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Archive for the ‘Themes’ Category

Beyond the stock market correction

The current stock market correction is likely to be over quite soon, the fund manager Neil Woodford suggested yesterday, and I suspect that he is right for now. His view, sensible as always, is that the main reason for the market’s fall is that investors have taken fright at the evidence of slower than hoped for global economic growth, particularly in Japan and Europe, plus a number of other contingent factors. The market correction, the sharpest for over two years, is long overdue, given increasing investor complacency in the face of Federal Reserve and other central bank manipulation of market prices. Read the rest of this entry »

Written by Jonathan Davis

October 17, 2014 at 10:28 AM

It’s all about her background, stupid

There is a long and interesting profile of Janet Yellen, the head of the Federal Reserve, in the latest issue of the New Yorker. As you might expect from this longstanding voice of the liberal New York elite, it paints her in a  sympathetic light, and usefully draws attention to how and where her views about the role of economics and the central bank were formed.  Here is a short extract, in which the author picks up on the fact that her first official public appearance after succeeding Ben Bernanke in the job was carefully chosen to send a message about her priorities:

She had gone to Chicago a few weeks earlier to speak at a conference for neighbourhood revitalisation organisations – not the venue a new Fed chair wouuld ordinarily choose for a maiden speech. Yellen was sending a signal. As she put it that day “Although we work through financial markets, our goal is to help Main Street, not Wall Street”. More than five years after the financial crisis, historically high numbers of Americans are still out of the labor force, working part time when they’d rather be full time, or unemployed for more than six months. Yellen spoke mainly about unemployment, and told the stories of three blue-collar Chiacagoans, two black, one white, who had lost their jobs in the recession. Her staff had found these people for her, and she had spoken to them on the phone before her speech. Two of the three – from Chicago’s desperately poor West Side – had criminal records.

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Written by Jonathan Davis

July 28, 2014 at 4:21 PM

Stock market bubbles under the microscope

My thanks to Tim du Toit, founder of EuroshareLab, an excellent Europe-wide stock screening service, for alerting me to this interesting and sensible academic perspective on stock market bubbles – how to measure them, what to think about them, how to react to them.  The author is Aswath Damodoran, a professor at the Stern School of Business at New York University.  His article includes a number of spreadsheets which readers can usefully adapt to make their own calculations of PE ratios and future returns.

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The many insights of prospect theory

My latest column in the Financial Times looks at some of the helpful ways that prospect theory illuminates how asset prices are set and fund managers are rewarded.  Prospect theory originally developed from studies carried out by psychologist Daniel Kahneman and his colleague Amos Tversky. Prof Kahneman’s must read book Thinking Fast, Thinking Slow continues to ride high in the bestseller lists. To read the column on the FT website follow this link.

Written by Jonathan Davis

July 2, 2014 at 12:41 PM

Interview with Terry Smith

Terry SmithTerry 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”.

Written by Jonathan Davis

November 1, 2013 at 12:14 PM

Two events in October

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.

The house price/general election nexus

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.

chart2 house

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Rich valuations for the stock market’s global elite

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 »

The “most dangerous investment environment ever”

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 »

Written by Jonathan Davis

April 23, 2013 at 3:06 PM

Cyprus and beyond: more thoughts

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.

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Written by Jonathan Davis

March 26, 2013 at 2:01 PM

Cyprus: new fault lines in the Eurozone

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 »

Written by Jonathan Davis

March 25, 2013 at 4:12 PM

Change on the way at the Bank of England?

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 »

Written by Jonathan Davis

January 27, 2013 at 8:29 PM

Hold on to your hats in Japan

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 »

Written by Jonathan Davis

January 21, 2013 at 3:33 PM

Myopia in the stock market

We all know that private investors are typically scarred and scared out of owning equities by their aversion to incurring losses. Yet the scale of that aversion is staggering, according to some research recently reported by the Franklin Templeton fund management group.  Its annual survey of investor sentiment allows it to ask investors what they think has happened to the stock market each year, and then compare that perception to the reality.

So for example the proportion of the 1000-investor sample which thought stocks had fallen in 2009 was 66%. Yet the S&P 500 index in that year was actually up 26%. The comparable figures for 2010 were 48% (who thought the market had fallen) and 15% (the actual market rise). More than half the survey also thought stocks had fallen in 2011, when the market in practice was flat.

The fund manager’s theory is that these figures are testament to the behavioural bias which prompts humans to give undue importance to one bad experience – the 2008 crisis, which sent the S&P index down 40% – and ignore more favourable outcomes. Whatever the explanation, the data certainly helps to explain why so much money has flowed out of equity funds into bond funds since the crisis broke, in apparent contradicton to common sense and historical experience.

Written by Jonathan Davis

October 17, 2012 at 3:59 PM

A dissenting view on inflation

Has the Bank of England lost control of interest rates? You won’t hear that view from any official source, but it is worth listening to the economist Peter Warburton, the founder of the consultancy Economic Perspectives, whose often dissenting opinions have been more right than wrong over the past couple of decades. He argues differently in this contribution to the Shadow Monetary Policy Committee’s latest review of economic conditions, in which he warns about the incipient threat of price inflation. It is well worth reading: I suspect it will look very prescient when we look back in years to come.

It is becoming increasingly obvious that the Bank of England has lost control of UK retail borrowing costs. During the three years-plus that Bank Rate has been set at ½%, the average interest rate paid on banks’ and building societies’ notice deposit accounts has risen from a low of 0.17% in February 2009 to 1.83% in July 2012.

Admittedly, the quoted monthly rates have bounced around, but the average for 2012 is 1.41%. This is a measure of the average cost of retail funds to the banking sector; the marginal cost is closer to 3%. On the other side of the balance sheet, Santander UK has recently announced a 50 basis point increase in its standard variable mortgage rate, to 4.74% from October. Clearly, the level of Bank Rate has played no role in the evolution of market rates for the past three years. The MPC’s consideration of a cut in Bank Rate is perverse and farcical in this context. As and when the UK economic news flow permits, Bank Rate should be raised in order to reconnect it to the structure of market rates. However, with UK activity indicators currently erratic and weak, now is not a good time to do this. Read the rest of this entry »

Written by Jonathan Davis

September 4, 2012 at 9:41 AM

The risk of a short circuit in markets

Richard Burns, until recently the senior partner at Baillie Gifford, is now chairman of a range of the firm’s investment trusts, including Mid Wynd International, a special situations fund that holds positions in interesting companies that are too small to make a difference to its flagship funds. This is his most recent take on the investment environment, taken from the trust’s annual report. With the Eurozone crisis continuing to cast a shadow over events, and equity markets not obviously cheap, cautious and pragmatic investors (a type much in evidence in Edinburgh) are mostly marking time for now.

Repeated central bank stimuli have managed to contain, for now, what would otherwise have been a combination of Western debt deflation and deep recession. These interventions buy time, but not an indefinite amount. Policy making in the afflicted parts of the Western world appears to be running up against the laws of diminishing returns. Underlying sovereign balance sheets are deteriorating further meantime. What has happened is akin to stripping insulation from the bare economic wire – governments and central banks are that insulation. As time goes on, and in the absence of a more potent recovery, the risk of short-circuit increases.

Read the rest of this entry »

Written by Jonathan Davis

August 30, 2012 at 9:04 AM

Why quality stocks pay off

It is no accident that some of the best performing fund managers of the last few years have been those who have stuck to investing in powerful global equities with a consistent history of profitability and sustainable earnings and dividends. In the UK those who fall into this camp include Neil Woodford at Invesco Pereptual, Nick Train of Lindsell Train, Sebastian Lyon at Troy Asset Management (mentioned in my last post) and Terry Smith, whose equity funds solely buy and hold this kind of high return on equity stock. It is also of course at the root of Warren Buffett’s long success as an equity investor.

But why do so-called quality equities (defined as stocks which have low leverage, high returns on equity and consistent earnings) perform so well, yet are so regularly overlooked by the majority of investors in favour of more speculative growth stories? A recent research note from Jeremy Grantham’s team at GMO uses long run US data to highlight the persistently superior performance of quality stocks and their particular attractions in today’s binary (“risk on, risk off”) market conditions. The primary driver behind this superior performance is the ability of these companies to preserve and grow capital, not to lose or squander it as many do, either through incompetence or normal competitive pressures.

Here are a couple of short extracts from the GMO research paper:

True competitive equilibrium is a rarity in the global economy. Instead, we find persistent winners and persistent losers. The competitive paradigm says that highly profitable activities attract capital, and that capital flees those with low profits. This is the market mechanism behind mean reversion, which is supposed to close the profitability gap. In reality, certain companies earn persistently high returns on equity. Superior returns are delivered to investors in the form of dividends, stock buybacks, and accretive growth.

Read the rest of this entry »

Written by Jonathan Davis

August 18, 2012 at 12:17 PM

An invidious choice

I find it hard to disagree with these comments from Sebastian Lyon, the CEO of Troy Asset Management, writing in the annual report of Personal Assets, the investment trust to which he and his colleagues now act as Investment Adviser, following the death of Ian Rushbrook four years ago.

The secular bear market in UK and US equities is now in its thirteenth year. How much longer must we wait until we can again be fully invested (or even geared!) and reap the double-digit returns we long for? Ask the policy makers! Stocks would be considerably lower were central banks not keeping stock prices artificially high by means of zero interest rates and quantitative easing. Despite these interferences, stock markets have gone sideways during the past year. Savers have not been rewarded for taking risk and hence our cautious strategy has paid off, for now, although we are likely to lag short term rises in the market should further monetary interventions be forthcoming.

Politicians in Europe are confronted with the invidious choice between severe austerity, which is likely to lead to periodic recessions and declining tax revenues, or incautious borrowing in the hope of buying growth. Both approaches will eventually force governments to pay higher rates of interest on debts. The maths do not stack up. No wonder governments are looking to extricate themselves from an intractable problem by leaning on central bankers to pull their inflationary strings. But our greatest concern is that the European challenges that have dogged markets since early 2010 are merely the dress rehearsal for the main event – a US fiscal crisis. While the UK and Europe have at least tried to tame their budget deficits, the United States has pushed ever harder on the fiscal accelerator. Stock markets swooned last August when they got a shock preview of what might happen should the brakes be applied. Following the public disagreement in Washington over increasing the public debt ceiling, the Dow Jones Industrials Index fell 13% in seven trading days. Read the rest of this entry »

Written by Jonathan Davis

August 16, 2012 at 7:56 PM

The truth about future economic growth

Rob Arnott, the chairman of Research Affiliates, is one of the most articulate and interesting market analysts in the States, and someone whose ideas and research I have followed for a number of years. In my latest 30-minute podcast, I discuss with him the outlook for investment returns – and how they will be dramatically influenced by what he calls the three Ds now hanging over the world – debt, deficits and demographics. All three are conspiring to drag down likely future rates of economic growth in the developed world. Investors need not despair however, Rob argues: better returns are available if investors switch their focus from conventional benchmarks to a multi-asset strategy based on broad economic, rather than purely financial, criteria. Before listening in, click the link below to download a copy of the slides he used to develop his arguments at a recent presentation to a London Stock Exchange seminar. The podcast can be downloaded from here. Recommended.

Arnott LSE Presentation July 2012

Written by Jonathan Davis

July 29, 2012 at 5:30 PM

Patience the number one requirement

It is more than 15 years since I first trawled up to Edinburgh to meet Ian Rushbrook, the iconclastic onetime Ivory & Sime partner who took over the running of the near-dormant Personal Assets Trust in 1990 and soon turned it into one of the most successful capital preservation vehicles for private investors there is. Ian featured in my book Money Makers (first published in 1998, soon to be re-issued in a new edition).  A smart young fund manager called Sebastian Lyon was one of those who read my book and liking what he read, later made a pilgrimage to Ian’s den behind Charlotte Square to learn more about the business of managing money.

Now, several years on, as CEO of Troy Asset Management, a fund management business that originated as the guardian of  Weinstock family money, he also acts as Investment Adviser to Personal Assets, following Ian’s untimely death three years ago. The trust has since gone from strength to strength, delivering NAV growth of 51.7% in the three years to the end of November 2011, outperforming the FTSE All-Share by a useful margin as a result. With shareholders funds of more than £400 million, and a succesful no-discount policy in place, shares in the investment trust have now reached the giddy heights of being included in the FTSE 250 index. Read the rest of this entry »

Written by Jonathan Davis

December 20, 2011 at 4:18 PM