Wednesday, 17 December 2008

Investors wary after year of false dawns

Wall Street Journal and Financial News

By Jason Corcoran

15 December 2008

Fund managers have called the bottom too often

The investment horizon has experienced so many false dawns over the past 18 months that investors could be forgiven for regarding any rose-tinted outlook as a mirage.

Every time the stock market suffers another steep drop, fund managers and investment sages pronounce that the market bottom is in sight and now is the time to buy.

Fundamentals, technical signs and precedents may have backed up some of their theories but subsequent slumps in valuations have not borne out their views.

Ken Kinsey-Quick, head of multi-manager strategies at UK asset manager Thames River Capital, said: “The problem with predictions is that no one has a perfect crystal ball. Anyone making a prediction is taking a risk which gives them about a 30% chance of being right and looking like a superstar.”

Many potential superstars, however, have looked like chumps because their “unprecedented buying opportunities” have been so wide of the mark. Over the past year, asset managers have made the case for investing in financials, consumer cyclicals such as retailers, builders, media, industrials and Asian equities.

In the spring, several hedge funds and long-only investors jumped into banking debt believing it was cheap.

Funds such as Thames River Capital, Centaurus Capital and Union Bancaire PrivĂ©e began buying leveraged loans and asset-backed securities that had been languishing on banks’ balance sheets since the credit crisis began in the summer of 2007. Kinsey-Quick said: “We bought into bank debt and got caught by the falling knife.

It looked cheap and the fundamentals were good but it’s even cheaper now because liquidity has dried up over the past three months since Lehman Brothers went bust. We lost about 4% on the investment this year. One advantage of experience is not to double down.”

London-based hedge fund Centaurus Capital started buying banking loans in April. A source close to the firm said it had not lost money on its investment until September when Lehman’s bankruptcy triggered a market meltdown.

The source said: “Everyone was thinking [in spring] that the worst was over when Bear Stearns nearly went under and that the banks would not be allowed to go under. I remember people saying you need to be long in debt financials but a succession of things happened after that you couldn’t legislate for.”

Centaurus, which had a restructuring plan for its flagship $1.2bn Alpha fund rejected last week, said credit was never more than 50% of its multi-strategy fund and usually between 20% and 30%.

Eric Debonnet, deputy chief investment officer at French fund of hedge funds HDF Finance, said he never believed the story about buying cheap debt. He said: “Our view then and now is that it’s too early because we still need many more bankruptcies before we reach distressed. The right time is when we are getting close to the highest default rate. S&P is forecasting 7% to 10% and today we are only at 1% to 2% depending on the country.”

Some asset managers have stressed that they have been investing in banks because of their long-term value. This was the reasoning expressed in June by Bill Gross, chief investment officer at Pimco, when he said he remained invested in the corporate debt of big investment banks, including Citigroup, Morgan Stanley and Goldman Sachs, holdings that have since fallen in value.

UK fund managers have been similarly burnt in the short term by the collapse of the banking industry. Listed manager Schroders held UK bank Lloyds TSB at the start of the year and bought into HBOS in the summer and more recently, Royal Bank of Scotland.

Nick Purves, Schroders UK value fund manager, said: “We accepted the outlook was bleak but the share prices were very low at the time. Banks are by their nature very risky but we feel they now have enough capital to survive and are worth investing in over the long term.”

Schroders believes the current valuations of UK banks and equities represent good long-term buys and it points to the dividend yield of stocks rising above the yield on 10-year bonds.

In the US, the dividend yield on the Standard & Poor’s 500-stock index is about the same as the yield on 10-year Treasury notes, about 3.5%, the first time such convergence has happened in about 50 years. In the UK, the FTSE 100 is trading on a price-earnings ratio of about 7.5 times, a figure that puts it in the lowest 20% of valuations for the FTSE since 1965.

Ian Lance, Schroders UK equity specialist manager, said capitalising on such valuations had historically generated returns of about 20%.

He said: “Over the past six months, the dividend yield on the highest yielding UK stocks has risen to its highest point in over 20 years – even if you exclude financials. The dividend yield on non-financial stocks now exceeds the yield on 10-year gilts.”

However, this correlation between equity and bond yields could be a false dawn as companies may be forced to slash dividends to conserve cash, making the sustainability of such payments impossible in a deep downturn.

Jeremy Siegel, professor of finance at the Wharton School of the University of Pennsylvania, claimed stocks had reached a “selling climax” on July 15, which he believed would be seen as the bottom for the market.

In September, Goldman Sachs’ chief US portfolio strategist David Kostin called the bottom for equity markets and forecast a 12% upside on the S&P 500 by year-end.

Anthony Bolton, who managed the £2.4bn Fidelity Special Situations fund for 28 years, said in October he was buying shares for the first time in two years because some valuations were the cheapest he had seen in a lifetime.

Jeremy Grantham, founder of investment management firm GMO and a long-term bear, said in October that stocks were then more attractively priced than at any time since 1987. He said: “If we look at values like this and fail to buy them, we will subsequently not only look like fools, we will be fools.”

Investor Warren Buffett also said in October he had begun to buy stocks although with the caveat that he was not predicting that the worst of the sell-off was over.

A sustained upturn has yet to materialise. Robin Griffiths, technical strategist at Cazenove Capital Management, has pinpointed times and dates when investors should enter and leave the market.

In August, Griffiths said October 14 at 3.30pm was the right time to invest because indices would rise by between 25% and 30%.

Griffiths, who predicts market movements after studying historical graphs, trends and data, told Financial News last week that his basic story remained intact. He said: “Our timing schedules are generally quite good but we have had monstrous volatility which has ruined the trend.”

Griffiths said historic data for dividend yields and price earnings ratios showed that current bargains had been equalled only in October 1987, October 1974 and in 1930. He said: “We have to accept the conditions that produce these bargains are really scary, and we need to steel ourselves to copy Buffett, and be greedy when others are in fear.”

Griffiths predicts the market will rally following Barack Obama’s inauguration as US President on January 25, but will run out of steam by May.


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