Investors have endured a difficult six months. The credit crunch was first felt in August 2007 when a number of major banks began writing down the value of their bond portfolios. As a result, banks stopped lending money and suddenly liquidity dried up. One of the first casualties of the credit squeeze was the house builders. Investors then focused their concerns on the consumer which impacted both domestic consumer plays and the Asian markets which are dependent on significant exports to the West.
Whilst not wishing to underestimate the underlying weakness in the economy, it is our feeling that the recent market falls (particularly noticeable in the Dow Jones Industrial Average which suffered its worst June since 1930) are more a result of extreme pessimism and depressed sentiment than a true reflection of fundamentals. Logic and reason are no longer important factors in investment decision making and the disconnect between share prices and company news has widened.
Throughout the last few turbulent years we have maintained a positive attitude and have adhered to our strict investment discipline - looking at companies which are fundamentally attractively valued. Working within this framework has allowed us to escape the property crash unscathed and to avoid the worst of the sub prime related bank write downs. However, we have still been penalised for holding good quality companies at historically low and, what we believed at the time were, attractive valuations.
The resources companies currently account for over 30% of the FTSE 100 index. In 2006, property and building services companies were predominant in the index and in 2000, Technology, Media and Telecoms stocks represented over 30% of the index. Knowing this and what subsequently happened in those sectors, can we really advise that it is the right time to invest in resource related companies? We don’t believe “it’s different this time around”. Resources are not a pure play on growth in emerging market economies (which have themselves succumbed to the weakness in global stock markets) and they are not an anti equity bet because they are ‘safe’ hard assets (just look at the property market). The fact that these are cyclical businesses and that many commodity prices have failed to break through the highs reached over a year ago, are facts that are being ignored. We do not believe the strength of the resources stocks is sustainable.
One sector that has suffered at the expense of the fascination with mining and oil companies is the banking sector. According to Merrill Lynch*, a net 62% of fund managers are overweight the oil and gas sector and the same percentage are underweight the banking sector. During times of excessive pessimism or euphoria this kind of disparity is not uncommon.
Investors must remain rational in these irrational markets. In the short term, returns are questionable but in the long term value should win out. For this reason we adhere to our investment discipline, focusing on strong cash flow, low valuations and attractive dividend yields. We expect stock markets will continue to be difficult but when we turn the corner we want to be in the best position and the right frame of mind to benefit from potential future returns.
30 June 2008
*Europe Fund Manager Survey: full of extremes (18th June 2008)
