EXIT, PERSUED BY A BEAR

Blog  |     |   by Graham Cross

Graham Cross, CEO Helm Godfrey
Graham Cross, CEO Helm Godfrey

 

It isn’t often that a neo-Malthusian perma-bear like me is roused to defend the bulls, but one of our own has gone rogue. In fact, by the look of my email inbox, Crispin Odey – he of Odey Asset Management – is on the rampage.

The headlines are clear enough…

‘Hedge fund manager Odey says UK stocks could plummet 80%.’  (bloomberg.com, 01.11.2016).

‘Odey: Stockmarket could fall 80% as UK heads for recession.’  (investmentweek.co.uk, 02.11.2016).

But should we really take the ‘locals’ at their word? Two questions spring to mind. 1. is Crispin Odey forecasting an immediate decline of 80 percent in the value of the FTSE 100 index? And, 2. if he is, should we take remedial action?

Both of those questions are easy enough to answer. (And for those short of time and/or patience the answers are ‘no, I don’t think so’ and ‘certainly not’).

You’ll find the full text that provoked those headlines reproduced below – it comprises the ‘manager’s report’ section in the September 2016 Odey European Inc fund factsheet.

That first paragraph is the one that gives rise to the more eye-catching headlines and, tellingly, betrays a sense of outrage aimed squarely at The Old Lady of Thredneedle Street.

Maybe it’s just me, but I don’t get the impression that Mr Odey is presenting a meaningful forecast here; certainly not one that can be appreciably quantified and subsequently judged for accuracy (I am not sure if he is forecasting a decline per se or a specific decline of 80 percent, nor is there any mention of a timeline for these events). Rather, he’s illustrating what I think are an unlikely set of circumstances in which it is possible that the FTSE 100 Index falls 80% toward a resting P/E of 13. OK. But, albeit unlikely too, I could set out the circumstances in which the FTSE 100 Index gains 80% toward a P/E of 13. Neither warrant much attention.

Of course, Crispin Odey really is very bearish and he really is signaling his distaste for what he perceives to be hugely inflated valuations. But ‘bear is bearish’ is no headline… especially when this bear has been bearish for ages…

His ‘apocalyptic worldview’ dates back some seven years, as documented in a forbes.com article on 08.04.2009. Back then he was ‘was worth listening to’ because he had ‘a great track record’ and back then he was advocating a short position in the market for gilts.

Little wonder that he is angry with the Bank of England today. Beginning in April 2009, the redemption yield attached to the 10-year gilt has fallen from 3.4 percent to just 1.2 percent after hitting a low of 0.6 percent in August this year. Indeed, over the same period and from the perspective of a sterling investor, the FTSE UK Conventional Gilts All Stocks index has gained 55.3 percent compared with a fall of 3.4 percent from the Odey European hedge fund. Meanwhile the fund’s own benchmark, the MSCI Europe index has gained a whopping 130 percent. Presumably, by the logic laid out in the Forbes article, Crispin Odey is not worth listening to today.

But, of course, the real reason investors ought to ignore those headlines is that ‘market timing’ is a mug’s game.

The interests of retail investors are best served by a properly diversified portfolio (one that is designed with a multiplicity of potential scenarios in mind and with aggregate risks matched to the extent that investors are willing and able to carry) and a focus on the long-term in the context of a clearly defined financial plan.

As it happens, I concur with some of the things he is saying. Like him, I think a British recession is not at all unlikely. Similarly, I view the current account deficit to be the source of some considerable anxiety and, like him, I think that inflation is headed higher. There’s nothing particularly contentious here.

Indeed, it is likely that expectations for higher inflation have already fueled the rise in gilt yields from 0.6 percent in August to 1.2 percent today and may well fuel a further rise in yields. The Bank of England’s November ‘Inflation Report’, published today, sees inflation rise to a peak of 2.8 percent in the middle of 2018.

But, I think that Crispin Odey’s view that the Monetary Policy Committee should be raising Bank Rate is nothing short of lunacy, even in the face of an inflation rate that overshoots the mandated 1-to-3 percent target range. That’s because higher inflation is, in large part, a function of one-off events in the market for commodities (higher prices) and foreign exchange (a lower sterling conversion rate) which will, all things being equal, wane in their influence in a reasonably short timeframe. Why raise the cost of capital for households and businesses with a potential recession clouding the horizon?

ODEY EUROPEAN INC, MANAGER’S REPORT

‘These times are getting interesting. The FTSE 100 share index is now up 30% over five years, whilst earnings have fallen by 80%. On an earnings yield of 1.6%, the stock market could fall by 80% and, provided profits did not fall, would be on a 13x P/E multiple. The Bank of England is proud that they have engineered such a pleasant result but there is now increasing evidence that this is unsustainable.

On the back of the uncertainty for overseas investors in UK PLC following on from the Brexit result, the current account deficit is ballooning and the budget deficit is following. Carney, the Governor of the Bank of England, has responded by flooding the money markets with more cash, QE, and in the process supporting the government 10yr bond at a current yield of 1.2%. However, as sterling falls against all its trading partners’ currencies, it is mechanically ensuring that inflation rises up through 3.5%.

Traders have been buying into sterling weakness on the back of an 18% fall in the trade weighted index since the Brexit vote, but do they not understand that the further the pound falls, the greater the difference between next year’s inflation rise and today’s interest rates. Sterling is getting more expensive, the further it falls. Carney is really under pressure and should be raising interest rates, but it now looks as though a rise in interest rates will be over his metaphorical dead body.

We are now destined to have a recession in the UK as well as inflation. It will be difficult for the stock market to remain above all of this. What QE has done is to make investors complacent but also optimistic that only an upturn in economic activity, spelling higher profits could trigger upward interest rates. What the UK is promising is rising wages, recession, inflation and falling profits. Not exactly the prize that ticket holders in the FTSE and the gilt market have paid up for.’

(Crispin Odey, Odey Asset Management, September 2016 factsheet)

IMPORTANT INFORMATION

While a reasonable course of action regarding investments may be formulated from the application of our research, at no time will specific recommendations or customised advice be given, and at no time may a reader be justified in inferring that any such advice is intended. Although the information contained in this document is expressed in good faith, it is not guaranteed. Helm Godfrey Partners Limited will not accept liability for any errors or loss arising from the use of this document. Readers are directed to our terms and conditions. Crown copyright material is reproduced with the permission of the Controller Office of Public Sector Information (OPSI). Bank of England data reproduced with kind permission of the Bank of England.


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