Report on Q4 2018 – full of sound and fury

Report on Q4 2018 – full of sound and fury

5 Jan 2019

Over the first nine months of 2018, the UK stock market was barely changed. In Q4 the world’s obsession with uncertainty overtook it. Trump took on China again, Trump took on the Fed, Congress took on Trump, the ECB took on Italy, the Conservative party took on Theresa May, everyone took on Saudi Arabia and the oil price took fright. While a falling oil price is sometimes considered broadly beneficial to the world economy, it is currently identified as a harbinger of global recession. The FTSE 100 fell by 10.7% in Q4, the 250 by 13.9% and the All Share by 13.1%. The rule that in nervous times investors favour large international shares (i.e. the FTSE 100) overall held good, though not on a scale to promote rejoicing or relief. For roughly the 17th time since the financial crisis the fear of impending inflation faded away. The underlying assumption that we are living in long-term deflationary times held good again. Government bond yields have duly subsided again. The US ten year yield has slipped from 3.0% to 2.6%, the UK 10 year gilt yield is now c.1.2% as opposed to 1.5% three months ago. It is times such as this (when the Japanese stock market’s daily change is one of the news headlines on the Today programme) that it is most important to remember our (or my) basic investment rules. Sharp and extensive falls in the price of classes of assets are caused only by the forced capitulation of unwilling and unhappy sellers. Great market collapses are invariably accompanied by the realisation that something that everyone took for granted is no longer true. Black Monday in 1987 was, with hindsight, a financial services event. Stockbrokers, fuelled by American money following Big Bang, were being paid more than bank directors had earned only a few years before. It was the time of Loadsamoney (Harry Enfield), Money (Martin Amis) and Serious Money (Caryl Churchill) and I am prepared to say without embarrassment that it was bloody marvellous to be part of when you were in your mid twenties. But when it was over you knew it was over. When the DotCom bubble burst in 2000 it...

DEFEATISM – THE DISPIRIT OF THE AGE

DEFEATISM – THE DISPIRIT OF THE AGE

11 Jun 2018

When making investment decisions I try to employ pragmatism and to avoid behaving emotionally or irrationally. As a rule of thumb, most other words that end in “–ism” are not useful. Optimism, pessimism, idealism – these are all attitudes that we find appropriate or inspiring in our daily lives but when it comes to making decisions supposedly based on evidence, they load us with confirmation bias. I read a good piece about The Psychology of Money which points out no fewer than twenty common mistakes that can damage your wealth. One that I particularly liked was titled: “The seduction of pessimism in a world where optimism is the most reasonable stance”. Brexit, or the contemplation of it, appears to have plunged half of the UK into some kind of collective nervous breakdown. It is group-think of the most destructive kind and its victims wallow in anything that can be spun as bad news. Bluntly, they see pessimism as a virtuous scourging exercise because the people must pay for their sins. This is a phenomenon that is far from new. Gilbert & Sullivan wrote the Mikado in 1885. The song “As some day it may happen” is a “little list” of “society offenders” which reads rather oddly in 2018 (lady novelists?; seems harsh). But 133 years on, we are still very familiar with: “The idiot who praises, with enthusiastic tone, all centuries but this and every country but his own.” The current leader of the Labour Party, anyone? Moreover, anyone who is upbeat today is liable to be seen as deluded or laughable or even dangerous and fanatical.    The current President of the United States, anyone? In my report on Q4 2017, just after the Trump tax cuts had been implemented, I wrote that: Almost all the reporting in the UK mocks Donald Trump and strains to suggest that he is incompetent and dangerous. This remains mostly true though some people are beginning to contemplate the idea that Trump’s thoroughly unfashionable bullishness may be effective. He is bullish and he is demanding: put those two words together and you might come up with the word bullying – just how unfashionable can this man get?...

Report on Q1 2018

Report on Q1 2018

30 Mar 2018

In my report on Q4, I wrote that “for the third successive quarter, the markets were mysteriously calm.” The calm was disrupted in Q1 for sure: the main UK indexes fell by between 6% and 8%. The German DAX was -6.3%. Supported by a falling dollar, the US markets, though volatile, did better with the DJIA -2.5%. I hinted before that the stock markets might be vulnerable to rising interest rates or, more specifically, rising bond yields. In February it started to look as if this was happening; the US 10 year treasury yield had risen from 2.40% to 2.94%; but by the end of the quarter it was back to 2.74%. A similar pattern played out elsewhere. The 10 year gilt yield rose from 1.20% to 1.69% but ended the quarter back at 1.34%. It would seem that the wait for inflation goes on. Aside from the usual nonsensical white noise about “uncertainty” it is hard to escape the conclusion that the stock market is truly concerned about the ability of large corporations that feature in our lives daily to invest capital, service debt and pay dividends. Here is your day described in terms of dividend yields: you are woken by the ringing of the house phone (BT: 6.8%) and switch on the light (National Grid: 5.6%); you turn up the central heating (Centrica: 8.5%) and clean your teeth (Glaxo: 5.7%); you decide to go into town but your car has no petrol (BP: 6.0%, Royal Dutch Shell: 5.8%) and needs a new rear light (Halfords: 5.4%) so you decide to take the bus (Stagecoach: 9.0%, Go-Ahead: 5.8%); you do some shopping in Currys PC World (Dixons Carphone: 6.0%, Vodafone: 6.7%) and M&S (Marks & Spencer: 6.9%) before treating yourself to a pub lunch (Marstons: 7.4%, Greene King: 7.0%). Is it the end of the world as we know it? Yet, against this rather sinister background something quite different has been happening. Companies who want to buy each other seem to like these prices very much. On 22 December GVC announced its intention to buy Ladbrokes plc. On 17 January, Melrose bid for GKN; on 30 January UBM agreed to be taken over;...

Why investors love uncertainty

Why investors love uncertainty

18 Oct 2016

Every five minutes, someone, somewhere, says that “markets hate uncertainty”. This is an example of anthropomorphism or the attribution of human characteristics to animals, objects or ideas. Benjamin Graham, the father of value investing according to Warren Buffet, wrote about Mr Market, an obliging business partner who offers to buy you out or sell you a larger stake on a daily basis. Mr Market can be generous or miserly but his defining characteristic is that he always shows up. Mr Market is in fact, a market.  Regrettably, the temptation to turn Mr Market into a soap opera character who experiences human emotions has proved too much for many commentators. Watch, read or listen to today’s news and you will find that Mr Market is an extremely judgmental fellow. Donald Trump makes him very unhappy. He is incandescent with anger about Brexit. Interestingly, Mr Market is not a great believer in democracy. When he thinks that voters in the US or the UK are making a mistake he stamps his foot in rage. He much prefers the smack of firm leadership. When Saudi Arabia, Iran and Russia attempt to collude to restrict the supply of oil he performs a little jump of joy. Enough. Mr Market does love or hate anything. Markets are just places where buyers and sellers look for each other and sometimes meet. If you want to attach a smiley face to the chart of a rising market that’s up to you but remember that higher prices result in losers as well as winners. Witness the UK housing market – oldies = smiley face: youngsters = sad face. The sloppy thinking that leads people to say that markets hate uncertainty invariably evolves into the confident factual statement that “investors hate uncertainty”. This assertion is central to the fund management industry that wants to frighten you into paying to have your savings looked after. Please see my post “Clients are very nervous”. But the truth is the opposite. Investors love uncertainty because it causes assets to be mispriced. It is only the mispricing of assets that leads to good opportunities to buy and sell. I don’t want to be unkind but if someone...

OSTRICH POST II – DADT

OSTRICH POST II – DADT

25 Jan 2016

Don’t Ask, Don’t Tell (DADT) was a (now repealed) US official policy that insisted that gays serving in the military must take part in a cover-up. On the grounds that they kept their sexual preferences a secret they were excused from being openly bullied, discriminated against and dismissed. Something that everyone knew to be untrue (the idea that the US military was staffed entirely by patriotic heterosexuals) was sanctioned in a big game of “let’s pretend”. If everyone acted as if it were true it would be just as if it were actually true. But DADT turned out to be too convenient a device to be confined to such a narrow issue. It was perfect for the treatment of subprime mortgages! It was clear to many insiders that people who had no realistic chance of repaying were being granted loans to buy properties that had to rise in value to bail out the borrower, that these debts were being insured on terms that didn’t come close to reflecting their risk and that the loans were being repackaged and sold on, backed by credit agency ratings that were uninformed and irresponsible at best. Yet even when the crisis was unfolding at speed, banks and other financial institutions were saying publicly that everything with which they had been stuffed was AAA quality. Check out The Big Short for a great explanation of the story. The trouble with DADT is that it is like a Ponzi scheme. Once you have started to pretend, you have to keep going. The morons working at the soon-to-be rescued banks did not mean to buy toxic junk. But once the mistake was made the easier option was to keep playing along. Like a trader who hides loss-making positions in the bottom drawer (or a secret computer file), the final thing you can try to buy is time. You literally decide to wait for a miracle.    Something like this is going on with Quantitative Easing (QE = DADT). As I have pointed out elsewhere, the truth that QE was a device for inflating asset prices in order to save the banks from marking them to market was spun into an officially...

Melting capex

Melting capex

24 Dec 2015

This seems to be a time in which people have a touching faith in the idea that progress can be achieved through international negotiations. Certainly, the mutual back-slapping following the Conference Of Parties (COP21) in Paris implied that a new era of cooperation has arrived. COP21 had 25,000 official delegates and an estimated further 25,000 fellow travellers (doubtless all busily offsetting their air miles). The direct aim of this conference was to agree to a temperature target for the earth in the year 2100. With nearly 200 nations represented, it is understandable that everyone was pleased and relieved that everyone agreed that something had probably been achieved. The obvious problem is that in 85 years (2100) almost none of the 50,000 attendees will be alive. COP21 is a group-hug endorsement of the contemporary notion that everything that is hard to face now can be flipped into the future. The tendency to defer tough decisions is arguably human nature (though there must be some humans out there somewhere who prefer to face up to difficulties – where are they?) Certainly, putting off the evil hour has dominated central bank policy for nearly ten years to the point that markets were effectively begging Janet Yellen  to pull the trigger on the first rate rise of what might turn into the new current cycle. Avoiding short-term unpleasantness has resulted in a massive build-up in off-balance sheet liabilities for future UK taxpayers through an expensive policy known as PFI. It has allowed students to be obliged to fund their own education on penal terms, using teaser rates to distract attention from the financial burden that will dog them in years ahead. The probable widespread default that will hit the Student Loans Company will be underwritten by all taxpayers in the future. While much political capital is made out of trying to deny benefits to immigrants, nobody seems inclined to address the monumental unfunded liability that arises from the need to pay pensions to and healthcare costs for our dramatically aging population. We’re probably going to need a large number of working age, tax paying immigrants to help us out at some point. The inevitable car crash that will...

Dare you trust these dividends?

Dare you trust these dividends?

21 Sep 2015

Perhaps the most pertinent question for UK stock investors today is “can I trust those high dividend yields?” Glaxo has pre-announced that it will maintain its dividend at 80p per share this year and next year. That’s a yield of 6.2%. Royal Dutch appears to yield 7.5% on the basis of paying $1.88 (c.120p) also “guaranteed” for 2015 and 2016. If these companies can be relied on to continue these pay-outs, it matters little whether Janet Yellen dares to raise the federal funds rate from irrelevant to insignificant or indeed whether Mark Carney goes mad and does the same with the bank rate.  Here is what I previously wrote about the interpretation of high dividend yields. Shares that yield 5% The market does not like these companies. They are seen as unreliable. This may be because there are external threats that are beyond the power of management to prevent or mitigate or it may be that management is simply mistrusted. It might also be the case that they are mature businesses that are, rightly or wrongly, thought to be approaching the end of their life-cycle.   Shares that yield 6% The market does not trust the dividend. It expects it to be cut (or “rebased”, in modern corporate terminology). Naturally I agree with every word of this and everything that follows should be seen in the context of those comments. I will briefly discuss Glaxo and Royal Dutch before moving on to some humbler companies. There is a summary at the end. GLAXO           Price:  1296p                    Hoped for dividend:  80p                       Yield: 6.2% Glaxo is showing off by paying a bonus 20p in respect of Q4 (year-end March 2016). This seems to me an unnecessary answer to the sceptics who would anyway be confounded merely by flat progress. People dislike Big Pharma about as much as they dislike Big Tobacco and they both look like industries that spend a fortune on lobbying. Glaxo needs to generate $3.8bn of free cash flow to pay its 80p dividend without adding extra debt (nearer $5bn this year with the bonus). In 2014 it made free cash flow of $5.5bn; in the year to March 2015 free cash flow was...

Gifts in the mail

Gifts in the mail

15 Jun 2015

The privatisation of Royal Mail in October 2013 was a lesson in how the City can run rings around politicians who fancy themselves as financial sophisticates. In this case the sap-in-chief was Vince Cable, a man whose CV includes many “economics advisor” titles. Despite this supposed in-house expertise, his department for Business, Innovation & Skills hired a vast syndicate of City banks, perhaps believing in the wisdom of crowds. It is well known that the shares were priced at 330p, that the institutional offering was oversubscribed by 24x and the retail portion by 7x. Most applicants for shares got none at all but 16 priority investors shared 38% of the entire offer (representing 22% of the company). On the first day of trading the shares closed at 455p. Within a few weeks, seven of the sixteen priority shareholders had cashed out completely. The grounds on which the priority investors had been selected were said to include their willingness to be long-term shareholders. It is hard to escape the conclusion that the government behaved with a mixture of ignorance and fear. For many years, financial institutions have gorged themselves on the naivety of their customers but, as a citizen, I find it very disappointing that my elected representatives are quite so useless. The underpricing and mishandling of the IPO was something of a public humiliation that may have contributed to the ejection of Vince Cable in the recent general election. It took only until March 2014 for the National Audit Office to publish a report that criticised the government for being cautious and pointed out in restrained language that “the taxpayer interest was not clearly prioritised within the structure of the independent adviser’s role”.  Royal Mail was something of a dinosaur company in stock market terms. It was a state-owned business that retained a highly unionised workforce and huge defined benefit pension liabilities. Moreover, it was obliged to maintain a national postal delivery service while the potentially more lucrative parcel delivery service was open to new competitors who could to some extent cherry-pick the services that they fancied. Letter volumes are in clear decline as most of us prefer e-mail while parcel volumes are rising...

The ECB, QE and the waiting game

The ECB, QE and the waiting game

12 Feb 2015

Quantitative easing is a process by which a central bank buys relatively safe assets (mostly government bonds) and thereby puts cash into the hands of the newly-ex owners of those assets. In the early years of the financial crisis, this was effectively a life-support system for financial institutions which, post-Lehman Brothers, looked like they might fall domino-style. As the central bank bids up asset prices it creates a rising tide that floats many boats. One side effect of this is that the wealthy become wealthier. QE is quite tricky to justify from this point of view. If it is necessary to prevent the collapse of the banking system it is a jagged pill that needs to be swallowed. As I have written before, this is broadly how the Bank of England justified QE in 2009. “Purchases of assets by the Bank of England could help to improve liquidity in credit markets that are currently not functioning normally.” But gradually, while the music remained the same the lyrics changed. Expressing an idea that was essentially imported from the US, the justification from the Bank in 2011 was quite different. “The purpose of the purchases was and is to inject money directly into the economy in order to boost nominal demand.” You see what they did there? Once again, it was party time in financial markets. Bonds and equities were rising nicely. Bonds were rising because the Bank was buying them and other people were buying them because the Bank was buying them and equities were rising because they looked cheap compared to bonds. And property in the areas where financial people live began to go up again, despite the fact that prices appeared to require mortgages that quite high incomes could not plausibly service and that damaged banks could not reasonably be expected to offer. My friends and I have done splendidly from this once we had “got it”. And although I don’t know any influential people, some of my friends do. Call me a conspiracy theorist if you want but these influential people soon popped up all over the place saying how brave and wise central bankers were to extend QE. THE HIGH MORAL...

OIL…….Something Happened

OIL…….Something Happened

7 Jan 2015

The recent sharp fall in the price of crude oil is one of those rare financial events whose importance is appropriately reflected in press headlines.  Oil has a strong claim to be the world’s most important commodity and also the most political. OPEC was founded in 1960 by the charming quintet of Iraq, Iran, Saudi Arabia, Kuwait and Venezuela. According to its website: “OPEC’s objective is to co-ordinate and unify petroleum policies among Member Countries, in order to secure fair and stable prices for petroleum producers; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on capital to those investing in the industry.” Were these companies rather than sovereign nations, this would be an illegal price rigging cartel subject to enough lawsuits to employ every lawyer until the end of time. As it is, it’s a legal price rigging cartel that everyone else has to live with if they wish to continue consuming oil. In 1973, OPEC became explicitly political when the US supported Israel in the Arab-Israeli war. It banned exports to the US and the barrel price of crude quadrupled from $3 to $12. It was a shocking inflationary impact that the world did not need. The Iranian revolution in 1979 saw a further leap from $14 to $40. The next great move came in the 21st century as global economic growth was propelled by developing countries such as China and India that became huge importers of oil. The price touched $140 until the financial crisis torpedoed the world economy in 2008 and the price fell right back to the 1979 price of $40. It is worth making a couple of points here. One is that the oil price has shown itself to be very volatile with changes in marginal demand having a huge impact. The other is that, partly thanks to OPEC, the market’s opinion of whether oil is cheap or expensive has largely relied on referencing its own history – the most unsophisticated way of valuing anything. That having been said, it is obvious that oil over $100 makes costly oil supply viable, notably from Canadian oil sands but also from fracking. The world...

Report on Q4 2014

Report on Q4 2014

5 Jan 2015

In a confusing financial and political world in Q4, the UK stock market offered small but notable evidence of calm in as much as the FTSE 250 (+4.5%) easily outpeformed the FTSE 100 (-0.9%), reversing the trend seen in Q2 and Q3. Normally, larger shares perform better in nervous times as they are seen as safer havens. In the case of this quarter, the collapse of oil and oil sensistive shares (including other resource and energy related companies) may have delivered a particular blow to the FTSE but I am still inclined to take the 4% gain in the FTSE 250 at face value. For 2014 as a whole, the FTSE fell by 2.7% following a rise of 13.9% in 2013. Once again, major governmrnt bond yields provided a supportive background. German 10 year Bund yields fell in the quarter from 0.93% to 0.54%. A year ago they were 1.96%. 10 year Gilt yields have fallen from 2.88% to 1.72%. While these seems incredibly low to anyone who has followed gilts over the years, it could be seen as high when compared to the equivalents in Spain (1.62%) and Ireland (1.25%) and France (0.83%). Last quarter I wrote that “bond markets are shrieking the news that global growth has made a long-term shift to lower levels”. The fall of nearly 30% in the oil price in Q4 appears to confirm this view, though it can be argued that a cut of this scale in the price of such a key commodity will ultimately benefit the economies of all countries that do not depend on oil revenues.Initially, though, the effect is more likely to be felt by oil producers and will play out as generally negative in the short term. See my next blog post for more discussion on this. In the UK, the political future appears more important than usual. But it does not seem likely that a change of government would result in a great expansion of government spending. Nor does it seem probable that a referendum would result in a vote for the UK to leave the EU. Most of the political outcomes that frighten investors are highly unlikely and their probability...