This is a site where I post brief comments on professional investor views, must-read articles on topical themes and important financial market trends. There is also a link here to the Independent Investor website, where you can find details of my background, interests, books and newspaper columns, as well as seminars and publications. If you don’t know me already, I have been following financial markets for more than 30 years, initially as a senior correspondent on The Times, The Economist and The Independent, more recently as an investment professional and author/columnist for the Financial Times and The Spectator. Although I am now a director of three investment companies, and a Senior Adviser at Smith & Williamson Investment Management, any views that I express here are entirely my own, and based on my independent reading and research. Please read the investment warnings with care. If you like what you read here, why not also take a trial of my soon-to-appear newsletter Investor Q and A? Jonathan Davis
Andrew Smithers, as he notes in his latest World Market Update, has been saying for ages now that the equity markets are overvalued – but probably going up. In other words, while on long term valuation measures equities are priced to deliver below-average returns over the medium term, in the near term with momentum and other factors, principally central bank monetary stimulus, egging them on, they can easily go on rising for quite some time. (For what it is worth, that has been my basic stance for most of this year too: markets are far more volatile than the fundamental value changes). But is that period now due for pause?
While we are not yet calling an end to this, we see it drawing to a close. The two key supports for the US stock market are corporate buying of equities and quantitative easing (“QE”). The former is threatened by current fiscal plans and the latter by the need to taper QE should unemployment continue to fall. If the Federal budget is finalised as currently indicated then a decline in corporate cash flow seems highly likely and corporate buying, which has fallen recently, is likely to fall further.
If the current budget is not modified, the economy is likely to slow and this would probably cause the Fed to taper its tapering. If the budget is modified, the impact on corporate cash flow would be reduced but the chances of Fed tapering would be increased. Equities have been pushed up by the combination of corporate buying and quantitative easing. It is possible but unlikely that both will remain in place during 2014.
We all know that equity markets rarely move in a straight line. 2013 has been a great year, with the main US indices driving through their pervious all-time highs early in the year and heading for full year gains of 20%-25%, with almost all the gain coming from positive rerating (higher multiples) rather than from earnings growth. The mid-year “tapering” wobble seems to have passed. Equity fund flows have been running at their strongest since 2004, with bonds on course to produce a negative return for the year as a whole. A correction would be helpful, though I somewhat doubt we will see it before the second quarter of next year.
My longstanding correspondent Ken Fisher, the West Coast money manager, has a typically contrarian take on how the new head of the Federal Reserve, Janet Yellen, should be regarded by the markets. In a column for the Financial Times, he says that, although an adherent of Ben Bernanke’s approach to monetary policy, she is in reality more of “a closet” hawk than a dove. This is essentially because while she supports QE, in practice that kind of monetary stimulus only forces down long term interest rates, inhibiting rather than encouraging banks from lending. She is also in favour of requiring banks to shore up their capital bases, which also inevitably tightens the flow of credit to the real economy and leads to slower than expected economic growth. Read the rest of this entry »
Terry Smith, the CEO of Tullett Prebon and founder of Fundsmith, was in top form when I interviewed him last week. An edited version of our conversation, which covers a range of topics, including the global economy, the impact of QE, current market valuations and stocks in the Fundsmith portfolio, appears in today’s issue of Money Week. If you are interested in reading the full length version, you can find it on the Independent Investor website. Simply follow the link to Money Week articles on the right hand side. Sample quote: “I’m not convinced there is a recovery – certainly, not of anything like the magnitude that people say there is”.
Two events in my diary which you may be interested in. (1) Face to Face with John Kay: Martin Vander Weyer, Business Editor of The Spectator, and I are hosting an hour-long session of Q and A /debate with the prominent economist, author and FT columnist John Kay in London on October 22nd, starting at 8.45 am. Topics to be covered include banking reform, monetary policy/QE, the future of the Eurozone and investment strategy in an uncertain environment. More details here and ticket information from the Capital Briefings website. (2) The Ten Commandments of Investment Success: I am teaching a two hour seminar on the principles of successful investment on October 24th at 9am, also in central London, organised by the How To Academy. You can find out more by clicking on this link from the Academy website. This is something that I have been working on for a little while and hope to repeat at other venues in future.
Stern words today about the roots of the current emerging markets crisis from Stephen Roach, the former chief economist at Morgan Stanley now less stressfully ensconced at Yale University, where he is a senior Fellow. You can read the full broadside here, but this is a short extract, highlighting how the huge destabilising capital flows into – and now out of – emerging markets can be directly traced back to the policy of quantitative easing. The countries now suffering most are those, such as India and Indonesia, which have run large current account deficits and/or have failed to make necessary structural reforms during the good times:
A large current-account deficit is a classic symptom of a pre-crisis economy living beyond its means – in effect, investing more than it is saving. The only way to sustain economic growth in the face of such an imbalance is to borrow surplus savings from abroad. That is where QE came into play.
It provided a surplus of yield-seeking capital from investors in developed countries, thereby allowing emerging economies to remain on high-growth trajectories. IMF research puts emerging markets’ cumulative capital inflows at close to $4 trillion since the onset of QE in 2009. Enticed by the siren song of a shortcut to rapid economic growth, these inflows lulled emerging-market countries into believing that their imbalances were sustainable, enabling them to avoid the discipline needed to put their economies on more stable and viable paths. Read the rest of this entry »
Theer is another fascinating article by Michael Lewis in the latest issue of the glossy magazine Vanity Fair, which is fast establishing itself as a must-read destination for students of folly, drama and malfeasance in the world of financial markets (no shortage of good raw material there). His latest piece chronicles the curious case of a Russian computer programmer named Sergei Aleynikov, who was prosecuted for stealing computer code when he left Goldman Sachs to join a rival high frequency trading operation. Mr Aleynikov’s conviction was quashed on appeal, but only after he had spent a year in jail. The article is interesting not just for the human story that Michael Lewis unfolds with his characteristic verve, but also for the light that it sheds on the phenomenon of high frequency trading. (Students of the phenomenon that is Goldman Sachs will also find plenty of evidence to support their prejudices, good or bad).
Here is one passage from the long article:
By mid-2007……Goldman’s equities department was adapting to radical changes in the U.S. stock market—just as that market was about to crash. A once sleepy oligopoly dominated by NASDAQ and the New York Stock Exchange was rapidly turning into something else. There were now 10 public stock exchanges in New Jersey alone, all trading the same stocks. Within a few years there would be more than 40 “dark pools,” or private exchanges, one of them owned by Goldman Sachs, also trading the same stocks. (Why the world needed 50 places, most of them in New Jersey, in which to buy and sell shares in Apple Inc. is a question for another day.) Read the rest of this entry »
One of the reasons I gave up being a full-time business journalist in favour of a career in investment was the fear that I might be falling prey to the all-pervasive cynicism to which so many members of the media sadly seem to succumb over time. Excessive exposure to the doings of government can have that effect on you. I could not resist a wry smile however at seeing the attached chart, published by the economics pundits at Capital Economics. It shows the close correlation that exists between house prices and the political fortunes of the party currently in power. As might be expected the relationship appears to be both powerful and close, and, I fear, is not at all accidental. Political party strategists know full well that consumer confidence, in which rising house prices are the key component, holds the key to earning electoral victory.
Buy on the promise, sell on the news? That may be the initial temptation of those of us who have been happily playing the Japanese recovery story for the last few months, now that Mr Abe’s Liberal Democratic Party has won a resounding victory in the Upper House elections at the weekend. The result means that with a comfortable majority in both chambers, the flag-waving Prime Minister is well placed to push through his programme of economic reforms, aided by the expansionary monetary policies now being embraced by the Bank of Japan. Despite the size of his majority, some will worry that the impetus to complete the much-needed structural reforms – the so-called third arrow of Mr Abe’s strategy – will weaken now that the election is over. The LDP traditionally represents many of the powerful vested interests that have killed reform agendas so many times in the last 20 years; could they do so again?
It is possible, but my instinct is that answer will be no. The Japanese equity market retains its attractions. The key insight that the professional investors I talk to keep bringing back from Japan is that for the first time in living memory all the interested parties – the government, the central bank, companies and now the electorate – are all aligned in the same direction, prepared to give Abenomics its head. The programme is certainly not without its risks, and it has important implications for investors in other countries around the globe, as Henry Maxey, the CEO of Ruffer LLP, points out in its latest investment review. Read the rest of this entry »
Reports by the Wall Street Journal that officials at the Federal Reserve are drawing up plans for starting to rein in the current programme of QE are worth noting. Jon Hilsenrath, the Journal reporter who wrote the story, is widely held to be the Fed’s favourite unofficial channel for making known its future intentions. Could it be that even the Fed is starting to get concerned about the runaway effect that its monetary stimulus is having on asset prices? Throw in Mr Bernanke’s warnings about excessive risk-taking last week and it is tempting to suppose that even the Fed would be happy to see a pause in the the advance of risk assets, at least for now.
That would certainly seem to sit quite well with the normal midyear seasonal pullback that we have seen for each of the last three years. The worry with QE has always been that it is easy to get started on it, but very difficult to stop. Now that the Japanese have joined the QE party in an even more dramatic way, the ripples are being felt in financial markets all round the globe, compounding the scale of the eventual problem. Yields in a number of credit markets (eg junk bonds, leveraged loans) have fallen to what look like dangerously complacent levels. Companies such as Apple are obviously happy to take advantage of the ultra-low rates on corporate debt, but whether that achieves any longer term benefit remains to be seen – not so obvious when the purpose of the debt is committed to share repurchases rather than new capital investment. All the while a return to the levels of economic growth we witnessed before the crisis broke in 2008 remains stubbornly distant. Read the rest of this entry »
The news that Paul Walsh, the CEO of Diageo, has unloaded a huge amount of stock (£16m) after exercising a raft of share options draws attention to the extent that the prices of high quality companies with strong global business franchises and the ability to generate cash have been bid up to very rich levels. The veteran market-watcher Richard Russell has observed something similar on the other side of the Atlantic.
What do billionaires Warren Buffett, John Paulson, and George Soros know that you and I don’t know? I don’t have the answer, but I do know what these billionaires are doing. They, all three, are selling consumer-oriented stocks. Buffett has been a cheerleader for US stocks all along. But in the latest filing, Buffett has been drastically cutting back on his exposure to consumer stocks. Berkshire sold roughly 19 million shares of Johnson and Johnson. Berkshire has reduced his overall stake in consumer product stocks by 21%, including Kraft and Procter and Gamble. He has also cleared out his entire position in Intel. He has sold 10,000 shares of GM and 597,000 shares of IBM. Read the rest of this entry »
These are the latest comments on the implications of the drastic policy measures being adopted by central banks in a so far unsuccessful attempt to stimulate their economies. They come from one of the most successful managers of a “real return” fund in the UK. Iain Stewart has been running the Newton Real Return fund since its launch in 2004, with only one small down year (2011). Anyone interested in capital preservation in the current uncertain climate is likely to find much that resonates here. The full story can be found here (source: FE Trustnet).
“Fixing the price of government bonds is a very risky policy as it can lead to mis-allocated capital. I would say now is the most dangerous environment I have ever seen. It feels nice when stock prices just keep going up, but if anything, those assets are being pushed up by policy. It may be an uncomfortable thought, but we need to keep reminding ourselves that the reason we are all bathing in an ocean of liquidity some five years on from the financial crisis is that we have, to date, failed to lay to rest the legacies of the last cycle. The problem is that forcing mature, ageing economies to grow through monetary easing is recreating the distortions and excesses which caused the crisis in the first place”. Read the rest of this entry »
Albert Edwards, the lead strategist at Societe Generale, has added some typically forthright (and witty) comments on the latest developments in Euroland. By making explicit the fact that both uninsured bank depositors and all classes of bondholder have been required to take part in the rescue/liquidation of the two largest Cypriot banks, the troika (EU, IMF and ECB) has highlighted the fact that cash itself is now officially potentially an unsafe asset. He wonders also (as do I) how long it will be before a Eurozone country finally decides that remaining in the single currency is not worth the trauma that staying in involves.
Most economic analysis concludes, probably correctly, how much more costly it would be for either a creditor or debtor nation to leave the eurozone system compared to struggling on within it. Indeed for Germany, despite becoming increasingly irritated by having to dip their hands into their rapidly fraying pockets, the crisis in the eurozone has been accompanied by the lowest unemployment rates since before re-unification in 1990. Read the rest of this entry »
As usual it will take a day or two for the markets to decide which of their initial reactions to the Cyprus bailout – relief that a deal has been struck, or concern at the implications of the terms imposed by the troika – will prove dominant. Some things do seem clear from what we have learnt already:
- This was the most acrimonious bailout negotiation yet, with little love lost between the Cypriot negotiators and the troika representatives on the other. Talks came close to breakdown on several occasions over the course of the past week. Apparently tipped off in advance that the Russians would not come riding to the rescue, the troika played hardball – and eventually won, although not before the Cypriot President had threatened to resign and/or take Cyprus out of the euro – a desperate course of action which the influential Archbishop of Cyprus, for one, has openly advocated.
- Although the deal will avoid the outcome of Cyprus leaving the euro for now, that still remains a possibility. The bailout creates a number of important precedents, raising the possibility that bondholders and depositors in troubled banks elsewhere in the Eurozone could be forced to pick up the tab if their bank needs to be rescued in future. The Dutch finance minister who now heads the Eurogroup said as much yesterday, and subsequent attempts to smooth over his remarks – which were remarkably explicit – have been less than convincing.
What to make of the Cyprus rescue deal announced this morning? Is it necessary? Absolutely: the Cypriot banking system is insolvent, and has been ever since the Greek rescue deal last year, if not before. Is it fair? Probably not. Knowing how weak the Cypriots’ bargaining position was, the troika (EU, ECB and IMF) has played hardball with one of the EU’s smallest member countries, which makes it certain that for every irate mobster or money launderer who loses a chunk of their capital, there will also be many hard luck cases.
The deal administers rough and ready treatment to bank depositors in the country’s two largest banks, while preserving – belatedly, and at the second attempt – the general principle that depositors with less than $100,000 euros are still protected from loss by state guarantee. (Important to note that while the EU has enshrined this principle as a political objective, the guarantees are only as good as the individual state that provides them. Cross-border deposit insurance, under which the EU would collectively guarantee bank deposits in all member states, is necessary if the banking union which the EU is trying to edge towards is ever to become a reality, but it remains so electorally toxic that it won’t be introduced any time soon). Read the rest of this entry »
In the modern era strong equity market performance in January is not, as used to be believed in days gone by, a reliable forerunner of a good year ahead for the stock market, which is a pity as 2013 has certainly got off to a roaring start, with both the S&P 500 and the world index up by 5.0%, and the main Japanese indices up by nearly twice that amount. After its lacklustre performance in 2012 the UK equity market produced an impressive 6.4% and China, a dark horse favourite for top performing stock market, a tad more. However, as this useful corrective note from Soc Gen’s top-rated resident quant Andrew Lapthorne makes clear, there are some curious features of the markets’ generally impressive performance that give cause to doubt quite how enduring this rally will in practice prove to be.
Firstly debt issuance by companies is riding high and a large chunk of this debt is being used to buy back shares. This creates a virtuous circle, where increasing debt issuance supports share prices, pushing down implied leverage and volatility at the same time, which in turn supports ever cheaper credit for the corporate. So, once again, with one of the key marginal buyers of equities the corporate, using capital raised in the debt market means that, as ever, the fate of the corporate bond and equity market are intertwined and as such last week\’s weakness in the high yield bond market is worth keeping tabs on. Read the rest of this entry »
I have always liked the pragmatic approach to economics of the Financial Times Economics Editor Chris Giles, whose balanced pieces are a useful corrective to the doctrinally-driven work of most economists. His recent article in the Financial Times included this sensible comment on the most recent speech by Sir Mervyn King, Governor of the Bank of England, which I think was a significant milestone on the road towards what increasingly looks like a coming change in emphasis in UK monetary policy.
On Tuesday evening, Sir Mervyn King completed his slow conversion from being an activist on what economists call the “demand side” to a “supply side” pessimist. Where the Bank of England governor once saw monetary policy as a simple tool to reinvigorate spending and bring the level of output back to its previous trend, his speech indicates he now sees the pre-crisis period as infected by unsustainably overexposed bank lending and “unsustainable paths of consumption”. Read the rest of this entry »
The dramatic upwards move in the Japanese equity market since the autumn has plenty further to go, according to Jonathan Ruffer, the founder of the private client fund management group Ruffer LLP, one of the professionals whose latest thinking I (and many others) like to follow closely. Ruffer as a firm has held an overweight position in Japan for quite a long time, and now stands ready to be vindicated if Japan’s new reflation policy takes hold, as the markets now seem to be assuming. Writing in his latest quarterly review, he comments as follows:
We hold roughly half of portfolios in equities, in the UK, Europe, US and Asia, but the largest geographic position is in Japan. This market was broadly flat when we last wrote to you, although we had made good money in financial and property stocks. In the last quarter these and other holdings surged further, providing a strong finish to a dull year. The rationale in Japan remains intact; it is the warrant on world economic growth, and so more of the same in terms of monetary stimulus should favour Japan without the rest of the world’s downside. The stability of Japan, its lack of overcapacity, and the absence of financial or labour fragilities, give some protection, and afford it the ability to generate a self-sustaining economic recovery. The low expectations built into the possibility of a Japanese economic recovery provide the opportunity for further sharp market rises. The major obstacle to a more bullish backcloth has disappeared with the appointment of Abe as Prime Minister, and the forthcoming retirement of Shirikawa as Governor of the Bank of Japan. In this new world, the investment danger for foreigners is a weak yen (we have been fully hedged), but this is a benefit to the equity market. Read the rest of this entry »
The New Year has started well, with plenty of evidence that professional investors are continuing to rediscover their appetite for risk assets, with the price of equities, corporate bonds and high yield debt all heading higher. The charts for leading equity indices, including the S&P 500 and the FTSE All-Share, have been trending higher ever since Mario Draghi, the head of the European Central Bank, announced last summer his intention to “do whatever it takes” to prevent the eurozone from falling apart. He has every reason to be pleased with the response to his intervention, which to date has been effectively cost-free. Would it were always so easy! European stock markets, having been priced for disaster before, have led the way up as fears of the euro’s fragmentation recede. Volatility, as measured by the VIX, has meanwhile fallen to multi-year low levels. Read the rest of this entry »
For those with an interest in the interminable eurozone saga, this syndicated interview with the French president Francois Hollande is well worth reading. It sets out clearly the main current differences in approach between M. Hollande and Mrs Merkel as they set off for the latest European summit, which starts today. As always the meeting will attempt to paper over the cracks between these two very different ideas of how greater political and fiscal union in Europe should be achieved. There is still a long way to go before a really durable solution that can guarantee the euro’s survival is reached (if indeed that proves to be possible).