9th September 2011

Artemis: The Hunters' Tails

The widening gyre ...

How times change. Ten years ago on Sunday, as a great evil was in train the US was running a budget surplus. Oil was $28/barrel, the S&P 500 stood at 1,092 and the US economy was taking the crash of dotconnery in its stride.

Now the US budget deficit is $1,580 billion. Oil’s around $114 (or $89 in New York), the S&P 500 closed yesterday at 1,185 and the economy is weak at best. The US will grow 1.1% in Q3 and 0.4% in Q4, instead of the 2.9% and 3% predicted in May, the OECD said yesterday. Japan will expand by 4.1% in Q3 before stalling in the fourth, and the three biggest euro economies will gain 1.4% — and then shrink by 0.4%. Sobering stuff.

The ‘new world order’ is illustrated further by the fact that Hermès, that maker of bags and ties for the affluent or mendacious, has overtaken Soc Gen, France’s second-biggest bank, by market value. At €28.4bn, Hermès’ market cap is almost 50% greater than Soc Gen’s (at €15.1bn,) even though it has 5% of the staff and 8% of the revenue. The p/e for Hermès, incidentally, is now 55x next year’s earnings. The gap between bag and bank is the equivalent of two Marks & Spencers. Basel Fawlty, indeed.

“Things fall apart; the centre cannot hold;” wrote Yeats. The sheer intractability of the eurozone’s problems is evident in the hilltop Italian village of Filittino, southeast of Rome. Italy’s austerity includes the rule that, to save administrative costs, villages of less than 1,000 souls must merge. But rather than come under the hegemony of Trevi, six miles down the valley, the 554 villagers of Filettino are seceding from Italy. Inherently schismatic and disputatious, how can the eurozone survive, let alone thrive?

We turn to our éminence grise, Adrian Frost of Income: “Will the current concoction of austerity, stimulus and fiscal policy allow economies both to reduce debt and limp towards recovery? In the US and the UK the answer is inconclusive; but there is at least some semblance of a decision-making structure. In Europe, such structures are notable by their absence so markets fear a bureaucratic stumble into recession. The market could well be right. If Europe were ‘one’, then its debt position would be better than that of the US, the UK or Japan and something could be done. But it is not ‘one’: feta will never taste like frankfurters.”

So equities are ‘pricing in’ a poor economic outlook; and volatility whether Greece, somehow, stays — or goes. That is, equities have fallen already, anticipating the recession which is not yet confirmed — and may, just, be avoided. But of course equities could go lower yet if the economic runes read ruder still.

And so?

We are buying, as last week, especially on the dips — very selectively. Valuations may express pessimism, but there may still be too much optimism about earnings forecasts, we reckon. On the other hand, we think M&A will continue. If a fund manager is offered a 50% takeover premium to today’s market price, this could represent a 15% discount to its price three months ago. That certainly focuses the mind. Anyway, for instance and for Income, [y]our two Adrians have used the proceeds from the Northumbrian Water takeover to add to BT, Tate & Lyle, Diageo, Smith & Nephew and Man Group as, for UK Smaller Companies, Mark Niznik has been enjoying Axis Shield.

Bar James Foster’s small remaining position for Strategic Bond in Greek telco OTE, we have no direct exposure to the peripheral eurozone or PIIGS. James is maintaining his overweight in financials; but as with High Income, our kirk here is, as they say in sunny Scotlind, broad: debt issued by asset management companies, property and casualty insurers and life companies. In all these cases, solvency is strong.

For Strategic Assets, with his net equity exposure up to 89%, William Littlewood continues to believe that equities are “the least bad asset class to own. We typically own shares in stable, less cyclical companies on low p/e ratios. A p/e of 8, 9 or 10x equates to an earnings yield of 10-12%. This compares favourably with cash (yielding next to nothing) and bonds yielding 2%. Looking at it a different way, at 3.7% the dividend yield on the FTSE is higher than that on gilts. This is historically anomalous. The S&P dividend yield, meanwhile, has reached parity with the yield on treasuries, even before the sizeable contribution from buybacks in that market.”

And for Global Income, amid the Sturm und Drang Jacob de Tusch-Lec believes that, critically, “the outlook for dividend growth looks good.” In the short-term, ‘visibility’, as the brokers say, is very poor. But ahead of an awful anniversary, and even as Yeats’ rough beast slouches on, we remember with Julian of Norwich the promise that all shall be well; and that all manner of things shall be well.

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