Where do we go from here?

2nd Oct '09 by djpreston

11 comments 3656 reads

Well, I guess that is the question that we, as investors, both private and professional want to know. Personally I hate markets like these but lets explore where we are right now and see if we can draw any conclusions.

There is no doubt whatsoever that the markets have been tremendous for those who took the bull by the horns back in March and ploughed money into the market. Indeed, anyone who believes in the old adage that the time to buy is at times of maximum pessimism (John Templeton) would have been piling into the markets or selected areas of the markets from late January onwards. After all the common view back then was that the global economy faced a new "Great Depression" and banks (RBS and Lloyds in the UK) would be nationalised and it was the end of Capitalism. If that wasn’t the time of maximum pessimism, I don’t know what else would be.

Moving away from the past to now. We’ve seen the Dow up 60% in 6 months and FTSE 100 up almost 50% but has the situation improved sufficiently to warrant it?

I’ve been speaking to other managers so have collated their thoughts and comments and will use these within this article (no names of course).

There are, at present two camps, those who did invest in the early part of the year and those who thought it was a bear market rally and are still largely hoarding cash. Of those who did invest, most are and have been taking profits over the past month. The common theme is that neither group really knows where we are headed in the near term. That economic indicators have improved is not in doubt. The question is whether this is purely down to the restocking of the pipeline, global stimulus and cost cutting, or if it is now a sustainable recovery.

To further complicate the decision making process there is the question of inflation/deflation and which will prevail and when. It is taken as read that economic theory is that increased stimulus (Quantitative Easing) will inevitably lead to rising asset prices and inflation. However, there is little sign that inflation will take off in the near term due to a breakdown in the transmission systems with banks being forced to improve balance sheets (hoarding the cash being put into the system), the likelihood of a big…

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Stockhound

7th Oct '09

I notice you are taking Peak Oil Theories into account in your long term asset allocation decisions. I've always been a fan of the Krondatieff Wave theory of growth, and am slightly sympathetic to the Elliott Wave theories both of which suggest we've passed a key cyclical peak in the long term economic cycle.

My other hand balances this doom and gloom outlook with a great belief in growth impact of the technological revolution. The economy is much more efficient than before in all areas of sensible production (i.e. non-finance related... ), and I believe we are seeing a global fillip to growth of the order of 1-2% annually. (Yes we'd be in a severe depression without it!)

The impact of these views on asset allocation is obscure, but may suggest that market neutral approaches, and absolute return strategies may be the best. There is so much uncertainty in the markets today, and in such times caution pays off.

Of course not everyone can access absolute return strategies, and many have been extremely poor performers lately due to the hedge fund bubble... which makes it even harder to make a decision.

Any comment on these points?

loglorry

Nice post DJ

I think we are quite probably just climbing the wall of worry still. I'm afraid I remain a bit of a bull at this point. As you point out there is still a lot of cash out there earning next to nothing with rates so low. At some point the returns on stocks are going to look pretty attractive compared to rates on that cash.

I think the key however is to try to look for situations where we'll see good returns if things stay pretty much the same. It is probably that total meltdown has been avoided. If things got very bad again money on the sidelines would probably keep things afloat. However there is a good argument that says we stay range bound for a few years until the nasties work there way out of the system.

So what will do well if things stay pretty much the same? I think there are some opportunities out there still. The big one has to be the bank preference shares. Many still at 50% of par. The chance of a tender or else good dividends over the next few years. If coupons are suspended then this would seem like a good buying opportunity as they will likely be resumed in a few years. This sits well with the "it will work as long as things don't get worse" scenario. The banks can keep back payments on ordinaries for a few years to boost balance sheets and retain profits from increased lending margins while servicing debt.

Property companies with a big discount to NAV look interesting too. It would seem banks are reluctant to foreclose on the big lending and happy to renegotiate term of lending. While property prices are in the dog house rents are on the whole still being paid. Companies like Carpathian CPT with huge discounts to NAV look like a good play as long as things don't get any worse.

Man Group is an interesting one. The shares have been knocked based on a lot of redemptions and the funds under management being reduced. I'm not convinced these fund managers have any magic powers to be honest. Their funds tend to do very well in bull markets and start to fall apart in bear markets. However I think they have been knocked a bit too much as we might well see them recover even if markets stay pretty much level.

lfc

Hi djpreston

You talk about forces that could move the market both up or down but it would be useful to be able to relate this to a specific value on, say, the FTSE100. E.G. what level would correspond to fair value in your opinion given different economic prognoses relating to the balance of those forces? Without such a pin any discussion is qualitative rather than quantitative. OK as far as it goes but at some stage you need to put it all together and decide if the current market level constitutes value or not.

I'd be interested in knowing what metrics you would use to calculate this and any tentative conclusions.

rgds

djpreston

In reply to StockHound (post #1)

Interesting comments Stockhound. I must admit I am not "into" the different wave theories but there the technological impact on productivity is of course very valid, both in terms of good points and bad (reducing the amount of "blue collar" work positions for instance and thence increasing unemployment).

As to the market neutral theories, there is certainly nothing wrong with a good relaibel double digit return and proper hedge funds do have a place in portfolios where appropriate. I love the way that the term hedge fund has been perverted from the original where such funds were normally hedged to reduce risk rather than just massively leveraged funds (RAB's commodity funds being perhaps one of the most spectacular exampes of a directional fund).

In reply to loglorry (post #2)

Cheers Log

Im broadly of the view that yes, the worst is probably over but Im just finding it hard to find real value. Unless I can feel I have a real no brainer then Im not really that interested. I guess thats why we have a ton of the prefs too. How nice to see yet another div roll in on them taking the income so far to 40% on just three quarterly payments!!

Id like to think that we are set to rise higher its just that I dont think anyone really knows (somethign reinforced by colleagues at different firms) how the Q3 figures will play out.

The one concern I have with my strategy at the moment is indeed the cash on the sideline argument. I think we saw some evidence of that yesterday. Yes we could well fall 10-1% in the short term but there would, as I said in the article, be buyers, perhaps limiting the downside.

I wasnt really trying to make a judgement call on the short term just expressing a feeling of frustration (shared by colleagues) about how the immediate future is very hard ot call and how we'd decided to to lock in some gains and move more defensive/able to exploit opportunities.

Man is an interesting on since we've just sold out at c 295p (ish) having been invested around the 165p level. Man's funds have been generally good over time but certainly last year wasnt great for them. A quality company though.

In reply to lfc (post #3)

The peice wasnt meant to be thats specific in terms of targets etc, more just a brain dump of concerns and other random thoughts.

I hate using targets since the markets are much more complex than that. FTSE is dominated by the intl earners, oils and miners and so isnt that representative of the UK economy but more an international growth play in some respects. So to say "Id buy FTSE at 4500" would be wrong in some respects since the market may stay around the current level but other names I was interested in could fall 10%, 15% or more. I guess im trying to say that Im working on gut instinct.

However, that proviso aside, I could see 10-15% off the markets or even more if the Q3 figures disapoint and equaly a 10-15% rally if they dont as cash sat on the sidelines moves in. I woud be more bearish on the downside were it not for the cash in funds waiting to be invested which will limit the downside.

In reply to djpreston (post #6)

Yes I appreciate that but at some stage once you have decided where the economy is going, even if it's by gut-feel alone, you need to link that to a stock market level in order to determine whether or not ot invest - i.e. whether or not it constitutes value.

So for example when you say;

how is it possible to answer the question without some reference to what 5000 on FTSE100 means. Reference only to how much it has moved only tells you it is more expensive than it was not that it is neccessarily expensive. One persons 5000 might be double-dip recession looming whilst anothers might be a nice V shaped recovery!

Hope that makes more sense.

Aye, lfc I know where you are coming from. That's why I've said what sort of market wide movements we could see. But what metrics ie valns on specific stocks is what you really want me to state?

Again this differs according to the type of stock. I did a piece on smin back in june and said where I thought that could be and when it hit that in 3 months sold. We're totally out now (must update that thread). Then again, I was buying
RB around 2800p 14x pe as it was cheap given the quality of the co and the historic PE range. The thought was that any amaemic recovery would see genuine quality, dependable growth stocks given premium ratings. Then there's asset plays, pcfs etc etc as well as special situations.... That's all very difficult to summarise in terms of a post, especially when you factor in varying targets based upon different macro economic overlays and as I say in the article, I'm not sure where the global macro is headed at the moment.

D

Monevator

13th Oct '09

Nice piece and thoughts.

I hold Man Group and agree that hedge funds are to an extent are manifestation of magic dust fallacy. But if the market keeps rallying then the magic dust looks like it's working again, and the punters come back. Man is as much a sales operation as a fund manager, and its reach is excellent.

djpreston, I think for me the key is when you said:

Don’t get me wrong, there are a lot of companies out there that look decent long term value but the short term looks just too uncertain for me and I’ve been struggling to find companies that I like at a decent price that offsets this uncertainty.

We all know exactly what you mean of course and I'm sure you've been here 100 times before.

The whole escapade of the last 18 months has reminded me again that things are always uncertain - it's just sometimes we forget that they are.

i.e. In mid-2007 all these problems were there, they just weren't in the price.

For me the Wall of Worry absolutely exists, and it's rationale to the extent that investors have been reminded about the downside risks.

The reason I highlight your quote above is because I think all I can do is look for good value on a stock level, and/or drip money into a tracker at the index level.

Forecasting the next uncertainty to become a certainty in contrast is clearly incredibly difficult, and where I've tried (e.g. the housing bubble for the past five years in the UK) it's caught me out.

If you're better at this sort of thing, more power to you! :)

Oh, on the subject of pref shares, I am in a minority view that they're partly hero trades. Rather you guys than me, but good luck with them.

best

Mattybuoy

15th Oct '09

Warning: unscientific post ... :-)

Macro stuff is entirely dodgy atm I agree. I am coming round to the view that we will basically continue to rally until such time as the FED/BoE stop printing money, whenever that may be.

I spllit my small pot into two segments. One is "investments", which comprises companies that are solvent and should still be around in 10 years time whatever happens. Dividends are nice with these, and I try to only buy where I feel I would never sell, barring accident. Current holdings are things like ANTO.L, CNE.L, MX.T, POG.L, NKO.T, POT.N, TRP.T, VGR.N.

There are many stocks I would like to add to this list ...

The second (smaller) segment is what I would call "punts", where I attempt to read the zeitgiest as it were. Current holdings are things like CNX.AX, GIP.AX, GKP.L, PELE.L, PRL.L, SKR.L & VST.V.

My idea is to use the gains from the punts to "fuel" holdings in the the investments. Once the money printing stops, and punts cease to work, I will essentially just collect divis ad infinitum and hope for the best :-)

19th Oct '09

Just an update as to where we are now.

Evidence from the Q3 figures thus far seems to back up the wider indicators that there is real strength behind the growth so we hav put back in some of the cash we took out, focussing mainly on what Matty above has referred to as "investments". In our case that has seen us acquire holdings in stocks like AZN, CBR and ASHM, all decent solid businesses that shouldnt give too many sleepless nights. Pleased to say that we got the ASHM around the 250p mark before the results.

These wont set the world on fire in terms of performance but do look sensible, slid businesses that can be held.

Where do we go from here?

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Djpreston

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