Adventurous Investor

August 12, 2011 5:34 pm

Stop panicking and trying to play the macro game

I’m sure many of you have been worrying about a long list of big issues – ranging from whether the US is dying as an economic superpower, to whether the euro will survive the week. I expect many more are fretting about a double-dip recession. Even adventurous types may be considering the not insignificant probability that China’s economy will experience a hard landing in the next few months.

But my biggest worry, frankly, is you and me: ordinary investors trying to play the macro game by laying off risk and piling into safe haven assets as a precaution against monetary fiat and... then, a few months later, forgetting all our worries and piling back into risky assets. Our short-term myopia – powered by fear and panic – is likely to produce its own destructive legacy, in low returns and high trading costs.

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We need to remember that the equity market is actually a junior cousin of the dominant bond market – and quite the most worrying aspect of recent weeks is that even share investors are starting to talk a little too much like bond investors. Of course, some caution is necessary, as is some sensible readjustment of attitudes towards debt. Even I accept that the chances of a double dip have increased in the last few weeks.

Russian funds update

When I wrote about Russian property company Raven Russia, I said that the growing emerging market consumer sector hadn’t done much good for the Russian-focused fund, Aurora Russia. It invests in fast-growing companies in DIY stores, a document storage company and a mortgage-lending business. On paper, these assets would seem to be worth over 80p, but the shares are marooned at about 38p.

Just days after my column, a new board was brought in at Aurora to repel a band of shareholders looking to realise value from the fund. The new non-executive chairman has a record of realising investor value via quick restructurings, and his board is looking to get some initial public offerings away, which may close that share price discount.

So far, the shares have gone nowhere but down. But maybe this is another special situation in the making – all the underlying businesses are producing cash or profits.

But let’s call a spade a spade. This is market timing gone mad, with investors looking for patterns in almost everything. So let’s list our worries and attempt to answer them as dispassionately as possible.

First, the downgrade of US debt doesn’t seem to have resulted in financial Armageddon, although it won’t have done anything to inspire long-term confidence in lending to Uncle Sam. No one in their right mind believes that Italy will actually default (or even needs to), and the market has already priced in Greek default. All that’s happening is that the markets are pushing the politicians into a form of monetary union, whether they want it or not.

Second, while jitters in the markets might hasten a double-dip recession, the likely slowdown in GDP terms will probably be fairly muted. It’s not going to be a massive meltdown, as in 2009. It may even prompt a third round of quantitative easing, perhaps focused on the US housing markets. Even if QE3 doesn’t happen, equity investors know what’s going on: as economist Ken Rogoff keeps reminding us, what we’re experiencing is normal in economies that are painfully deleveraging over many years. It’s low growth, and maximum pain.

If we accept this view of a dismal decade of stop-start, how do equity prices actually look? I’d suggest that big UK quality stocks are beginning to edge towards “interesting”! For example, take the top 10 UK-listed companies. They comprise 43 per cent of the entire market capitalisation of the FTSE 100 and more than 30 per cent of the FTSE All-Share index. However, the projected price/earnings ratio of these massive companies is 9.84 at current prices, with a dividend yield of 3.6 per cent and forecast dividend growth (excluding BP) in the coming year of 5.6 per cent. At these levels, they are fairly priced, if not actually a raging buy.

My advice, therefore, is not to panic. Instead, stay focused on whether market X or company Y represents good value based on current knowledge. If the answer is no, then it’s a bad investment, even if the economy starts improve.

But to my contrarian mind, it’s a time to look for “special situations” – interesting companies where investors are heading out the door at alarming speed. Plenty of these will be value traps but, as the volatility continues, more of these shares will prove to be good investments for the coming decade.

adventurous@ft.com

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