Tony Yarrow's Fund Management Blog
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BLOG SEPTEMBER 3rd, 2010 Synopsis- The inflation/deflation debate Stock markets and leading indicators The Glaxeau Lafite index revisited, and a look at the Dow/gold index Wise Investment funds performance update MILIBAND OF BROTHERS You won’t have missed the big fraternal battle that’s been taking place this summer, a power struggle that’s becoming increasingly fraught and personal, and is taking up more and more media attention. On its outcome could rest the whole direction of policy for the next decade. The brothers in question are, of course, the Flation twins, Dave and Nigel. Their Christian names are almost never used, and they’re known universally by their initials-N.Flation and D.Flation. At first sight, there’s a close family resemblance-they are after all twins. But look closer, and you’ll see an important difference. N. Flation is a normal person, while D.Flation,who died some years ago, is a ghost, often referred to as ‘the spectre of D.Flation’- which explains why he is seen so much less often than his brother. D.Flation is normally seen wearing black, as you may have noticed. Some commentators suggest that there’s little to choose between their policies, but in fact there are profound differences between them, and as their in many ways diametrically opposed views of the world affect what we do as investors, it makes sense to pause for a moment and consider what they’re both saying. D.Flation’s manifesto This view of the world is a sombre one. It looks at the history of Japan over the last two decades, and predicts that the world is going the same way. There are three main elements, a stock market and property bubble that burst, a weak policy response which magnified the problems rather than solving them, and the effect of an ageing population, which became highly risk averse and saved a significant proportion of its disposable income, when the economy needed spending. All these elements, says Dave Flation, are present today. There is no possibility of meaningful economic growth while the banks can’t or won’t lend. The huge levels of debt will hamper recovery for the foreseeable future. There is spare capacity in all areas of the economy, which prevents companies from raising prices. Once deflation takes hold, and prices in the aggregate are falling across the economy, interest rate policy stops working, because you can cut interest rates to zero, but no further. All that’s left is quantitative easing (QE), but governments used up most of their capacity to stimulate last year, and their options are now limited. Economies, notably the US, are visibly slowing as last year’s stimulus wears off. What do we do as investors? Well, you might think that UK government stock yielding 3.0% doesn’t look attractive, but that’s the mistake that investors in Japan made in the early 90’s. As deflation takes hold, no other investment gives enough security, and as prices fall, the fixed return on gilts and treasuries gets more and more attractive. Forget share dividends-they are illusory, and will have to be cut as the economy, and in due course company profits, shrink further. N. Flation’s manifesto Nigel thinks that the demographic argument is spurious. Japan’s population is shrinking by half of one percent per annum, and its working population is shrinking by 1.0% per annum. This profile doesn’t hold for the world as a whole, where the overall population is growing by 200,000 souls each day. Secondly, he considers living standards. Overall, world living standards are improving-this is certainly true for the three countries China, India and Brazil where roughly 40% of the world’s population live. Finally, he looks at the supply and demand for commodities, an important determinant of the inflation rate. Demand is rising (more people, higher living standards) and supply is struggling to keep up. Nigel believes that inflation numbers have been depressed over the last two decades by the influence of China, which has exported an increasing number of products at ever lower prices to the West. However, this trend is ending. Migrant workers are getting fed up of being exploited, and are striking for higher pay. The bosses are happy to settle.Result-wage inflation in China is rising at an annual rate of 15%, which has to be passed on to the end-user eventually. Also, the Chinese yuan is being held at a low level, and will inevitably rise over time, increasing the cost of Chinese products to the Western consumer. MARKETS AND LEADING INDICATORS We don’t know which of the two brothers is right. It is an important argument and one which we wrestle with continually. For what it’s worth, we think that Dave (D.Flation) has the more powerful arguments in the short term, but further out (we’re not sure how far out, maybe five to ten years, maybe less) Nigel (N. Flation) is more likely to be right. However, among all the market turbulence of the last few months, investors have come down firmly in the deflation camp. Over the last few weeks, the price of UK and US government stock has soared, leaving yields on these assets at record low levels. Our investors have very little exposure to government stock, as we considered it to be over-valued even before the latest rises. To give you an idea, there was a point last week when the Treasury 5% 2012 issue, which has almost 18 months left to run, was priced at a redemption yield of 0.58%, meaning that investors were prepared to pay to get a return of less than 0.9% over an 18-month period, which is almost certain to be below the rate of inflation during that time (the latest RPI number was 4.8% per annum) Compared to gilt yields at these levels, corporate bonds look cheap, and good shares look spectacularly cheap. However, if D.Flation is right, this argument is an unreliable one, because the relationship at times of deflation can be misleading. At the end of March, the yield ratio (the amount of income you’d get from a portfolio of gilts divided by the amount of income you’d get from the same value of shares) was 1.50. Today, it’s 1.17. To restore the ratio to its end-March level, assuming gilt prices don’t change, the FTSE-100 index would have to rise to 6950, up 28% from its current level. This gives you a good idea how risk-averse institutional investors have become. Interestingly, private investors seem to be getting less risk-averse, as the memory of What Happened in 2008 begins to fade, and the continuing absence of proper returns on deposit accounts becomes ever more irritating. TECHNICAL UPDATE My last blog contained a detailed analysis of the FTSE-100 graph. Over the last few months, there has been much volatility, but the direction still isn’t clear. The downtrend pattern described last time is less definite now than it was, as the sequence of falling lows has been broken. The prediction I made last time that we wouldn’t see a new low below 4823 ( the July 5th closing level) has proved right-so far. For now it seems best to think of FTSE-100 as trading in a range between 5000-5500. There will be a decisive break one way or the other sooner or later, and my money would still-marginally-be on an upwards break-but the market has rarely been more trendless, a by-product no doubt of the two opposing and both highly credible interpretations of what’s unfolding. WALL OF WORRY There is an old saying that ‘a bull market climbs a wall of worry’. I am still more or less of the view that we’re in a bull market, but there are-I need hardly remind you-headwinds, mainly concerns that a slowing US economy could lead to a return to recession, the ‘double-dip’. It’s worth reminding ourselves what a recession actually is, and there is a precise definition. A recession is where an economy contracts for two successive quarters. So, let’s imagine that the level of the economy is 100.00. Three months later, it’s 99.9, and three months after that it’s 99.8. The economy has contracted by 0.2% in six months, and that’s a recession. What happened in 2008-9 was that the UK economy contracted by 6.5%-a bigger contraction than at any time since the 1930’s. If you’re expecting a double-dip, the second one will be a dull affair compared to the first. Please don’t expect a repetition of the wholesale panic and dislocation of that terrible six months in 2008-9. It isn’t-that’s already happened, and it won’t come back. Think of it, if you will, like the Black Death. The initial onslaught, in 1347, wiped out a third of the population of Europe. Over the next twenty-five years, the plague returned every few years, but with decreasing mortality each time, as more and more people became immune. In the end it was noticed that the disease only killed the weakest souls-the very old, the very young, and those who had diseases already. In terms of companies today, I find that a useful analogy. But try telling that to the boys and girls at the Financial Times. I have christened the wall behind my desk the ‘wall of worry’, and I stick the depressing headlines from the F.T.-there are plenty- up there. ‘Investor confidence crumbles’, ‘Confidence drains away amid double-dip fears’, ‘Spectre of deflation is back to haunt investors’, ‘Flight to safety as confidence in recovery fades’ and much else. LEADING INDICATORS I’ve started keeping a close eye on the US volatility index, known as the VIX (aka the ‘fear’ index). Volatility is a measure of how returns deviate from their average over a given time-period. While taking Hugh’s dog, Griff, for a walk the other day it occurred to me that the man and the dog are a good analogy for volatility. During the course of the walk, they both start and end up in the same place-the difference being what happens in between. As we go along, the dog will chase several rabbits and at least one pheasant, he’ll go swimming (shares sometimes ‘take a bath’ too), he’ll come back to check I’m still there, and in short will cover about five times as much distance as me. If you knew where the walk would start and finish, you could more or less predict where the man would be at any given time. The dog could be absolutely anywhere. The more scared people are, the less they know what things are worth, and the more prices tend to move around, which is the reason why the VIX is such a good prediction tool. A look at what the VIX has done over the last couple of years is instructive. In the crisis it shot up to a new all-time high level of 81, and then fell back, rapidly at first and then increasingly slowly, but with numerous upward spikes, reaching a level of just 16 at the end of March this year. Then came the sovereign debt crisis, and the VIX shot back up to 46, before subsiding again, reaching 22 a few weeks ago. The double-dip fears have pushed the VIX back up, but only to 27.5, and in the last few days it has fallen sharply back to 23.2. The VIX is a good leading indicator because it starts rising before periods of market turbulence. Tentative conclusion-the market has now absorbed the potential for a double-dip recession and in the last few days has begun to look beyond it to a period of recovery. THE GLAXEAU LAFITE INDEX REVISITED My last blog introduced the Wise Investment Glaxeau Lafite Index, which comes in two versions. The first one looks at the number of Glaxo shares you’d have to sell in order to buy a case of Chateau Lafite 2000. The second looks at the amount of annual income you’d forgo in selling those Glaxo shares. There is a serious point to this index, which is that I believe that investors’ decade-long risk aversion has created bubbles in alternative assets, of which Chateau Lafite 2000 is a good example. When I wrote the blog in mid-July, I believed that the ratio had reached an extreme point, but it has moved further in the last six weeks, as the price of a case of Chateau Lafite 2000 has risen from £ 15,000 to £ 17,760, while the price of Glaxo shares has hardly changed. This means that the basic index has risen by 10.5% to 1400, while the yield index has risen 13.1% to £ 882. One of my readers kindly pointed out that the Wise Investment Glaxeau Lafite Index could be called WIGGLE for short, while the Wise Investment Glaxeau Lafite Yield Ratio could be known as Wiggle Your Rear. THE DOW GOLD INDEX This index can be traced back for over a hundred years, and gives a lot of useful insights. It tends to be volatile, as the prices of these two assets often move in opposite directions. Roughly speaking, since 1970, shares did better in the 80’s and 90’s, and gold did better in the other two decades. You obtain the index number by dividing the Dow Jones Industrial Average number by the price of an ounce of gold in US dollars. The current ratio is 8.3. There have been some extreme valuations. In the early 80’s, the index briefly got down to just over 2, while at the end of the 90’s, after two decades in which shares had soared and gold languished, the figure was just over 40. Today’s 8.3 looks comfortably in the mid-range of long-term performance. Trends tend to be tested to destruction, and as gold is fashionable and shares aren’t, it seems likely that the precious metal will outperform for a while longer. But for me, gold is a nightmare. I have always liked to invest in things you can eat, drink, wear, read, live in or at least pay an income that allows you to do one or other of these. Gold does none of them ( except you can wear it-sort of), and its price is entirely at the mercy of supply and demand. FUND PERFORMANCE UPDATE From the start of 2010 to the end of August, TB Wise Investment made a return of +1.0%, while TB Wise Income was + 2.2%. During the same period the FTSE-100 index was down 1.0%, while the IMA Active Managed sector average, the sector in which both funds reside, was down 0.7%. From the start of 2010 to the end of August, TB Wise Income is 19th and TB Wise Investment 37th out of the 128 funds in the IMA Active Managed sector. In the almost 18 month period since markets began to rise in March 2009, TB Wise Income is up 63.6% and TB Wise Investment is up 57.9%, and the funds are placed 12th and 15th respectively out of 118 funds in the sector. From April 1st, which looks increasingly like an important inflection point in markets, to the end of August, the FTSE-100 index fell 7.6%, the Active Managed Sector was down 6.5%, TB Wise Investment was down 5.0%, and TB Wise Income rose 0.1%. Figures quoted are on a total return basis, with income reinvested, and are net of all charges. Despite its marginal outperformance of both benchmarks over both periods, I have been disappointed by the performance of TB Wise Investment so far this year. I mentioned last time that investors can’t seem to get enough of certain funds, such as Standard Life UK Smaller Companies Trust, while completely avoiding others, such as HG Capital, which has won awards as the best Private Equity trust in the UK for each of the last five years. So, while the UK’s best UK smaller companies fund is up 24% on the year, the UK’s best private equity fund is down 0.6%. Several such laggards have held TB Wise Investment back, but there have been encouraging signs of movement over the last few days. HG came out with a strong set of interim results last week, and the price has started to respond. Other laggards have moved sharply higher, too. TB Wise Investment tries to buy good assets when they’re deeply unfashionable. The value in certain investment trust the market doesn’t like is eye-watering at the moment. If recent trends continue, it should be possible to report better numbers soon. SEMINAR We all hope you’ll be able to come to our annual seminar on Thursday October 14th. Please let Kerri know if for some reason you haven’t received an invitation. This year, I’ll be talking about economies and markets, Hugh will be talking about all four Wise funds, and Angus will cover upcoming changes at Wise Investment, in particular our new discretionary management offering. As usual, there will be good food and drink, and plenty of time to eat, drink and chat. I’m away on holiday from September 14th to October 6th, so this will be my last blog till after the seminar. The next one will probably be in early November. With best wishes, Tony PLEASE NOTE-THE OPINIONS EXPRESSED HERE ARE THE PERSONAL VIEWS OF TONY YARROW AS AT SEPTEMBER 3RD 2010, AND DO NOT CONSTITUTE FINANCIAL ADVICE All fund and index numbers quoted in this blog are taken from Lipper ------------------------------------------------------------------------------------------- BLOG JULY 21st 2010 IT ISN’T NEARLY AS BAD AS YOU THINK Economy, markets and funds The China Syndrome plays out The Credit Crunch revisited – three years on Some ‘crunchy’ opportunities Wise Investment launches a new index The ‘odd years‘ phenomenon explained
This stuff is dry, but important. The market is distorted by the violent movements in the price of BP, up till recently its largest component. It is also the summer holiday season, when trading is thin, and market movements tend to be larger and more erratic than normal. All the same, the pattern is quite regular. The July 13th high was nearly as high as June 21st one, but not quite, suggesting a continuation of the downtrend pattern, which would be further confirmed if there is a new low below 4823. Our guess is that we won’t see a lower low, and that the downtrend we’re in is nearly over. At the moment, around 8.0% of TB Wise Investment and 5.5% of TB Wise Income is in cash. We want to invest the money back into the markets as soon as possible, and though our hunch is that we are near the low point, we prefer to wait till the chart confirms that the downtrend is over. We were a bit surprised that the uptrend which came to an end at the end of March didn’t take the index back above 6,000, and were then a little surprised at the extent of the fall, and subsequently rather nonplussed by the speed of the six-day rally, which our funds lagged behind. Still, though one is often wrong, it is important to have a sense of where things are heading, and adjust it as events unfold. The markets’ main worry just now, even more than the sovereign debt problems in Euroland, is the potential for a ‘double-dip’ recession in the US. Leading indicators – things like housing sales and housing starts, consumer and business confidence surveys and unemployment figures – are pointing towards further weakness in the economy later this year. However, we get a sense that the downward pressure in the stock market is easing now, so though we expect another downward spike or two, possibly not taking the market below its July 5th low point at 4823, we think that by the end of the summer the market will have built a good base from which to make further gains through the autumn and into 2011. Please note that the downtrend is a fact, while our view of it being near its end is an opinion. Our opinion is based on several factors. One is the strength of the fixed interest markets. Both government stock and corporate bonds have continued to be strong, and the stock market is now a lot better value relative to fixed interest than it was at the beginning of April. Also, the five-day losing streak which is just ending looks far less convincing than the rally which preceded it. In six days, the FTSE-100 rose 9.3%. Then in five days, it fell 2.5%. Today (July 21st) it has started rising again. Finally, the financial sector is holding up much better than it did. For most of the last three years, financial companies have done worse than the market on bad days. Recently, the opposite is often the case. This seems to us to be a sign of growing confidence, and it may indicate that the worst of this sell-off is behind us. There appears to have been a market inflection point at the beginning of April. Since then investors have become less fixated on mining shares, and more prepared to look for value in other sectors. This tendency has helped all our funds. From April 1st to date (July 20th), the FTSE-100 has lost 9.5% on a total return basis. TB Wise Investment is down 4.0%, TB Wise Income and Evenlode are down just 0.9% and 0.3% respectively during this period. FUNDS TB WISE INVESTMENT TB Wise Investment aims to beat the stock market, and cash. So far this year it has done both, up 2.4% where the FTSE-100 is down 2.8%, and is 31st in the Active Managed sector out of 131 funds for the year to date. I continue to hold all of my pension fund and nearly all our ISAs (the rest being in Evenlode) in this fund. Wise Investment holds funds which we now know very well, in interesting sectors, managed by intelligent and experienced people we know we can trust. Often these funds are priced in the market at a lot Iess than the value of their underlying assets. I do this because I don’t know a better way to invest money. Going back a decade to the start of 2000, this method has beaten the stockmarket overall by around 40%, and over all periods apart from a period of a little over 18 months, which began in mid-2007, and ended early last year.
I’d like to mention two of Wise Investment’s larger holdings, both of which have held performance back recently-HG Capital (7.8%) and Ecofin Power & Water Opportunities Trust (5.1%). Both have done well for us over the longer term. HG Capital’s underperformance began on April 20th last year. Since then, FTSE-100 is up 35%, while HG is down 2.1%. There are a number of factors. Investors are skeptical about private equity in the absence of freely available bank lending. HG held a lot of cash on its balance sheet last year, saying that the right sort of deals at the right sort of price weren’t forthcoming. This made the fund unattractive to a market on the look-out for exciting recovery stories. Early this year, HG had a rights issue, raising even more cash, and proceeded to buy into six companies (an Austrian high-tech lock manufacturer, a German recruitment consultancy company, Sweden’s leading provider of care for the disabled, and the Isle of Man Telephone company, among others) as well as putting more money into its alternative energy fund. It is still too soon to see how these new companies are doing. Meanwhile, HG, generally acknowledged to be the best quoted private equity fund in the UK, has for several years traded at a premium to its peers, which have all been at very large discounts to their net asset values. It may be that investors are worrying whether HG still deserves its premium rating. HG is currently at a 13% discount to its net asset value – a wide discount by its standards, but low compared to Electra at 25%, and others. I am prepared to be patient. HG has read the cycle perfectly so far, and has bought what appear to be excellent companies at what looks like the bottom of the cycle. Longer term performance is good, too. Since the beginning of 1999, HG has compounded returns at 15.3% per annum, compared to a market return of 2.1% per annum. Ecofin’s underperformance began on June 15th last year, since when the fund has fallen 6.6% compared to a market return of 23.1%. There have been two problems, a general aversion to ‘boring’ utilities, and weakness at Hansen Transmissions, a large holding in the fund, which makes gearboxes for wind turbines. Hansen’s share price has halved in the last year. I met Ecofin’s Chairman, John Murray last week. Ecofin are concerned about Hansen, but have stuck with it. Hansen expanded rapidly a few years ago, just before the credit crunch led to the cancellation of a lot of wind-power projects. Currently, there is uncertainty on both sides of the Atlantic over what government policy towards wind power actually is, so there is very little activity. Meanwhile, Hansen has replaced its salesy Chief Executive with the former Finance Director, and Ecofin have appointed a member of their team to the Board, who are concentrating on cost-cutting and improving the cash-flow. I also asked John about a report in the FT, which mentioned among Hansen’s problems an industry move towards gearbox-less windmills. John tells me that only smaller windmills can operate without gearboxes. The industry is moving towards larger, offshore turbines, which need gearboxes. The gearbox-less ones are unlikely to form more than 10% of the market, John thinks. We will be doing further research into this area.
We continue to hold this fund because of the expert knowledge of its management team, and the long-term case for investment in power, for which demand is likely to rise over time.
However, it hasn’t all been problems. This is being a good year for smaller companies. Standard Life UK Smaller Companies (3.2% of the fund) and Herald Trust (4.5% - tech-related smaller companies, mainly UK) are up 15.0% and 9.3% for the year to date. Herald is still very cheap on a discount of 21.7%. TB WISE INCOME Our clients like to remind us what a bad fund Wise Income is. Agreed, the fund was badly positioned going into the credit crunch, with exposure to geared property funds particularly costly. However, it’s a little-known fact that since the start of 2008 (I like to say ‘during the last quarter-of-a-decade’, which makes it sound like a longer time) TB Wise Income has performed better than the great Neil Woodford’s Invesco Perpetual Income, and with lower volatility. The average holding in Wise Income yields over 6%. Now, for something to yield over 6% in an environment where the base rate is 0.5% and likely to stay there for a long time, there is either something badly wrong with the asset that produces that income, or it is undervalued. Only time will tell, but we have got to know the assets we hold in Wise Income very well over the traumatic last couple of years, and our strongly-held view is that they are undervalued. Wise Income had an excellent second quarter, which has continued into July. Since the start of April, while the FTSE-100 index has fallen 9.5%, the fund is down just 0.9%, placing it second in the Active Managed sector out of 131 funds over this period. Wise Income has held around 10% cash over the last few weeks. This morning (July 21st) we reduced the cash to around 5.5%. THE CHINA SYNDROME PLAYS OUT We have been concerned for some time about the sustainability of Chinese economic growth in the short term. The following sentence appeared in the Global Overview section of the FT on Saturday:- ‘A further worry for some in the markets came from signs that Chinese growth – long seen as the saviour of the global economy – was slowing. While year-on-year GDP growth eased relatively modestly in the second quarter from the first, avery weak report on June industrial production hinted at a more serious slowdown to come’ (my emphasis) We all know what happened to the US economy when their house-price bubble burst after June ’06. Now that the Chinese housing bubble is also coming to an end, it seems likely that the economy will be weaker in the next year than most forecasters expect. It’s generally assumed that the authorities in China can fix any problem that arises – and maybe they will here, too, with a few judicious interest-rate cuts. All the same, we expect a slowdown. We don’t know how it will play out. It’s possible that there will be a stock market correction in mainland China, Hong Kong, and Taiwan, with overseas investors repatriating their savings, to the benefit of our investment strategy. But other outcomes need to be considered. Who could have predicted that a world banking crisis in late 2008 would have led to a savage recession in manufacturing in early 2009? There may be unexpected consequences and the situation will need to be carefully watched. THE CREDIT CRUNCH REVISITED Three years have passed since the start of the credit crunch (July 1st, 2007). Then, the FTSE-100 stood at 6,750, and didn’t look bad value to us, being still a few percentage points lower than its December 1999 peak. We thought that the over-valued asset was property, and moved a lot of money out of it. It’s clear now, looking back, that the crisis wasn’t about the valuation of shares, but about how much people had borrowed. Shares and funds got hit in exact proportion to the amount of borrowing they had, more or less regardless of the underlying quality of the company, or asset. The new ‘credit crunch’ valuation methodology persists, and has led to what we feel are significant opportunities. SOME CRUNCHY OPPORTUNITIES Let’s imagine that you are a property fund manager, and you have £ 100 million to invest. Plan A – you go out and buy £100m worth of property. Along comes the credit crunch. The properties halve in value. You now have £50m worth of properties, but you still have most of your tenants, and some rental income – in other words, you’re still alive. Plan B – you go out and borrow £100m from your friendly bank. You buy £200m worth of properties. Along comes the credit crunch. You now have £100m of property, and £100m of debt. Your by now very unfriendly bank manager is constantly reminding you that you are in breach of your covenant, and must sell property. You are now a forced seller in a buyer’s market. Result – your fund probably won’t survive. This was exactly what happened in the REIT (Real Estate Investment Trust) sector a couple of years ago. One or two of the funds which had borrowed nothing or very little (UK Commercial Property, F&C Commercial Property) got through pretty well. Some of the more indebted funds either disappeared (Teesland Advantage) or survived in a very reduced form (Invista, Invesco). The most interesting ones to us are the ones in between, where borrowings were around 30% (Standard Life, ISIS, IRP). There was a point around eighteen months ago where neither the fund managers nor the market could be sure that they’d survive. In the end, the funds have come out stronger than before, but the market still doesn’t trust them, which is why they are still yielding around 8%. They have good portfolios that are near to fully-let, they have good, experienced managers, and they will never look at gearing in the same way again. Another example is life insurance companies, and the better wealth management firms. Investors didn’t expect them to pull through the recession, and they were priced for oblivion. The prices have recovered, but an enormous amount of bad news is still priced in. The life insurance companies are, as an analyst put it in the FT a couple of weeks ago, ‘remarkable value’, and a fund manager we know recently wrote to the chief executive of one of the quoted life assurers, telling him that his company’s share price should be at least double where it is, and asking what he and other board members were going to do about it. It’s becoming clear which of the fund management houses should do well over the next few years – the ones that top fund managers have recently been migrating to. They are all priced for unending recession, and many of them pay nice, fat dividends. IT ISN’T NEARLY AS BAD AS YOU THINK I was reflecting the other day on the fact that we are now into the fourth year of the Crisis. The funny thing is that the media are always telling us how the bad bit is just about to start. Thinking back, the time to have been most worried was before the whole thing kicked off – around 2006, say, when most people, including all journalists, weren’t worried at all. Doesn’t the fact that we’ve had three very difficult years mean that we’re nearer the end of the crisis than we were when it began? Suppose that this crisis was the Second World War, a major event in most people’s book. Three years in, and we have reached the middle of September 1942. What’s happening? Well, it’s bad and can only get worse. The Germans have occupied the whole of Western Europe – France, the Low Countries, and most of Skandinavia. They are in the process of annexing Russia, and are at the gates of Stalingrad as we speak. The Germans also control the whole of North Africa, and their allies the Japanese have come in to the war, destroyed the US fleet at Pearl Harbor, and are blazing a trail of destruction through South-East Asia. Up to this point, almost nothing has gone right. A year from now, things are going to look a whole lot better. The German army will have been encircled outside Stalingrad, two million of them will have surrendered, and the whole front will be inexorably unravelling, as the Russians move steadily westwards. North Africa will be in the hands of the Allies. It will be less than a year till D-Day. I’m sure you get the point. We are further through this thing than anyone bothers to tell you. It isn’t nearly as bad as they think. WISE INVESTMENT LAUNCHES A NEW INDEX Several of my clients have been telling me recently how well their investments in fine wine have been doing.
I have been reminded of 1989. After the stock market crash in 1987, a large number of investors gave up on shares and decided to concentrate on ‘real’ assets instead. The fashionable assets that year were fine art and classic cars. A number of records were set in the art world which haven’t been broken till recently. Classic cars reached prices far above anything seen since. Then came the recession of 1990, and down went the prices. Today, it’s fine art again, and fine wines. I decided to do some research. I found out that 2000 was a particularly good year for Chateau Lafite. Since the start of 2001, the price of a case of Chateau Lafite 2000 has risen by 21% compound per annum, or by 700% altogether. This dramatic rise has been caused by demand from the new millionaires and billionaires in China, and by investment demand over here. We tend to think that all asset prices are depressed because we are in a recession, but recession hasn’t stopped the price of art, gold, wine or government stock from rising ever higher. Shares are the only asset class which pays more income today than it did a decade ago.
So, we have launched a new index – the Wise Investment Glaxeau Lafite 2000 Index. This index calculates the number of Glaxo shares you need to sell at any given time in order to buy a case of Chateau Lafite 2000. At the beginning of 2001, your Glaxo share was £18.90, and the wine was £1,875 a case. Today, Glaxo is £11.84, and a case of Chateau Lafite 2000 is £15,000. So, in January 2001 you needed 99 Glaxo shares to buy a case of Lafite, and today you need 1,267. Interestingly, the annual income you’d have lost by selling 99 Glaxo shares in 2001 was £33. Today, you have to sell 1,267 shares and the income you lose is £780. We think that at a level of 1,267, the Wise Investment Glaxeau Lafite 2000 Index is at an exceptionally high level, with both the shares very undervalued and the wine very over-valued. Given a recession in China, you may see at least one of the elements in this equation change. ODD YEARS EXPLAINED In the late 80’s, I began to notice that the stock market tends to perform better in years ending in an odd number than in years ending with an even number. This tendency appears to be completely random, but it has persisted up to this day. In an article in the Financial Times last Saturday, Trevor Greetham of Fidelity explains this phenomenon by saying that it coincides with the global inventory cycle. Businesses stock up, and de-stock all at the same time, stocking up in the odd years and de-stocking in the even ones. Greetham dates the ‘odd-years’ phenomenon to 1998, though in fact it is a good deal older. He goes on to say that the company profits being announced at the moment are good, based on last year’s higher activity levels, but that now we are in the early stages of a de-stocking phase, which is being reflected in the weaker stock market. He expects activity – and stock markets – to pick up towards the back end of this year. For interest, the whole sequence is shown below, and gives the annual return on the FTSE-100 index (excluding dividends). The same pattern can also be observed in the Hoare-Govett UK Smaller Companies Index, and the Dow-Jones Industrials, which are the only other ones I’ve checked.
As usual, all share price and market statistics quoted in this blog have been taken from our Lipper database. If you have found this blog useful or interesting, and have a friend or colleague who you think might be interested, please ask them to contact becky@wiseinvestment.co.uk PLEASE NOTE – ANY OPINIONS EXPRESSED IN THIS BLOG ARE THE PERSONAL OPINIONS OF TONY YARROW AS AT JULY 21st 2010, AND DO NOT CONSTITUTE FINANCIAL ADVICE. TONY MANAGES TB WISE INVESTMENT AND TB WISE INCOME -------------------------------------------------------------------------------------------
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