10th April 2014

As always, a few of the key thoughts from the discussion:

How markets are defying gravity

The markets continue to look unreasonably expensive considering the delicate economic climate in almost all regions. Companies also seem to be finding the environment tough, with more debt downgrades announced recently than at any time since the second quarter of 2009. Continued quantitative easing and low interest rates are supporting markets.
Flow of funds data implies that there are currently only two net buyers of equities: companies themselves (through buybacks), and Private Equity companies (who are reporting the best funding conditions in memory with low interest rates and weak covenants). Indirectly, dividends also continue to support the market as cash in the hands of investor creates positive momentum.
None of this represents a fundamental reason to be comfortable with current valuations.

Beneficiaries of a weaker China

The People’s Bank of China (PBOC) continues to imply that they are in control of all areas of the economy. The panel believes it is more likely that they are observers of the developments and post-event commentators. If this is true, it heightens concerns that the slowdown may have a wider impact. Should this be the case, who would be the chief beneficiaries?
Money is leaving China at a prodigious rate: $330bn left China in the fourth quarter of 2013. Money is leaving Japan at the same time. It seems plausible that a significant amount is flowing into Australia and propping up what appears to be an overvalued Australian Dollar. Should the Aussie Dollar weaken, exporters in that region should stand to benefit. More directly, should the Chinese currency weaken, some of the industrial companies in that region (often listed in HK) should also benefit from more competitive export conditions.

…and other topics

The panel all agreed that it is too early for commodities despite it being one area where share prices have been falling. With China (a major consumer) slowing, capacity still coming online from the recent boom, and “no real despair” in the share prices, it is hard to see a floor for the prices. The last commodity bull cycle was extended by China’s extraordinary growth. That makes it even harder to predict when the current (still early stages) of a bear cycle may end.
The panel also agreed that historically at least, the energy sector has been a good places to invest in bear markets. Further, the time to make money on energy stocks is not necessarily when the oil price is at peaks, but rather when the companies are producing cashflows. Typically, companies overspend when oil prices are high, and excessive capex destroys cashflow. When the capex is reined in, the fruits of the previous cycle flow through to investors. Having been a losing sector in the last 24 months, it may just be a winning sector in the next 24.

Peter Hollis, Russell Napier, Angus Tulloch and the Kennox investment team.

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