It is increasingly clear that the stimulus applied by Western authorities to remedy the 2008 credit crisis has many
botox-like characteristics. The benefits are fading rapidly and the side effects are not proving pleasant.
Against this backdrop, market levels need to be viewed in a longer term context than just the golden years of the baby boomers.
The valuation levels to which we became accustomed in the 1980s and 1990s reflected the halcyon baby boomer
growth years. It would seem we now face a reversion to the longer-term mean.
Positive indicators
We would first note that the corporate sector as a whole is healthy and balance sheets strong. Aggregate cash levels are significantly higher now than at the peak of the ‘tech’ or credit bubbles.
Furthermore, the valuation of equities is clearly more attractive than that of bonds. The dividend yield on the FT All Share Index is now 3.8% to the 10 year gilt’s 2.4%, and of course dividends offer the prospect of growth over time which interest coupons do not.
In the short term equities as an asset class have been caught in the downdraft of the European
sovereign debt crisis. However, calling markets is tough, and few people do it well consistently. Many who sell well fail to get back in again lower down.
Warren Buffet appears to share this view. He invested $4bn in equities in the third quarter after $3.4bn in the second,
which is the most he has invested since the third quarter of 2008. In the last week of September, he announced
Berkshire Hathaway’s first ever share buyback, declaring his shares to be “cheap”.
Asia remains a long term theme. Growth in China is decelerating from an unsustainable 11-12% down to 8-8.5% as a result of Beijing’s prudent guidance of the tiller. Inflation, having risen disproportionately on the back of food prices, is now peaking and anticipated to ease over the coming months. With the approach of Western economic storms and inflation moderating, monetary policy has shifted from stimulus-withdrawal to stable.
On the negative side
The current ‘panic button’ issue is China’s shadow banking system – trust companies that disintermediate credit from the regular banking system to finance riskier businesses. However, these are all part of the China’s financial structure – Beijing is ahead of the West in ring-fencing its commercial banks! Trust company assets total $600bn, or 7% of loans in the formal banking system and they are not permitted to leverage their investments. Local governments, again a part of Beijing’s structure, do in many instances have ‘non-performing loans’ (interest not being paid) – because these loans were made at the behest of Beijing to finance infrastructure projects such as schools, which do not pay interest.
Some property developers have over-extended themselves and a correction is due. The China story is not without its
warts, but, with a savings-rich population upgrading their lifestyles, it seems to us it has significantly fewer warts than
the Western world.
We embrace such diverse resources as property in land-constrained countries such as Singapore, and orbital slots for satellites, benefiting from the growth in bandwidth usage on the back of high definition television, videos-on-demand and mobile data.
Another theme relates to the oil servicing sector, benefiting from the long term spend required to keep the world adequately supplied with oil and gas. That quest increasingly involves deeper and more complex drilling, including in deep seas. Non-conventional sources are being developed such as oil sands and shale gas; refinery upgrades are required to meet increasing environmental legislation. All these call for greater engineering and support services – significantly, regardless of shorter-term fluctuations in energy prices.
