What To Worry About Now
Owain Bennallack | Tuesday, 5th January, 2016
This article was originally written on 15 December
I don’t know about you, but I got really bored of the wall-to-wall coverage of the UK bank Stress Test results.
All those front pages about how the Bank Of England had given the banks a clean bill of health after putting them through a rigorous hypothetical workout that assumed a UK house price crash, high unemployment, a slumping global economy…
All those editorials on how our banks haven’t been so bombproof for 30 years…
Those double-page articles illustrating their cash-rich balance sheets with images of Scrooge McDuck…
You didn’t see endless headlines about how safe the banks are – and not even one mega-wealthy duck picture?
Come to think of it – neither did I.
The Titanic sunk once
Of course, I’m being facetious.
The news channels did report how the banks had passed their stress tests with fairly flying colours.
But there was no fanfare – and nothing like the breathless reporting we saw when the banks were, in reality, under extreme stress.
That bad news sells isn’t news to anyone.
But I do think as investors we need to think differently.
Today I hear many people say the banks are too risky to invest in.
A few said the same before the banking crash – fair enough – but I suspect more are letting memories of that crisis provoke an emotional reaction.
The UK banks were profitable investments for decades. In the end they got greedy and complacent, and we know what happened next.
But there’s no reason to think it’s going to be repeated any time soon – not with all the capital they now have to hold and the level of scrutiny they’re under.
There are other legitimate arguments against buying bank shares.
For instance, the regulatory and capital burden they now operate under – the very thing I believe makes them much safer – might also have permanently impaired their earnings power.
But saying you fear a banking crisis in 2015 sounds to me a bit like warning of the threat of icebergs to passenger liners in 1913…
Risk increases as perceived risk decreases
The meltdown in the commodities sector in 2015 is a different situation, but in much of the commentary I hear similar echoes of a barn door being closed long after the horse has bolted.
Just a few years ago we were infatuated with the commodity super-cycle – the idea growth in the developing world would underpin almost limitless demand for materials such as oil, iron ore and copper.
It reached a peak when GMO’s widely read Chief Investment Officer Jeremy Grantham put his intellectual weight behind the commodity boom, saying a “great paradigm shift” was under way wherein:
“Accelerated demand from developing countries, especially China, has caused an unprecedented shift in the price structure of resources […]
“Statistically, also, the level of price rises makes it extremely unlikely that the old trend is still in place.
“From now on, price pressure and shortages of resources will be a permanent feature of our lives.”
Investors caught up in the frenzy couldn’t get enough of the mining and energy firms charged with giving the world more of what little it had left at ever-escalating prices – only for what looks in retrospect to have been just another bubble to pop, and for prices to plunge.
From super cycle to bumper bust
Since April 2011, when Grantham made those comments, the share price of mining giant BHP Billiton has fallen 75%.
Many of the FTSE’s oil exploration stocks have fallen even further.
As for oil, it’s down from over $120 a barrel to less than $40.
Yet rather than take the collapse in commodities as a reminder of the inherent cyclicality in these markets, people seem to be shunning them out of fear, just like the bank stocks.
I don’t know when the storm clouds will part – but I would bet that selling at the point of maximum pain and then swearing off a sector because it’s too risky after prices have already plunged is not likely to be a winning investment strategy.
Pain spotting for fun and profit
Buying and adding to quality companies or to funds that give you wide exposure to economic growth and innovation is likely to prove a more fruitful approach for the majority of investors compared to betting on which area of the market is about to soar or crash.
But if you are going to try to trade in and out of market sectors, I’d suggest it’s sensible to go against the grain.
Deciding a sector is too risky after a crash has occurred and everyone agrees with you might make you feel comfortable.
But getting out of what other people are still comfortable owning but where there are unappreciated risks is more likely to make you money.
If I knew for sure what would blow up next, I’d be bellowing “Sell!” to my trading minions at my own multi-billion pound hedge fund.
But here are five areas I think are more likely to cause problems than make fortunes in the next few years:
- Bonds. As rates rise in the US and UK we’ll see volatility here, and perhaps trouble for companies who own or trade them.
- Quality stocks such as the big brewers. They’re certainly not going to go bust but their valuations are at rich levels.
- US equities. They look more expensive than European and UK shares.
- UK commercial property, especially in London. Looks toppy.
- Homebuilders – this is a tricky one for me, as I still like the sector and am invested in it. But it’s hard to deny builders have had a superb run and enjoyed near perfect conditions.
Those are only hunches based on where I suspect investors might be too complacent.
But it will be interesting to see in a few years how these areas have fared compared to the banks, miners and emerging markets that are so fretted about today.
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This article was originally written on 15 December
I don’t know about you, but I got really bored of the wall-to-wall coverage of the UK bank Stress Test results. All those front pages about how the Bank Of England had given the banks a clean bill of health after putting them through a rigorous hypothetical workout that assumed a UK house price crash, high unemployment, a slumping global economy? All those editorials on how our banks haven’t been so bombproof for 30 years? Those double-page articles illustrating their cash-rich balance…