6 Aug 07: From a momentum analysis standpoint, there is precious little signs of stabilisation on the FTSE-100 to hang your hat on for the time being. Yet a sharp counter rally could of course ensue with little warning. However, it is worth noting that we saw three ‘tell-tale’ signs of trouble brewing in recent months, so waiting for at least one or two positive indicators would the minimum before becoming more positive on the FTSE-100 on a 6-9 month view.
One prominent correspondent this week cited these reasons to be cautious on equities at this point in the cycle:
Earnings misses: in light of the numerous earnings “misses” last week combined with the plethora of corporate reductions in forward earnings guidance, just how accurate is the consensus earnings estimate on 2007 S&P 500 often cited as the key reason for why stocks are ‘cheap’?
Inflation: the following have increased on a year-over-year basis: corn (+38.5%), soybeans (+45.5%), wheat (+74.4%), milk (+121.8%), eggs (+167%), and the list goes on. How long before these prices start to show up the supermarket?
Valuation: The astute people at Gavekal make the following points on the curent climate: “It has been Charles Gave’s lifetime investment strategy to only trade when something is ‘totally abnormal’ (due to market confusion, lack of foresight, market distortion, etc.). As such, we give the most consideration to indicators displaying a net measurement that is significantly positive or negative. Today, our indicators show that a) the ‘very overvalued’ markets are: Australia, Canada, and Germany; b) ‘overvalued’ markets are: France, Hong Kong, Korea and Sweden; c) ‘neutral’ markets are: the US, UK, Japan and Taiwan. Not one of our valuation indicators is registering an ‘undervalued’ signal. As we are now heading into to the summer lull (with lower volumes), approaching equity markets with a bit more caution might make sense.”
Regular users of this site will recall the note from last month on ‘The $13 trillion US economy in apparent terminal decline’. An abridged version of this comment appears in the latest edition of Money Observer (‘Your Shout’, Star Letter, page 14, Aug 07).
We have donned hard hats as of this morning as we await the inevitable counter-attack from the ABTUS crowd (Any country but the US).
Matthew Phillips, 38, from Brighton, has recently returned from living abroad. He is looking to settle down into a more stable lifestyle so he can pay off his debts within the next five years.
Matthew earns an annual salary of £17,000 as part of the property team at a local newspaper in the West Midlands. The job has “brought me some much-needed stability, as it is the first nine-to-five job with a regular wage I’ve had in ages,” he says. He previously worked as a freelance fitness instructor, and the irregular income made it difficult to amass any savings.
After returning to the UK, Matthew took out a £7,000 loan at 6 per cent interest from Natwest in order to consolidate his debts and set up house. He also owes £3,000 in student loans and has £2,000 on his MBNA credit card at 2.5 per cent until April 2008.
Matthew rents a flat in Warwick with his girlfriend. He has no protection policies, but plans to join his firm’s pension scheme after working there six months. He used to own a house, purchased jointly with his parents, but sold it “to avoid the temptation of re-mortgaging to get out of debt.”
We asked three financial advisers to look at his situation: Keith Churchouse of Churchouse Financial Planning, Dane Halling of Arcturus Investments, and Jason Witcombe of Evolve Financial Planning.
Case notes: Matthew Phillips, 38, advertising salesperson, Leamington Spa
Income: £17,000
Pensions: None
Savings: None
Property: Pays £275 a month in rent
Debts: £7,000 Natwest loan, £3000 student loan, £2000 on a credit card
Monthly outgoings: £900-£1100
Debts
“Matthew needs to pay off his debts, and if he has no excess income then he’s got a big problem,” says Witcombe. “Get back to basics by sacrificing luxuries like a mobile phone and eating out, in order to generate excess income over expenditure.” Halling agrees that “the key for now is discipline in discretionary spending”. Churchouse recommends that Matthew keep a record of his spending and try to control it by budgeting. (more…)
The Dow broke through 14,000 yesterday and has hit record highs 52 times since October.
Two factors were flagged recently as part of the explanation for this remarkable resilience in the US economy and capital markets, despite the gloom surrounding property, hedge fund implosions and a host of other problems:
- There have been more LLCs set up in the past five years than at any time in history, and they account for millions of high-paying jobs. Here’s the remarkable thing: these knowledge workers are not counted as employed. Why? we have no idea. But clearly there are thousands upon thousands of small businesses generating wealth, spending and jobs, who are simply not on the official records. In other words, the headline unemployment rate includes these individuals, apparently.
- Another factor is that the wealthiest 20% of Americans account for 40% of consumer spending. Two dollars of spending for every dollar other Americans spend, and this segment has been growing at a 5% rate.
Other factors include: the economic impact of legal and illegal immigrants; the spending of the 12 million-plus non-documented workers; the fact that the median age of Americans is 34, compared to over 40 in Europe and over 45 in Japan; the 50% reduction in oil per GDP; and of course arguably the major factor which is continued relative low interest rates.
This is the first of a series of short notes on the current state of the debate on the key question for most private investors in the UK - is this a 1990, or a 1995, or a 2003-4 scenario?
The plus side:
- Rates remain low relative to 1990-2 15% peak
- Arrears and repossession rates remain low
- Longevity & immigration are secular trends that drive demand - 400,000 new entrants in 07
- Divorce, young people at university, second homes, buy to let are all other drivers of demand
- 160,000 new homes built in 2006 - in the 70s and 80s numbers were 350-400,000
The negatives:
- House price income multiples stand at 6 times
- Typical mortgage payments as a % of income are now 18.7%, a 15 year high
- US sub-prime market decline may be the tip of the iceberg
- Medium term path of inflation and hence rates are the key swing factors, and ultra hard to predict with any genuine conviction…
Fidelity’s FundsNetwork released sales data on Wednesday which shows that UK investors continue to pour money into property funds and income-oriented offerings.
Equity-income and property funds outsold other types of funds on the Fidelity platform during the first half of 2007. The IMA Specialist sector was the best selling sector, and three funds among the top ten sellers were property funds: they were Norwich Property Trust, New Star Property Unit Trust and Standard Life Select Property Fund.
May IMA data showed £431 million into the Specialist sector, of which £378 million went into UK domiciled retail property funds. The Specialist sector has been the best selling IMA sector among retail investors in every quarter since the fourth quarter of 2005.
The key questions for investors in property is whether we have seen the top of the market & how the sharp falls in US property prices might reverberate throughout the entire property spectrum.
Is this a short hiccup in property’s relentless upward march, or something that marks an inflection point?
Property has been the asset class du siecle - so far. In May 1997, the average house in Britain cost £74,000. By May this year its value had risen to £220,000, a three-fold increase. If you borrowed three quarters of the cost of that average house in 1997, covering your mortgage with your tenants’ rent, you would have turned the £18,500 deposit into an equity share worth £164,500, a nine-fold return on your original investment.
Interesting to note the FTSE 250 index has risen almost in line with house prices from 4,500 a decade ago to about 11,500 today. But the FTSE 100 has lagged markedly. Why? A major factor has to be the 1997 decision to abolish the £5bn a year tax credit on dividends which mauled the performance of pension funds, and caused a shift out of equities into bonds just as equities were recovering post-crash.
Since May 2 1997, the FTSE 100 index has gone from 4,445 to its all-time high of 6,930 before losing more than half its value by March 2003, falling to 3,287. Four years later, still 400 points off of its previous peak, it stands just 47pc higher than when Labour came to power. With dividend income reinvested you would only have doubled your money in 10 years, a compound annual return of just 7pc. With the RPI at more than 4pc real returns look even more lukewarm. According to Graham Secker, equity strategist at Morgan Stanley, Britain’s is the eighth worst-performing of the world’s 50 largest stock markets since 1997. European has risen 150% and the US by 100%. Little wonder enthusiasm for shares pales when compared to our enthusiasm for all things property related, whether it be principal residence, buy to let, direct property, overseas property, property shares & REITS.
How to find sustainable growth companies? It can feel a bit like looking for the proverbial needle in a haystack. A well known venture capital investor, Michael Moritz of Sequoia Capital, has created a list of 10 principles called the “Elements of Sustainable Companies”, which he has used to find oustanding companies coming out of the ‘Valley’ (Silicon, not Test…).
Among the names that Sequoia discovered after checking their business plans against that list of principles are: Cisco Systems (Nasdaq: CSCO), Electronic Arts (Nasdaq: ERTS), Flextronics (Nasdaq: FLEX), Symantec (Nasdaq: SYMC), Nvidia (Nasdaq: NVDA), Ikanos Communications (Nasdaq: IKAN), and, of course, Google (Nasdaq: GOOG). Not a bad track record.
Sequoia founder Don Valentine was on the board of Cisco from 1987 through 2005.
By investing in sustainable companies early, and then holding for the long haul, Moritz, Valentine, and others at Sequoia have generated major returns.
Here are the Sequoia rules:
Clarity of purpose. Great companies can be summarized in a single sentence.
Large markets. Buy where there’s a billion to be made. At least.
Rich customers. Not hard to grasp this one…
Focus. Simple products with obvious value are easy to sell.
Pain killers. Great businesses solve a real problem facing consumers.
Think differently. Inventive firms drive their competition nuts.
Team DNA. Talent attracts talent, and talent usually produces excellent returns.
Agility. Being first to new markets matters.
Frugality. Great managers allocate capital only where they must.
Inferno. Excellent businesses produce huge returns from even small doses of capital.
Easier said than done, but all the same a useful checklist.
Cisco Systems is the world’s leading supplier of data-networking equipment and software. Its products include routers, switches, access equipment, and network-management software that allow data communication among dispersed computer networks. The firm has also entered newer markets, such as home networking, security devices, storage technology, and Internet-based telephony. Services account for about 16% of sales.
Cisco has the following numbers: ROE 24%; Net Margin 20%; ROA 14%; $20bn in cash & $8.6bn in free cash flow over the last 12 months; $32bn in sales up from $19bn in 02; net income of $6.5bn up from $1.9bn in 02.
Click here for the story about how Sequoia Capital found Cisco very early on in its history.
Here’s today’s chart, showing Cisco ‘itching’ to break free from the reins.
General Electric’s CEO recently stated in Barron’s, ‘For the first time in maybe 20 years, our set of industrial businesses can grow to or faster than our financial businesses. . . . (more…)
