far as the US is concerned.
James Ferguson: I’ve been thinking about how all this might play out for some time – I’ve been expecting it for months. It seems to me that it is going to have a major impact on the US consumer and that the US is looking either at a growth recession, or possibly even a technical recession, depending on how things pan out. I don’t think anyone will argue that the re-pricing in the credit markets isn’t going to make life much harder for all the people who took out mortgages with low, two-year teaser rates and are now seeing those rates double, or even quadruple. Throw in high utility bills and food inflation and the US consumer is in a tough situation.
Having said that, I am still inclined to believe that all this isn’t about the availability of credit, but the pricing of credit. This is where I might disagree with Tim. I can see how things might get unbelievably bad for near-term mortgage-backed securities, namely those issued in late 2006 and early 2007, and I’d also say that you should assume all CDOs are toxic until proven otherwise. But even so, if you look at, say, high-yield credit spreads and corporate-bond credit spreads in the US, they may have risen a lot, but they still aren’t very high at all.
People have been talking about this being the worst credit market they have ever seen, but if so they can’t have been in the market more than a few years. Credit spreads ten years ago were about 11%. Now they are 3% – you had to pay 8% more to borrow money if you were high risk than if you were low risk. So why the panic now? Look at the bond market without listening to the hysteria and it will tell you that you don’t need to worry that much. Still, while everyone else is panicking, we might note the important thing from the equity point of view; namely, that the credit bubble of the last few years hasn’t really pushed a lot of shares up, so it shouldn’t – rationally speaking – push them down either.
TP: Except in that private equity has fuelled huge rises in the prices of second-tier stocks thought to be targets.
JF: I’m talking about FTSE 100 stocks. There I can see very compelling value, both in terms of dividend yields and earnings yields.
Luke Newman: I’d agree – the sale of more liquid assets means that there does seem to be value out there. There are complications – all the unknowns in the financial sector, for example. But if we look at things from the bottom up, this market is interesting. Until now it’s often private-equity speculation that has persuaded the equity market there was value being missed in any given stock. Now I think that the big FTSE 100 firms might take over that role. Consider what they’ve been doing with their capital recently. By and large, they’ve been using their cash – of which they have a lot – to buy back their own shares. Now private equity has found its funding sources getting tighter, we might see them getting into mergers and acquisitions instead. So the market might suddenly be driven by real companies with real cash. That makes me feel positive.
MSW: Ed, you look at Japan. How are things there?
Ed Cartwright: Horrible. The property market looks good, but that’s about it.
MSW: You must be excited about the yen rising though?
EC: I think its bounce is short term. The Japanese want their money to be abroad. In May, Pictet Asset Management launched a fund in Japan investing in international stocks with yield around the world. So far, they have raised $20bn. The Japanese retail investor doesn’t want to invest in Japan and I can’t see how the market can rise while that’s the case. The only thing propping up the market has been foreign buyers – and they’re all selling now too.
TP: To me, this just sounds like the time to buy – everyone is capitulating – it must be the bottom!
JF: I’d be really cautious about selling Japan right now. It is very over-sold from a technical point of view. I think it looks interesting. All the other markets around the world seem to get more and more correlated with each other, but Japan remains a bit of a perverse play. It isn’t that correlated, so it’s a bit of a hedge against everything else.
EC: There is one interesting part of the market – companies that either have a manufacturing base in China, or cater to Chinese consumption, have been doing well – there appears to be a China premium now.
TP: The Chinese markets define everything. They’re quite a force of nature.
MSW: That brings us back to the cheap commodity-related companies in the FTSE 100, doesn’t it?
LN: The market is still grappling with the sustainability and duration of resource earnings. How long will they really last?
TP: For me, this is an opportunity. Analysts have got resources wrong for years – they refuse to believe in the commodities super-cycle – and I’m sure they’re not suddenly going to find religion in this type of environment. That makes the big miners stand out as long-term buying opportunities.
LN: Yes. I don’t know what is going to happen in China in a decade, but you just have to look at the cash flow to see the value here. Some of these big firms are making enough cash to buy themselves in 2.5 years’ time, as long as the status quo continues in terms of commodities demand. And it’s quite easy to think that it will for that amount of time. The shares have gone up a lot, but thanks to matching operational performance the actual valuations have not.
JF: I think the reason the FTSE 100 looks so cheap is simple. For a while now when people have had the choice of buying FTSE 100 or something else, they’ve chosen something else; like the FTSE 250, which, what with all the private-equity interest, has just seemed more exciting. Everything appeared likely to get a bid at any second. Traders can’t wait months for Shell to prove it is good value, they just want to make money in a hurry – especially the new breed of hedge funds. There have been a lot of bond strategy funds out there putting money into all sorts of dodgy stuff – particularly mortgage-backed securities – in the knowledge that they’d blow up. Why? Because they hoped they’d make a good few years’ worth of huge performance fees before the blow-up came. And most of them have – they might have to shut their funds, but they won’t be poor.
TP: Turns out, doesn’t it, that a lot of hedge funds are nothing of the sort. My understanding of being hedged is reducing, rather than insanely leveraging, risk. Many funds seem to think otherwise.
EC: It’s true everyone knew this credit crisis was coming. I’ve spent the last two and a half years saying corporate credit spreads are suicidally tight and this couldn’t continue for a sustained period of time. So there is nothing strange about this situation coming to an end. Everyone knew it would. What we didn’t all know was the extent to which it would spread through the rest of the system.
MSW: How many hedge funds are there going to be in a year’s time?
TP: Fewer than there are today.
EC: In Japan, we’ve had more than 20 closures recently. In London, New Star stands out as a fund that’s closed its Japanese hedge fund, but there are others. People do vote with their feet. They don’t see you making money and they move on very fast. They can be flighty.
MSW: So what would you all buy right now?
JF: I’d buy the FTSE 100 – with a tracker or an Exchange Traded Fund, perhaps. If I was buying individual stocks, I’d probably avoid the banks, but I would certainly load up on oil. Shell and BP are outstanding value. And there might be one bank worth buying – Lloyds, on a yield of 7%, really looks like it offers value. It’s one for the brave anyway – the very brave.
LN: But Lloyds has been at a yield premium to the UK market for the last three years. There may be a problem here when it comes to bad debts if we are, say, six to nine months behind the US in terms of trouble in the housing market, for example. So I’m prepared to leave the banks alone. I certainly see a lot of value in the FTSE 100, but I wouldn’t just buy the index.
MSW: Are you nervous about the UK property market?
LN: Yes, I think we’re unlikely to see the same sort of gains in the UK property market as we’ve seen recently.
JF: But the banks are well hedged against property this time round, so I don’t see a property crash proving the same kind of problem as it did in the 1990s. They’ve got a much lower loan to value on the average mortgage, for example. I’m very bearish on the property market as a whole. The rise in credit spreads effectively means that there has been a 25-50 basis point rise in interest rates for anyone about to get a mortgage. I wouldn’t like to be a newish buy-to-let investor with 200 flats in Leeds. But that doesn’t mean I am necessarily bearish on all the banks – property prices would have to fall even further than I think they will for them to be in trouble this time.
LN: I think there is something else that will cap any real downside in much of the stockmarket. There is liquidity out there in the form of sovereign buyers from the Middle East and Asia who may well step in if prices fall. Now, what’s their cost of capital? Zero? 1%? They are not playing the same games as private-equity firms – they can buy and hold for a long time.
JF: The sovereign buyers are interesting, in that they might provide some sort of catalyst for the switch in market interest from buying the FTSE 250 to the FTSE 100. These guys aren’t interested in the small- to medium-sized companies. They are much more obviously interested in the big guys, for reasons of liquidity, longevity and asset capturing. I think all the things we have been discussing will work together to provide a very attractive two- to three-year horizon for large-cap stocks.
TP: For anyone who is still really bearish on financials in America, here’s something to buy. It’s a US-listed ETF called the Ultrashort Financials ProShare (SKF) and it is 200% inverse leveraged to the Dow Jones US Financials Index – so one to buy if you really hate US banks, which I certainly do. My other tips, on the basis that we are not on the brink of Armageddon and that the Asian infrastructure story is intact, would be two US-based engineering construction businesses, KBR and Fluor.
MSW: Ed, anything you would buy?
EC: If I was an institution and I was able to, I would buy the one commodity that I am still stratospherically bullish on – volatility. We’ve been buying a fund called Artradis in Singapore, which is structurally long volatility in Asia. It’s just a nice hedge. For ordinary investors, I like our own fund (KGR), which I own some of myself. Its net asset value has risen from 99p to 115p in a year.
MM: I run an income fund, so my aim is to look for things with sustainable margin structures and the potential to grow dividends, of which there are a fairly reasonable number in Europe if you take a medium-term view. For me, one of the beauties of times like this is that it does provide the opportunity to pick up individual stocks at good prices. One of the mysteries of the last few years has been that sustainable and high-quality businesses have been priced at similar levels to those that really aren’t either of those things. But now, as the risk environment changes, you would expect to see a return to there being some sort of quality premium on individual stocks.
With that sort of background in mind, I am keen on Syngenta, which is operating in the global agricultural market. As the global population rises, farmers increasingly need products that improve agricultural yields. It’s a long-term growth market – I like that. Essilor, another favourite, operates in a similar market, but one geared to an ageing population. It’s by far and away the largest global eyeglass manufacturer in the world and consistently grows its top line by 7%-9% a year. Not only do people in the West need more glasses as they age, but more and more Chinese and Indian people with a new disposable income are discovering that eyeglasses can have a massive impact on their quality of life. 7%-9% over the long term is great and the company dwarves its principal competitors, so it’s got huge advantages in terms of costs, distribution and innovation. It also has a very strong balance sheet.
Finally, I like SAP, which is a clear leader in enterprise IT. There is a long-term need for their products, and like the others they have a strong balance sheet. So whatever happens in the next three to six months, it’s a good long-term bet.
LN: I’ve been adding to our holdings in the resources sector. I still like Xstrata, but I think the most fascinating commodity is platinum. I would buy Lonmin and Aquarius Platinum. It’s a metal that is set to see rising prices in terms of its supply dynamics, but which is also controlled by an oligopolistic set of producers and refiners. We are also expecting to see more consolidation of the sector. I’m also interested in the aerospace and defence sector, I think Rolls-Royce at the £5 level looks good value.
JF: Before we finish, can I remind everyone of Warren Buffett’s adage, “Be fearful when others are greedy and greedy when others are fearful”. Early this year, if you had asked me about markets, I would have been telling you I was very fearful back then – over-optimistic, complacent, top of the trading range – and I could see all this US subprime was not immediately, at least, containable. Now they are all bonkers – they are scared as anything, prices are all back down to the bottom of the trading ranges. I think from a long-term private investor point of view this is a good time. When financial market problems hit the non-financial press, that’s always a good anecdotal time to start buying.
MSW: Right now?
JF: Yes. The news could get worse, but there’s a lot of bad news in prices already. If you’ve got money to put in, why not put in half now and wait and see if you get an ultra-low or some terrible blow-up.
LN: My mother and my grandmother are great contra-indicators. They’ve both been on the phone in the last few weeks asking if I’m OK. History would suggest that markets are a buy.