Friday the 13th

In the following "Perspectives" article on Morningstar.co.uk, RWC’s equity income team looks at unnatural events occurring within financial markets, leaving investors deeply confused. These events range from central banks spending billions to bring rates down despite bond yields being at an all time low; to the average holding period in UK equities falling from ten years in the 1950s to twenty two seconds in today’s markets. 

The authors, Nick Purves and Ian Lance, are value investors looking for strong free cash flows at the right price. The various contradictory indicators in today’s investment markets lead them to believe that dividend yield and value remain hard to find despite the relative attractiveness of equities against other asset classes.

13 Unnatural Events

1. The financial situation of many developed economy governments has never been worse….yet the rates at which they can borrow money have never been lower. The US has 3.3 times more debt outstanding than a decade ago and yet the yield demanded by the market has fallen from 6.1% to 2.0%.

2. Investors are lapping up corporate bonds (P&G 10-year bonds are at 2.3% and McDonald's 30-year bonds are at 3.7%) whilst selling the same companies equity where the well covered equity dividend yield is higher than the corporate bond yield.

3. Bond yields are below 2% indicating that there is a very low probability of inflation and a high probability we are turning Japanese. Meanwhile, gold races onwards and upwards as central bank money printing points to a probability of inflation.

4. Bond yields are at all time lows, and no one wants to borrow money even at this rate... but central banks keep spending billions to try to get rates down just a little bit more.

5. Some of the smartest investors in the world (Warren Buffett, Seth Klarman, Jeremy Grantham) think bonds are hideously over valued and yet most pension funds are looking to increase their allocations to bonds and bond funds continue to top the best selling fund tables.

6. Corporate earnings are at their all time highs, are strongly mean reverting and in the long run grow at about 5% nominal… so of course for this year, the sell side forecasts 10% growth and fund managers and strategists continue to talk about how cheap equities look on one year forward P/Es.

7. The average holding period for UK equity has fallen from 10 years in the 1950s to 22 SECONDS!! (Note to David Cameron, if you are expecting shareholders to exert greater influence on management remuneration, owning a stock for 22 seconds makes attending the AGM quite tricky.)

8. The European Central Bank (ECB), backed by European sovereign states, is lending money to European banks at 1% so that the European banks can lend money to sovereigns by buying government bonds of European states or put it back on deposit with the ECB.  Everyone seems to think this is great but when Bernie Madoff did it he was arrested.

9. Articles about how hedge funds swallow up 85% of their client’s investment gains in fees continue to appear alongside articles about investors’ intentions to increase exposure to hedge funds.

10. During the credit crisis the ratings agencies rated over 50,000 subprime CDO’s as AAA... and yet the markets still hang on their every word.

11. Luxury goods used to be the first thing to go in an economic decline whilst basics would hold up. But now we have Tesco posting their worst sales for 20 years whilst Burberry grows sales at 20% and new orders of Bentleys are up 50%.

12. The vast majority of economists and strategists have proved hopeless at forecasting anything ... And yet continue to be hugely over confident in their ability to predict the future.
“A Chinese hard landing is as likely as a comet destroying the earth.”  - Jerome Booth, Daily Telegraph 19th February 2012.

13. It seems from this year’s letter from Warren Buffett, most investors would choose pile A: enough gold to fill the infield of a baseball pitch, over pile B: which includes all the farmland in America with an output of $200 billion annually AND 16 Exxon Mobils generating $640 billion annually AND $1 trillion in cash, because ‘gold is the only true store of wealth’.

Authors Nick Purves and Ian Lance have over 40 years investment experience with a wealth of knowledge in income based strategies.  Nick and Ian joined RWC from Schroders in 2010 to establish the RWC Equity Income team along with John Teahan.  The team manages approximately £1.15bn across their mandates including the RWC Enhanced Income and RWC Income Opportunities funds.

From time to time, Morningstar publishes articles from third party contributors under our "Perspectives" banner. If you are interested in Morningstar featuring your content, please email submissions to UKEditorial@morningstar.com. The views contained herein are those of the author and not necessarily those of Morningstar.