Market Musings 29/5/11

A couple of things – both macro and company specific – have caught my eye since my last update. In particular, and I’m surprised that this hasn’t gotten more attention, a note from Morgan Stanley on the Chinese economy provides many grounds for concern. Regular readers of this blog will know that since starting it I have repeatedly expressed doubts about the health of China, but this is more bearish than anything I’ve come across before. Here are just a few extracts from the note* to give you a flavour:

• “April property sales in tier 1-2 cities have fallen 49% yoy and continue weak into May, additionally unsold inventory is rising” -> For reference, the note later describes Changsha, a city of 6m people, as a “tier-2 city”, so presumably these data cover all major urban areas.
• “CBRE…cautioned that government cooling measures had removed just speculative demand for investment properties rather than set a cyclical trough, and they estimate that investment properties accounted for as much as 50% of last year’s sales in tier-1 cities, of which many units are still unoccupied“.
• “Having met with over 20 producers, industry consultants and traders, [we] believe that recent policy tightening, high energy prices, and regional power shortages are slowing construction and manufacturing activities more quickly than we had anticipated“.

Morgan Stanley goes on to argue that it doesn’t believe that a “growth scare” is reflected in the price of Chinese equities, nor is it reflected in consensus forecasts for China. Clearly, this doesn’t augur well for China’s plcs. In terms of the read-through for the companies listed in this part of the world, it’s probably worth looking at what stocks you hold in your own portfolios to see what sales and profit exposures to China they have, while if you have a portfolio that’s more driven by trends in commodity prices, might I direct you to the table in this earlier blog I wrote which shows the % of global consumption of each major commodity that China is responsible for.

Elsewhere, having come back from my holidays, I see the weekend press is full of articles that belatedly follow my much earlier exortation to investors to “Sell in May & go away“. The other current school of thought about the market (I haven’t seen anything bullish in a while, although maybe I just read too many bearish commentators!) is that it’ll go sideways until the end of the year. If it does, then I would suggest that people consider shopping around some of the big dividend yielding stocks. Let’s be honest, your money is arguably safer invested in a defensive blue chip company with a strong balance sheet than placed on deposit in a worrying number of banks these days, while the dividend yields on offer in some companies are substantially higher than what you’d receive by putting your money on deposit or into short dated government securities (in the more financially sound developed countries!). What do I mean by that? Well, to illustrate, among the stocks I hold is Irish Continental Group (the parent company of Irish Ferries), which reported net debt of only €4.0m in its recent IMS and which pays a well-covered (by cashflows) dividend of €1 a year – a yield of 6.2% based on Friday’s closing price. Another share I’ve been buying recently is Standard Life, which yields about 6.3% (based on last year’s dividend). If you’re worried about the cost of oil for ICG, then why not consider hedging that risk by also buying some Royal Dutch Shell, which yields just over 5% (based off last year’s dividend). Obviously the major risk is an adverse move in the market (and as you can see I’m firmly in the bear camp), so this advice is directed solely at those of you who are happy to invest in full knowledge of the risk that the value of your investment can just as easily go up as down. But if you’re a long term investor or one who is focused more on income generating stocks, then those are three ones that you might consider the merits of buying and putting in the bottom drawer, to be disturbed only when the dividend cheques come through the letter box a few times a year!

Turning to the Central Banks, I note this article about the size of the Fed’s balance sheet, which again to me is just another illustration that the Bernanke/Geithner/Obama plan just isn’t working.

But the US hasn’t got a monopoly on ill-considered government proposals. In Ireland, the government’s planned theft of savings has worrying implications both for our reputation as a safe place to do business and also in terms of disincentivising people to prepare for their old age. Given our ageing population & mass youth emigration, the expropriation of private pensions will have horrific long-term ramifications. I cannot think of anything more immoral than a levy on peoples’ savings, which of course are comprised of income that has already been taxed.

Returning to my earlier comment about the soundness of our banks, here’s something that escaped my attention when it first came out some months ago – Ireland’s banks were rated the least sound in the world by the Global Competitiveness Report. We were last of 139 nations, behind Zimbabwe & Mongolia. Here’s another reference point for Ireland’s banks – Friday’s Irish Times reported that the 15% of loans in RBS’ non-core division, Ireland accounted for provided 78% of RBS’ total non-core bad debts. Speaking of sound banks, it continues to amaze me that Spain is seen as “different” to the rest of peripheral Europe, especially when I see things like this.

Another statistic that caught my eye this week was a small nugget buried in the inner pages of the Wall Street Journal – China overtook the US as the world’s biggest electricity consumer last year. It has a whopping 436 coal-fired power plants alone.

* From Morgan Stanley’s “Global Investment Perspectives”, published on May 26 2011.

Market Musings 10/04/11

Since I last offered my thoughts on the markets on Thursday morning we’ve seen some interesting developments, especially where interest rates and commodity prices are concerned.

 

Thursday brought news that the Old Lady of Threadneedle Street – The Bank of England – was, as expected, keeping rates on hold for now. I wouldn’t be surprised to see a hike at the next meeting, assuming that the Q1 UK GDP reading on April 27 doesn’t throw up any surprises. One central bank that did hike was the ECB, which raised rates (by 0.25%) for the first time since July 2008. The market is bracing itself for further rate increases over the coming months, and we could well see the ECB base rate hit 2.00% by year-end. This is bad news for the 400,000 tracker mortgage holders in Ireland. As I’ve said before, Ireland has had an inappropriate monetary policy on the way up, and now we have an inappropriate policy on the way down too.

 

The main culprit behind these rate increases is, of course, inflation. We got a few reminders of how frothy commodity prices have gotten this week with silver breaking the $40 level for the first time since 1980, brent crude hitting a 32 month high and gold reaching another record level. Indeed, China reported its first quarterly trade deficit for 7 years this week, as soaring commodity prices have added massively to its import bill. With the Federal Reserve’s QE2 programme scheduled to end in June, it will be interesting to see what the consequences of this will be. Bloomberg economist Michael McDonough wrote an interesting piece showing a strong correlation between commodity prices and Fed Treasury purchases, which is worth a look.

 

Despite all of the talk of austerity here, I was surprised to see that subsidies for flights between Dublin and Galway will be maintained until the middle of the summer. The PSO has, in my view, had absolutely no justification for the past few years given the major investment by the State in both road and rail infrastructure between the two cities.

 

Speaking of austerity, some eye-popping numbers – the US incurred a budget deficit of $830bn in the first six months of fiscal year 2011, some $113bn than in the same period in the previous fiscal year. Figures like that really show up the “historic” $38bn US budget deal for what it is – a complete joke which barely makes a dent in the deficit. On that note, Peter Schiff, as always, tells it how it is here. If you are looking for more details on the US budget, read this thought-provoking piece by Peter Tchir.

 

In terms of sector calls, Davy turned negative on UK housebuilders, which for me wasn’t a huge surprise given the scary updates coming out of firms exposed to the UK consumer in recent times. I was interested to see some predators looking at European debt too – BlueBay is buying Irish government bonds while SVP is attracted by opportunities in distressed debt in Euroland. Fisher Investments, whose insights I’m a big admirer of, released its latest guidance for investors.  It says that this year will be one where stock-picking skills are to the fore, a theme I’ve explored in my articles for Business & Finance magazine since the start of the year.

 

(Disclaimer: I am a shareholder in CRH plc and AIB plc) Turning to Corporate Ireland, the government confirmed that its stake in AIB is to rise to 92.8% – post the completion of this AIB will have 12.25bn shares in issue. Another plc that caught my eye was Fyffes. I was surprised to read that Fyffes (market cap €143m) paid its directors €2.7m last year, while Ireland’s biggest plc, CRH (market cap €12bn) paid its directors €8.0m in the same period.

 

In terms of the week ahead, I’ll be watching results from Punch and the IMS from Michael Page tomorrow to get more clues on the health of the UK consumer, while on Wednesday 3 Irish plcs – Tullow, Kerry and Fyffes – all go ex-div so watch out for some interesting price action there. All told my mood is bearish, I’m overweight defensives and see no reason to rebalance my portfolio.