This time it’s different – the plangent refrain of the investor suffocating in a bubble. Ah, what bliss it is to recall the golden days of the dotcom era, when we thought the mini-scooter-driven party would never end. We would all be commuting to work via the internet and downloading our memories into cyberspace in a kind of Neuromancer-meets-Facebook “mash up”.
Now we look back and scoff at the delusions of our younger selves. What on earth were we thinking? Boy, we were really stupid 10 years ago! We forgot to ask important questions like: What does this company do? And: How will it make money? Thank goodness the commodities super-cycle is nothing like that.
And just why is it so different? Because China and India are industrialising like crazy, of course! Who could pass up that opportunity? Hmm, well let’s just run a slide rule over that shall we?
Tony Dalwood, head of public equities at SVG Investment Managers, believes that mining stocks and other natural resources plays, which have run up on the back of the commodities boom, are heading for a fall. “Value investing has underperformed because commodity stocks like the miners have got ahead,” he says. “The market is focusing on cyclical peak earnings, but miners are heading for a problem when returns normalise.”
Panic and crisis
Adam Steiner, head of research, public equities, at SVG adds: “The investment time horizon of hedge funds and traders is microscopic compared to pension funds, and the markets are now very momentum driven. In moments of panic and crisis no one is using valuation to pick stocks – they just churn their portfolios to try and keep up to date. They don’t want to be underperforming the market at the end of the quarter.”
He argues that resources companies are “grotesquely overvalued” – mining is a cyclical industry and is generating the highest returns it ever has, but as costs go up and more capacity comes on stream this won’t continue. “Whenever you have a bubble there is always an argument that this time it is different,” he says. “People are pointing to the impact of China, but the increase in the oil price is not completely accounted for by that. To pretend the demand for resources is in no way influenced by the global economic cycle is crazy. If oil goes to $200 a barrel then the average US driver has to spend 10 to 20 percent of their income on petrol. So you have to ask – if everyone in China owns a car, how will they afford to drive it around? High commodity prices in themselves slow global growth.”
He adds that the population of China is only three and a half times that of the US, and the majority are peasants in the north and west. So the Chinese economy will only become two or three times bigger than that of the US and it will take a long time to get there. “You also have to keep in mind that a lot of China’s growth has been financed by US debt.” That is, consumers withdrawing equity against their homes to keep spending – something they are unlikely to be doing much of in the foreseeable future.
The commodity gurus argue that prices are supported by years of under-investment, which has created a pinch point – miners can’t get the stuff out of the ground fast enough, so prices keep increasing. But when new capacities come on stream, shouldn’t prices correct to more realistic levels, especially if the US is in the doldrums? So investors have to ask themselves: How far do we want to ride this boom? You can bet the chartists are hunkered down over their models right now trying to call the peak.
Buy-to-let blow up
Steiner is also worried about the horrors that may lie ahead for the UK, especially if the buy-to-let boom turns out to be the UK’s very own sub-prime meltdown. “The banks have only written down their lending impacted by the US so far, not their UK lending losses,” he argues. “That will come if we have a nasty house price plunge. For the last few years there has been a very strong tailwind that has helped retailers, banks and property, but that has now gone into reverse, and it is likely to be a headwind for another three to five years. The issue will become – how are banks going to make money now? The ratings will recover but the earnings won’t.”
SVG takes a contrarian approach and is focused on companies not at the peak of the cycle – particularly, telecoms, pharmaceuticals, software and media companies. Steiner says that pharma stocks are interesting as they are “off the scale cheap” – some 40 percent below their 20 year average. “All the arguments for pharma – such as the ageing demographics – remain intact, but they have been hit by the FDA tightening up its approvals process and the market is fretting over near-term fears.”
He adds that media is “mind-blowingly cheap” because of fears that if the economy does turn down, media will do badly. SVG is focusing on business-to-business companies such as DMGT and the WPP agency, which is more diversified, and therefore less cyclical than people seem to think. “This is the exact inverse of 1998 to 2001,” he argues.
It’s an interesting idea – that TMT will ride again after a speculative bubble in commodities goes pop. M&A activity in the small and mid-cap telecoms and software sectors has been brisk in the last couple of years, with strong private equity interest. “A lot of small and mid-cap deals are happening and they have raised a decent amount of money,” says Steiner. Telecoms has now re-rated a little, but SVG believes there is further to go. Perhaps it’s time to dust off that mini-scooter and drive back into the TMT market again.
If you want to read more about developments in the TMT sector, please visit:
Forever Blowing Bubbles
June 11, 2008 at 3:17 pm (Asia equity markets, Commodities, Macroeconomic commentary, UK equity markets) (bubbles, buy to let, China, Commodities, contrarianism, dotcom, miners, SVG, UK, value investing)
This time it’s different – the plangent refrain of the investor suffocating in a bubble. Ah, what bliss it is to recall the golden days of the dotcom era, when we thought the mini-scooter-driven party would never end. We would all be commuting to work via the internet and downloading our memories into cyberspace in a kind of Neuromancer-meets-Facebook “mash up”.
Now we look back and scoff at the delusions of our younger selves. What on earth were we thinking? Boy, we were really stupid 10 years ago! We forgot to ask important questions like: What does this company do? And: How will it make money? Thank goodness the commodities super-cycle is nothing like that.
And just why is it so different? Because China and India are industrialising like crazy, of course! Who could pass up that opportunity? Hmm, well let’s just run a slide rule over that shall we?
Tony Dalwood, head of public equities at SVG Investment Managers, believes that mining stocks and other natural resources plays, which have run up on the back of the commodities boom, are heading for a fall. “Value investing has underperformed because commodity stocks like the miners have got ahead,” he says. “The market is focusing on cyclical peak earnings, but miners are heading for a problem when returns normalise.”
Panic and crisis
Adam Steiner, head of research, public equities, at SVG adds: “The investment time horizon of hedge funds and traders is microscopic compared to pension funds, and the markets are now very momentum driven. In moments of panic and crisis no one is using valuation to pick stocks – they just churn their portfolios to try and keep up to date. They don’t want to be underperforming the market at the end of the quarter.”
He argues that resources companies are “grotesquely overvalued” – mining is a cyclical industry and is generating the highest returns it ever has, but as costs go up and more capacity comes on stream this won’t continue. “Whenever you have a bubble there is always an argument that this time it is different,” he says. “People are pointing to the impact of China, but the increase in the oil price is not completely accounted for by that. To pretend the demand for resources is in no way influenced by the global economic cycle is crazy. If oil goes to $200 a barrel then the average US driver has to spend 10 to 20 percent of their income on petrol. So you have to ask – if everyone in China owns a car, how will they afford to drive it around? High commodity prices in themselves slow global growth.”
He adds that the population of China is only three and a half times that of the US, and the majority are peasants in the north and west. So the Chinese economy will only become two or three times bigger than that of the US and it will take a long time to get there. “You also have to keep in mind that a lot of China’s growth has been financed by US debt.” That is, consumers withdrawing equity against their homes to keep spending – something they are unlikely to be doing much of in the foreseeable future.
The commodity gurus argue that prices are supported by years of under-investment, which has created a pinch point – miners can’t get the stuff out of the ground fast enough, so prices keep increasing. But when new capacities come on stream, shouldn’t prices correct to more realistic levels, especially if the US is in the doldrums? So investors have to ask themselves: How far do we want to ride this boom? You can bet the chartists are hunkered down over their models right now trying to call the peak.
Buy-to-let blow up
Steiner is also worried about the horrors that may lie ahead for the UK, especially if the buy-to-let boom turns out to be the UK’s very own sub-prime meltdown. “The banks have only written down their lending impacted by the US so far, not their UK lending losses,” he argues. “That will come if we have a nasty house price plunge. For the last few years there has been a very strong tailwind that has helped retailers, banks and property, but that has now gone into reverse, and it is likely to be a headwind for another three to five years. The issue will become – how are banks going to make money now? The ratings will recover but the earnings won’t.”
SVG takes a contrarian approach and is focused on companies not at the peak of the cycle – particularly, telecoms, pharmaceuticals, software and media companies. Steiner says that pharma stocks are interesting as they are “off the scale cheap” – some 40 percent below their 20 year average. “All the arguments for pharma – such as the ageing demographics – remain intact, but they have been hit by the FDA tightening up its approvals process and the market is fretting over near-term fears.”
He adds that media is “mind-blowingly cheap” because of fears that if the economy does turn down, media will do badly. SVG is focusing on business-to-business companies such as DMGT and the WPP agency, which is more diversified, and therefore less cyclical than people seem to think. “This is the exact inverse of 1998 to 2001,” he argues.
It’s an interesting idea – that TMT will ride again after a speculative bubble in commodities goes pop. M&A activity in the small and mid-cap telecoms and software sectors has been brisk in the last couple of years, with strong private equity interest. “A lot of small and mid-cap deals are happening and they have raised a decent amount of money,” says Steiner. Telecoms has now re-rated a little, but SVG believes there is further to go. Perhaps it’s time to dust off that mini-scooter and drive back into the TMT market again.
If you want to read more about developments in the TMT sector, please visit:
http://www.thomsonimnews.com/story.asp?sectioncode=7&storycode=42257