Market Musings 21/8/11

Activity on the blog has been quiet this week as I had to finish two articles for the new issue of Business & Finance magazine, in which I look at the outlook for global markets and also talk to two of Ireland’s brokers, NCB and Dolmen, about the options they have for investors looking to diversify out of Ireland and the eurozone. Sadly, this meant that this blog remained quiet while the markets were anything but that!

 

There was panic on the global equity markets as investors rotated out of shares and into “safe haven” assets such as gold, which continues to shoot higher. At the time of writing it is just under $1,852 an ounce, having surged 14% in the past 30 days (it’s up 47% in the past year). Another “safe haven” that has seen massive inflows is government bonds, and we’ve seen some chunky moves here, with yields on US Treasuries at levels last seen when Eisenhower was in the White House.

 

While there is no denying that the catalyst for the slide in equity markets – fears of a ‘double-dip’ recession and deleveraging slowing the pace of a future recovery – is real, the market reaction to me looks excessive. Concerns have been heightened by weak GDP readings across many of the world’s leading economies, however, low growth and high debt are hardly new concerns, and I believe that markets have more than moved to compensate for a more adverse scenario playing out. Moreover, given the hysterical tone of much of the financial commentary I’ve recently read, my view is that we are in and around the point of maximum bearishness (recall, however, the old stock market adage that nobody rings a bell at the top and bottom of the market!), and that shares will rebound significantly between now and the end of 2011.

 

While there’s no denying that the economic outlook is gloomy, things are nowhere near as bad as they were in 2008 (comparisons with 2008 have been repeatedly made this week) and it shouldn’t be forgotten that corporate balance sheets have dramatically improved since the onset of the global financial crisis (one article I read this week said that US and European corporates are sitting on $3trn in cash). Furthermore, with government bond yields at record lows and sovereign balance sheets in rag order, minuscule returns on cash and gold looking frothy (in the short-term, as it has spiked well above trend, however, the long-term fundamentals remain intact), I would submit that bluechips with strong balance sheets and well-covered dividends (dividend yields for many large corporations stand at a multiple of their countries’ bond yields) are looking particularly attractive here to people with money to invest. 

 

It takes guts to step in when panic like this sets in. Perhaps the market has further to fall. But when sentiment turns, and the huge sums of cash that have been parked at near-zero returns in the money markets in recent weeks rotate back towards riskier assets, the rebound in equity markets (I can’t see the funds rotating into government bonds or precious metals, given where they are trading at) will be an extremely violent one.

 

Turning away from the overall market and to specific companies, I was amused to see stockbroker Peel Hunt use the recent UK riots as one of the reasons why it recommends Domino’s Pizza UK & Ireland plc to investors as a buy:

 

“We would also take seriously recent social developments, which even after calm has been restored, may result in a subtle shift between the considerations for going out as opposed to staying at home. This cannot be bad for the delivery business”

 

I was pleased to see solid interim results from Kerry Group during the week. Growth was led by its world-class Ingredients division. The company  “remains confident of achieving its growth targets for the full year and delivering 8-12% growth in adjusted EPS” as previously guided.

 

I recently commented about how there has been a spike in share buybacks. On Thursday Ryanair disclosed that it has bought back a further 1% of its shares. I wonder if any other Irish plcs will follow the lead set by it, Abbey and United Drug given the recent market falls.

 

Finally, looking to the week ahead, the main scheduled Irish corporate news will be the interim results from Kingspan (Monday), Tullow and Glanbia (both Wednesday) and Independent News & Media (Friday). Doubtless they will provide plenty of talking points.

Market Musings 12/8/11

Markets rebounded a bit yesterday, but remain well below recent highs. Since my last update the main news has been the introduction of a short-selling ban in a number of EU member states, which I’ll look at in more detail below, while other things that have caught my eye include the price of gold, poor economic indicators in the UK and France, and also some corporate newsflow.

 

First up though, I was pleased to be “welcomed back” (!) by two readers who posed some really great questions to me about commodity prices and the short-selling ban yesterday. If there are any topics, within reason, that you’d like me to visit on this blog, feel free to get in touch and I’ll tackle it them here asap.

 

When the rumours about the introduction of a short-selling ban emerged yesterday afternoon, my initial response was to say that (i) this will does nothing to cure the problems in Europe’s banks; (ii) such measures have failed to work before; and (iii) bans are counter-productive because they increase the perceived riskiness of assets that are the subject of such bans, as market participants will no doubt become more wary about investments where governments and/or regulators intervene to significantly change the rules of the game.

 

These counter-arguments were put to me:

 

Well it’s time for something radical

It’s better than doing nothing and have rampers profit from what is nothing short of criminal with no risk of prosecution

If Italy and Spain are happy with their fundamentals they will not suffer from a suspension of short selling

The Irish and US experiences with bans are poor examples to give

 

My quick response to those four arguments are: (i) I agree that radical policies are needed, but I don’t see how a short-selling ban will do anything to cure the patient; (ii) The short-sellers wouldn’t have been circling around the banking sector unless something was very rotten in the system; (iii) Italy and Spain’s “fundamentals” – sclerotic growth, substantial public debt, big deficits, dire demographics, structurally high unemployment – would make me nervous; and (iv) I think using a fellow peripheral European country and the country where this bank problem first really started to emerge is fair.

 

To the above I would add the following: Bloomberg’s Mike McDonough, who is a must-follow on Twitter, produced this great chart which shows the experience of a short-selling ban across five countries, adding the UK, Germany and the Netherlands to the two I provided as examples.  As I said above, the ban does nothing to address the fundamental reasons why the market has turned negative on financials, namely worries about the growth outlook, the increasingly likelihood of substantial write-downs on holdings of sovereign debt and political calls for a punitive tax on banks. These problems will not go away as a result of  a trading restriction which Galileo Global Advisors describes as “knee-jerk” in a FT article that’s well worth a read. In particular for this bit:

 

A 2005 Cornell University study looked at short selling rules in 111 countries and found no evidence that bans reduced the frequency of market crashes. More recently, the International Monetary Fund found that 2008 prohibitions “did relatively little to support the targeted institutions’ underlying stock prices, while liquidity dropped and volatility rose substantially”.

 

Elsewhere in the FT, the influential Lex column concludes with this point that mirrors part of the argument I made yesterday:

 

Market gravity pulled weak companies down, as investors recognised that the shorts were right. When pessimism is justified, bans will not stop the truth from emerging.

 

Turning to France, earlier today it announced that second quarter GDP growth came in at zero, below consensus of +0.3%. Clearly this is the last thing Sarkozy et al need after the recent concerns about its economy. Staying with macroeconomic news, a study by LSL and Acadametrics says that UK house prices have fallen to a 19 month low.

 

In the commodity space, gold futures hit $1,800 an ounce earlier this week but have fallen back a little on CME margin hikes and also the uptick in equity prices. Given how volatile markets are at this time, I wouldn’t be surprised to see the upward trend resume in the near term – Merrill Lynch reckons gold will hit $2,000 in the next 12 months, which looks easily attainable given the troubled backdrop and the possibility of another round of quantitative easing in the United States. The margin increase serves as a reminder that while the path of least resistance is up, it will be a rocky one. One of my readers has asked if I can provide…

 

An analysis of the equity and businesses surrounding gold extraction and trade

 

…which is something I aim to tackle over the weekend, along with the dividend yield report I promised yesterday!

 

Finally, one “grey market” name I’ve written about before is One51. It released its 2010 annual report yesterday, which revealed a solid underlying performance, with pre-tax profits (before exceptional items) rising to €24.5m from €19.5m in the previous year. Its NAV of €2.56 per share was well down on the €3.66 at the end of 2009, with most of this decline down to a non-cash impairment charge on the value of its listed and unlisted investments. The main worry I would have on this front would be the value of its NTR stake, which it includes in the books at €48.7m, or just under 40c a share. Even if you wrote this to zero (which would obviously be an aggressively cautious step to take), you still get a NAV of over €2 a share, versus a current share price of €1.00. While its illiquid grey market status and significant Irish exposure mean that a discount to NAV is warranted in my book, a 50%+ discount looks excessive to me. One way that it could help to address this discount is by transitioning to a listing on the Irish Stock Exchange, which would improve the marketability of its shares. One area that has attracted media attention is remuneration levels at the group. While it is easy to point at how much the top dog in any company is paid, overall employee costs should not be ignored. The total P&L charge on this front of €65.4m was -6% from the previous year, while average wages & salary costs of €38k per employee (a whopping 14% below 2009 levels) are hardly excessive.

 

Two highly alarming stats to chew over – the percentage of Americans who don’t have $1,000 in savings to cover emergencies? 64%. The percentage of Americans who don’t have any savings whatsoever to cover emergencies? 24%.

 

And finally, seeing this gold-dispensing ATM was a highlight of my recent trip to Dubai.

Market Musings 17/04/11

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 & Findaproperty.com 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.