In my Money Week column I've been looking at how odd it is to have a rally led by banking stocks. Here's a taster....
What’s the best company in Britain right now?
You could make a case for Tesco, the sleek juggernaut of the retailing sector, now pushing aggressively into financial services. You could make just as persuasive a case for BP, the oil giant holding its dividend steady despite falling oil prices, and making big new finds in the Gulf of Mexico. You could equally well make a case for any one of a dozen retailers, miners, drugs or telecoms giants.
But the market has a different answer: Lloyds Banking Group. The bombed out, debt-laden, strategically muddled combination of Lloyds TSB and the wilfully mis-managed train-crash that was HBOS is rated by the market anyway as the company to back.
Take a look at the performance charts for the stock market rally of the last six months. It has been led by bombed out banking stocks, such as Lloyds, and the equally debt-riddled Royal Bank of Scotland. Much the same is true in the US: the S&P has been driven up by such paragons of financial reliability as Freddie May and Freddie Mac, as well as banks such as Goldman Sachs, which, whilst they may be minting money right now, were on the brink of insolvency only a year ago.
Nothing could better illustrate just how flimsy the rally in global stocks is right now. It has been sold as a rational response to the gradual recovery in the global economy over the pasty six months. But there is, in truth, nothing rational about the way that financial stocks have led the rally. Most of those banks are impossible to put any sensible valuation on right now. And the fact they are leading the upswing perfectly illustrates how the markets have lost touch with reality in the last few weeks.
Nowhere is that clearer than in the companies that have been leading the FTSE-100 index back up to the 5,000 mark.
Take Lloyds for example. Its shares have recovered from slightly less than 25p earlier this year, to more than £1 now, quadrupling in value. Likewise, RBS went all the way down to 10p a share, but is now back above 50p. That matters for the index – the banking sector, even in its much reduced state, still accounts for 16% of the FTSE. The rally has, to a large extent, been about the recovery of the banking stocks.
Much the same is true in the US. The two wholesale mortgage lenders, Freddie Mac and Fannie Mae, probably the two companies most exposed to the whole sub-prime debacle, saw their shares triple in value in the last month. The shares of the big Wall Street players, such as Goldman Sachs, have done just as well. Goldman is up from less than $60 at the start of the year to more than $170 now. Morgan Stanley has recovered from less than $8 to almost $30. Just as in Britain, the rally is largely about the recovery in the value of financial stocks.
And yet, how can we rationally come up with any meaningful valuation of companies that are, in effect, wards of the state?
Let’s focus on the two big British banks. The future of Lloyds and RBS is so cloudy that it is very hard to take any rational view of what the future might now hold for them.
What, for example, will the government do with its stakes?
Will the state-owned shares eventually be sold to the public, in a re-run of the mass-marketed privatisations that marked the last Conservative government? Will the state hold onto its shares indefinitely, gradually turning the banks into utilities, or instruments of social engineering? Will more radical options, such as turning the banks back into mutually-owned societies, be considered?
Right now, no one really has the foggiest idea. Nor will it become clear for quite some time yet. There is the small mater of a general election to be dealt with first.
No one really knows what kind of losses might still be racked up either. The credit-rating agency Moody’s reported this week that the UK banks were only half-way through reporting the losses they were likely to suffer as a result of the recession. They’ve already chewed up £110 billion in losses. But another £130 billion is still to come, it reckons, as the downturn ravages the value of commercial property, to which both Lloyds and RBS are heavily exposed.
Nor does anyone really know what kind of regulatory structure may emerge. It isn’t clear whether the European Union’s competition rules will allow Lloyds to control more than 30% of the British banking market long-term (hopefully it won’t). Or whether rules preventing unfair state-aid will be applied to RBS? Exactly the same doubts surround the American and European banks that have been soaring in value over the past six months.
In reality, the value of these companies is a complete mystery to everyone, including the people in charge of them. It is certainly a mystery to investors.
True, there is a big element of bounce-back. The banks aren’t closing down, and the global economy has averted a re-run of the great depression. The fears of earlier this year have turned out to be exaggerated. That accounts for some of the recovery.
But markets are meant to be forward-looking. And while the future is always to some degree unknowable, most companies can at least have a rough idea what their sales and profits might be in two or three years’ times. The banks have none at all.
In truth, many of the prices being set in this rally are quite literally a shot in the dark -- and one probably made by a blind man aiming at a black cat. And that isn’t much of a basis for continuing strength. The rally may well continue. But so flimsy are its foundations that there is little reason to assume it will.
Showing posts with label equities. Show all posts
Showing posts with label equities. Show all posts
Monday, 21 September 2009
Monday, 13 April 2009
A Bull Case For Equities.
It isn't all doom and gloom for the markets. There is a bull case for equities, as I point out in my Money Week column this week. Here's a taster....
Let’s Not Give Up On Equities – This Is When We Need Them Most:
Investors could hardly be blamed for giving up on equity investment completely. Despite the slight rally of the past few weeks it looks as if this decade will wind up being one of the worst for shareholders in a century or more. Barring a suddenly doubling of the markets in next few months, and there isn’t much chance of that in the middle of a grinding recession, virtually all the main markets around the world will go into 2010 lower than they went to 2000.
And yet, it would be a mistake to write off stock markets completely. Indeed, there is an argument for saying we may well be about to go into one of the best decades yet for equities. Why? Because there are literally thousands of companies around the world with shattered balance sheets that are going to need a lot of patient nursing back into health. And with credit hard to come by, managers won’t have much choice but to get that money from their shareholders.
And when companies need you, they look after you – indeed, it will only be by looking after shareholders, and making sure they are well rewarded, that companies will be able to get the capital they need.
Still, there is no mistaking the fact that this has been a rotten decade for anyone holding equities. Up until 2000, it was evident to everyone that shares performed far better than bonds. From 1900 to 1949, the annualized real return on the world equity index was 3.5 per cent, and that was achieved after taking in a couple of world wars. From 1950 to 2000, it was an impressive 9 per cent annually, according to figures compiled by Elroy Dimson, Professor of Investment Management at the London Business School. And yet in the years since 2000, the MSCI World index has lost a third of its value in real (that is inflation-adjusted) terms, while the major markets all lost between four and six percent annually, again in real terms. Indeed, two of the four worst bear markets in stock market history have occurred in the last ten years – and it would only take another small dip in the markets to make this one the worst bear market ever.
In fact, the conventional wisdom that equities out-perform bonds over the long-term is now being turned on its head. According to the American firm Research Affiliates, if you invested 30 years ago, US Treasury bills would have provided a better return than the S&P 500 Index. There are some periods you can take - February 1969 to February 2009, for example – when the 40-year return on government bonds beat the S&P 500. Since 40 years is about as long as anyone’s investment horizon can realistically be, it is going to be hard to make a case for buying shares.
No surprise then that some people are attempting to write off the equity markets. Given those dismal statistics, it is not hard to blame them.
And yet, take it from a different angle, and there is still a good case to be made. In the coming decade, corporate managers are going to really need their shareholders. They aren’t going to have anywhere else to turn to for capital.
For much of the last decade, chief executives blathered on endlessly about ‘shareholder value’. Yet, as they say in Hollywood script-writing classes, ‘show not tell’. In reality, shareholders were just an irritant. Managers could get all the capital they needed from banks, the bond markets, or private equity firms. The only sanction shareholders had was supporting a hostile takeover – and since that meant the board collected lavish payouts, it was seldom a very scary prospect.
This decade, however, CEO’s are going to need their shareholders like never before.
The credit crunch has left thousands of companies with shattered balance sheets. Even leaving aside the hundreds of companies left with unsustainably high debt piles by the private equity industry, there are many more that need money to get them through the recession. Beyond that, they will need money to rebuild their competitive strength for the moment when recovery finally arrives.
But the banks are not going to be lending companies tons of money any more. The bond markets will be too busy feeding billion after billion to governments that have run up vast deficits, and the private equity firms won’t be on permanent stand-by waiting to buy a subsidiary at vastly inflated prices.
The only place they will be able to get money will be from their shareholders.
For too much of the past decade, the stock market has looked too much like what its left wing critics accused it of being: a casino where hedge funds gamble with shares as if they were nothing more than chips on a roulette table.
One consequence of the credit crunch though will be to force the stock market to go back to being what it was originally designed to be – a place where businesses could raise the capital they needed to build new mines, start new factories, create chains of shops, or invest in research and development. Businesses that need capital are going to have to start thinking about how to build a loyal army of shareholders who will give them money when they need it.
In retrospect, it is hardly surprising the last decade was such a poor one for equity markets. They were irrelevant. With abundant capital available for everyone, there was no need to look after shareholders. But now, with capital scare, companies will have to pay attention to their needs. The best way of doing that? By making sure they earn a decent return on their cash.
You’ll probably hear a lot less about ‘shareholder value’ from chief executives in the next decade (which will be a great relief to everyone). Paradoxically, as you hear less about it, you’ll probably see a lot more being created.
Let’s Not Give Up On Equities – This Is When We Need Them Most:
Investors could hardly be blamed for giving up on equity investment completely. Despite the slight rally of the past few weeks it looks as if this decade will wind up being one of the worst for shareholders in a century or more. Barring a suddenly doubling of the markets in next few months, and there isn’t much chance of that in the middle of a grinding recession, virtually all the main markets around the world will go into 2010 lower than they went to 2000.
And yet, it would be a mistake to write off stock markets completely. Indeed, there is an argument for saying we may well be about to go into one of the best decades yet for equities. Why? Because there are literally thousands of companies around the world with shattered balance sheets that are going to need a lot of patient nursing back into health. And with credit hard to come by, managers won’t have much choice but to get that money from their shareholders.
And when companies need you, they look after you – indeed, it will only be by looking after shareholders, and making sure they are well rewarded, that companies will be able to get the capital they need.
Still, there is no mistaking the fact that this has been a rotten decade for anyone holding equities. Up until 2000, it was evident to everyone that shares performed far better than bonds. From 1900 to 1949, the annualized real return on the world equity index was 3.5 per cent, and that was achieved after taking in a couple of world wars. From 1950 to 2000, it was an impressive 9 per cent annually, according to figures compiled by Elroy Dimson, Professor of Investment Management at the London Business School. And yet in the years since 2000, the MSCI World index has lost a third of its value in real (that is inflation-adjusted) terms, while the major markets all lost between four and six percent annually, again in real terms. Indeed, two of the four worst bear markets in stock market history have occurred in the last ten years – and it would only take another small dip in the markets to make this one the worst bear market ever.
In fact, the conventional wisdom that equities out-perform bonds over the long-term is now being turned on its head. According to the American firm Research Affiliates, if you invested 30 years ago, US Treasury bills would have provided a better return than the S&P 500 Index. There are some periods you can take - February 1969 to February 2009, for example – when the 40-year return on government bonds beat the S&P 500. Since 40 years is about as long as anyone’s investment horizon can realistically be, it is going to be hard to make a case for buying shares.
No surprise then that some people are attempting to write off the equity markets. Given those dismal statistics, it is not hard to blame them.
And yet, take it from a different angle, and there is still a good case to be made. In the coming decade, corporate managers are going to really need their shareholders. They aren’t going to have anywhere else to turn to for capital.
For much of the last decade, chief executives blathered on endlessly about ‘shareholder value’. Yet, as they say in Hollywood script-writing classes, ‘show not tell’. In reality, shareholders were just an irritant. Managers could get all the capital they needed from banks, the bond markets, or private equity firms. The only sanction shareholders had was supporting a hostile takeover – and since that meant the board collected lavish payouts, it was seldom a very scary prospect.
This decade, however, CEO’s are going to need their shareholders like never before.
The credit crunch has left thousands of companies with shattered balance sheets. Even leaving aside the hundreds of companies left with unsustainably high debt piles by the private equity industry, there are many more that need money to get them through the recession. Beyond that, they will need money to rebuild their competitive strength for the moment when recovery finally arrives.
But the banks are not going to be lending companies tons of money any more. The bond markets will be too busy feeding billion after billion to governments that have run up vast deficits, and the private equity firms won’t be on permanent stand-by waiting to buy a subsidiary at vastly inflated prices.
The only place they will be able to get money will be from their shareholders.
For too much of the past decade, the stock market has looked too much like what its left wing critics accused it of being: a casino where hedge funds gamble with shares as if they were nothing more than chips on a roulette table.
One consequence of the credit crunch though will be to force the stock market to go back to being what it was originally designed to be – a place where businesses could raise the capital they needed to build new mines, start new factories, create chains of shops, or invest in research and development. Businesses that need capital are going to have to start thinking about how to build a loyal army of shareholders who will give them money when they need it.
In retrospect, it is hardly surprising the last decade was such a poor one for equity markets. They were irrelevant. With abundant capital available for everyone, there was no need to look after shareholders. But now, with capital scare, companies will have to pay attention to their needs. The best way of doing that? By making sure they earn a decent return on their cash.
You’ll probably hear a lot less about ‘shareholder value’ from chief executives in the next decade (which will be a great relief to everyone). Paradoxically, as you hear less about it, you’ll probably see a lot more being created.
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