Philip O'Sullivan's Market Musings

Financial analysis from Dublin, Ireland

Market Musings 17/04/11

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Not a lot has changed since I sat down to write my last wrap on the markets. We’ve seen further concerning signs from China and the US, more foolish policy decisions by governments and evidence that many people in Ireland have absolutely no concept of what a “firesale” really is.

When people ask me what the government should do to address the economic situation here, I immediately reply: “As little as possible”. The evidence on the ground in terms of Fás, the HSE, Dublin Airport Authority and State policy towards the banks should be enough to dissuade anyone wondering if the State should encroach upon any other areas of the economy. So what should the government do? I would say that it should live within its means, minimise red tape and keep taxes as low as possible. And if it does those sort of things and restores our reputation abroad, then I think it would be in with a good shot of winning things like some of this for the country, given that we: (i) can offer a glut of modern commercial property; (ii) can provide employers with an army of unemployed graduates; (iii) have people who speak the same language as they do in the UK; and (iv) are situated in the same timezone as London, which is vitally important from a trading perspective.

Alas, instead of trying to win that sort of investment, the Irish government appears to be focusing its efforts on things such as making hiring people more expensive at a time of massive unemployment. The government also has an odd strategy for the banks. It is proposing to create two “strong universal pillar banks”, one of which will be a combination of this turkey and this turkey. That doesn’t exactly fill me full of confidence.

There was a well attended property auction in Dublin during the week. Various media people and economic pundits gushed about it, describing it as a “firesale“. Except, of course, that the prices the properties achieved were anything but firesale prices. And here are a few reasons why I think that this is so:

  1. An analysis by Ronan Lyons reveals that the typical gross rental yield was between 8.5% and 9.0%. This, he tells us, is similar to the yields seen in the late 1990s, when Ireland was not in a recession. Given where the economy is currently at, I can’t see how these could be thought by anyone to represent bargain-basement prices.
  2. I ran an equity screening tool on my Bloomberg on Friday night on the EuroStoxx 600 – the 600 largest plcs in Europe – which revealed that 24 of them were paying dividend yields above 7%. So two dozen blue-chip corporations can pay you a higher yield than a lot of what sold in the “firesale auction”, and unlike Irish property these corporations can offer a decent prospect of capital appreciation over the next 2 years.
  3. Most, if not all, of the properties offered at the auction had a reserve price. A firesale is one where vendors are prepared to hit any bids, not walk away if they don’t like what’s being offered.
  4. The most expensive property sold in the “firesale” was a mews house for €550k. Here’s what €477k buys you in France.
  5. Analysis by the FT & show that 49 postcodes in the UK (12 in London) provide rental yields >6% for buy-to-let investors. And while economic circumstances are far from perfect in the UK, they’re a darn sight better than they are here.
Turning to the US, I see that some of the investment banks turned a little more bearish. In terms of a market view, Morgan Stanley note that QE2 is “highly correlated to equity performance”, and warn that end of QE2 and “EPS disappointment could catalyze multiple contraction”. Also, “later this year [Morgan Stanley] expect investors to worry about growth in 2012 as monetary and fiscal policies tighten”. In plain English they’re saying that if the Fed stops printing money in June and a weaker economy causes analysts to cut their profit forecasts, investors are unlikely to pay the same multiple of earnings for shares that they currently do. So, it’s no surprise to see a continued rush into precious metals. Staying with the US, Goldman Sachs cut its GDP forecasts late on Friday. In my experience, equity analysts always take their lead from economists, so expect a tidal wave of company downgrades in the short term from GS. 

China raised its reserve requirements for banks for the fourth time this year today. A reminder that George Soros recently described inflation in China as being “somewhat out of control”. JP Morgan has a good note here on the effect of the government’s interventions in the Chinese economy. In summary, I remain very, very bearish on China.
Oh, and don’t forget – seeing as many of our main trading partners are seeing their economies deteriorate, Ireland’s “small open economy” will not escape the effects of this, so expect further Irish GDP downgrades over the rest of the year.

Written by Philip O'Sullivan

April 17, 2011 at 9:08 pm

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