Vestra Wealth Conference Call
OPERATOR Hello, and welcome to today’s July Investor Call 2010. I am pleased to present
our speakers Mark Holden and James Follows.
For the first part of this call all participants will be on a listen-only mode, so there
is no need to mute your own individual lines, and afterwards we’ll have a question
and answer session. Mr Holden, please begin.
MARK HOLDEN Good morning, everyone. Thank you very much for joining us today. I am a
partner of the firm and I am also head of Investment Strategy, and I have with me
today James Follows, who’s a senior investment strategist and works very closely
with me. We will follow a similar format to before, in that I’ll give a review of the
markets over the last month and then James is going to cover the main topic
which is faltering recovery, and we’re going to look into the deterioration of some
of the economic data that we’ve seen, in the US and China particularly, over the
past month or so. And then we’ll go to questions and answers at the end and
you can ask us about either anything we’ve said today or anything else that you
may want to that may or may not be investment related.
So, welcome to the conference call. I just should say at this point it’s the first
anniversary of these conference calls, and I hope you enjoy them. Any feedback
- positive or negative - we’ll be happy to take but it’s been one year on since we
started this process.
Anyway, what’s been happening in the markets more importantly over the past
month? Well, with the exception of just the last few days I think that it’s fair to
say risk aversion, or the avoidance of risk, has certainly dominated investors’
minds. So in the last few days you’ve had quite a big equity rally which has offset
some of the big falls that we saw in the second quarter.
Part of that has been undoubtedly due to the fact that the euro has rallied.
Clearly, there have been fears about Sovereign default in the Southern European
countries, particularly with the PIGS, as we call them. Particularly Spain has been
very weak over the past few months, their Spanish Government bonds that is,
and the euro was under severe pressure as people were beginning to anticipate
the potential breakup of the euro. It got down to a five year low only a few weeks
ago, but has now rallied. Part of that may be due to the fact that the US dollar
has actually come under some pressure, and the US dollar is the world’s biggest
reserve currency and the US dollar weakness may be related to the topic we’re
about to talk about later. In other words, question marks about the sustainability
and strength of the US recovery because we’re starting to see some deterioration
in the economic data there.
At the same time, another big dollar-based economy is China. We know that the
Chinese have eased their currency peg with the US dollar, but they’ve also been
applying the brakes elsewhere in their economy. A slight revaluation of their R&V
is bad for their exporters and, therefore, may be impacting Chinese domestic
growth rates, but they’ve also been implementing things like increases in basic
salaries, minimum wages across China and in some cases these are 33%. So
China has been slowing at the same time which is, of course, the main economy
that got the world excited about recovery, nearly 18 months ago now, and that
will be adding to the woes coming alongside a potential slowdown in the US.
At the same time, as I say, the sovereign debt crisis may have eased a little bit out
of investors’ minds as they focus more on the economic data, particularly in the
US. As I say, that has helped the euro rally. But also, I think it’s quite important
that a few weeks ago we had the G20 meeting, and the world is now very split
with the way to go forward from here. If you went back a year, the G20 was all
aligned, everyone was going for growth, lots of communiqués about having to do
whatever it would take to get growth back on track. Now the world is very split:
the US are still going for growth, and are happy to do that, whereas in Europe and
the UK we’re talking about austerity, beginning to pay down some of the credit
crisis debt that we all know has ballooned out of control in the last year or two.
So there’s a big split, growth in the US against austerity in Europe and the UK.
At the same time we’ve now had the UK coalition. That’s been working pretty
well actually since the General Election, since it was formed in May. We’ve had
their emergency budget which was seen by the city, particularly, as good in the
sense that it did address some of the major issues about paying down debt, and
since then all we’ve heard about is austerity and that’s from the Queen down to
local authorities. So certainly, in the public sector and in the general public’s mind,
austerity is right at the forefront of everything we’re talking about. And that’s not a
bad thing particularly for gilts and for sterling.
Now what has actually been happening in the markets over the past month?
Well, the best performing equity market has been the Hang Seng, the Chinese
market. It’s up about 3% or so. And the worst is actually the US S&P market
which is down about 1% over the same period, and that is about the same as the
FTSE 100 has performed.
In the PIGS, as we call them - Portugal, Ireland, Greece and Spain, this is an area
we’ve focused on recently - we’ve had a huge bounce back in the Spanish equity
markets, up 15% in the past month. Having said that, it was one of the world’s
worst performing markets in the three months running up to that, and is still one of
the worst performing markets, year-to-date. Ireland was the worst performing of
the PIGS - it was down 3% - and Greece having something of a rally, not as much
as Spain, but up 6% over the period.
In the world of bonds: US Treasury 30 year bonds were the best performers, up
2.4% which is a decent move for government bonds. And Greece was the worst
performing government bond market - still falling there - down 12%. So we had
this rally when the EU announced their bailout package. We saw yields come
back from circa 12%/13% down to about 8% and we’re now back up at nearly
11%, so the Greek 10 year bond market government bonds have fallen 12%.
In the UK gilts are performing strongly. Again, credibility coming from the coalition
and all this talk of austerity is good for long dated government bonds, and in the
UK 30 year gilts are up about 1.3% in the past month.
And the world of currencies I alluded to earlier on, but the euro has had a bit of a
bounce back. It’s up about 3% or 4% against most of the major currencies in the
past month and the US dollar has taken the brunt of the selling, down about 5%.
Of course, that’s a big move for the currencies and particularly the world’s biggest
reserve currency. And the pound has benefited again from the coalition but also
from dollar weakness, so the pound against the dollar is up about 5%.
In the world of commodities, we’ve had a big bounce back in some of the
agricultural commodities and wheat is the star of that particular show; it’s up 17%
in the past month, so a very decent performance there. However, one of the other
agricultural commodities, palm oil, is actually the worst performing commodity all
round, down 2%/2½% over the past month and gold is not far behind it, down
about 2%. It’s the first monthly fall in gold we’ve seen for a while. It may be a bit
of profit taking but I suspect it’s also partly to do with the fact there’s slightly less
fear round about sovereign default in the very short term.
That sort of finishes my part of the presentation. I’m going to hand over to James
now and, as I say, we’ve sort of highlighted this is faltering recovery and he’s
going to look particularly at why we think that may be coming through in the US
and in China. Over to you, James.
JAMES FOLLOWS Many thanks, Mark. Good afternoon, everybody. Regular listeners on these calls
will know that we have been worried about debt for some time, purely because
consumption accounts for 65% of GDP across most of the western world. We’ve
drawn attention to the risks to discretionary expenditure from consumers repairing
their personal balance sheet, and our economist, Derek, has also spoken
eloquently of the inter-temporal problem that flows from those that used credit
cards and loans, etc, to bring forward expenditure. And we have also drawn
attention to the risks associated with indebted governments, bond market selloffs,
austerity measures, competitive currency devaluations, etc. Regular listeners will
recall that these worry points have kept us away from discretionary related stocks,
such as travel and leisure, house builders, retailers, like carpet, like textiles(?), etc.
Our preference has been very firmly with gold, defensive growth and emerging
Now, the issues faced by Greece, et al, over the last few months are well
chronicled and the sheer number of column inches devoted to debt and
European-wide austerity programmes may lead some to suggest that investors
have fully discounted the problem, yet worries over a faltering recovery continue
to swirl through the market and Mark remains solidly convinced that the markets
have further to fall. Will the UK revisit the lows of last March? Well, it seems
unlikely to those who point to evidence of value and recent M&A deals, etc. But
the worry factor remains firmly in place, for the simple reason that talk of double
dip - a slump in economic growth - cannot be easily despatched.
To explain this a little bit further, there are three subjects that I want to highlight:
the first of these is US housing. Since the US housing bubble burst four years
ago Americans have got used to seeing bad tidings on the property front, a mix
of falling sales and foreclosures has seen house prices nationwide collapse and,
according to the well followed Case-Shiller Composite Index, they’re now down
more than 30% from their mid 2006 peaks.
The reality is that the US government has tried to shore up the property market
by giving an $8,000 tax credit to first time buyers. That scheme stopped at the
end of March, so a drop in sales in March when new single family homes plunged
by a third to a seasonally adjusted annual rate of just 300,000, that drop seemed
entirely probable. But the devil’s in the detail: sales in both March and April were
also revised down sharply lower. So this is before the tax credit expired. This
implies that there must have been a wave of cancellations. And not only was the
May figure much lower than expected, it was also the lowest since records began
in 1963. That puts the 300,000 into context. So the lowest since records began
Perhaps more worryingly, sales plunged right across the country. On top of that,
the median sale price in May was down almost 10% from a year earlier, and the
lowest since December 2003. US builders have been cutting their inventories,
and they’re now at the lowest level in 39 years, but the stock of unsold homes
still equates to 8½ months of supply at May’s sale pace. That’s the highest level
in nearly a year. The reality is it took builders a record 14 months to find a buyer
for a completed home last month. The next few months, we suggest, are likely
to be very grim and not helped by the fact that home loan applications for new
purchases in the first three weeks of June are already 15% lower than May’s. This
of course reflects the ending of the credit.
Now, the Obama administration has put the credit back on - they’ve reintroduced
it - but we are worried that the negative trends I’ve just outlined will continue, for
the simple reason that existing borrowers are facing growing problems. We saw
recently bad news on the so-called HAMP programme: the Home Affordable
Modification Programme, which is Obama’s scheme to stop over-indebted
borrowers losing their homes by reducing their home loan payments. The news
was that more than a third of the 1.2 million borrowers who have enrolled in the
HAMP programme have dropped out. That’s higher than the number of people
who have actually managed to have their home loan payments cut.
When HAMP started the Obama administration put pressure on the banks to take
on borrowers without first insisting on proof of their income. When the banks
tried later to collect this information, many troubled home owners have found
themselves disqualified or they voluntarily dropped out. In other words, we’re
back to the original subprime problem: lending to people with incomes far too low
to service their debts. In the first quarter of this year 5.7 million borrowers were
at least 60 days late on their home loan payments, i.e. they’d missed two or more
payments, but only 30% of these qualify for the HAMP programme. That means
4 million delinquent borrowers, and we fear that that in turn may mean another
wave of foreclosures.
Now, the second area I want to highlight is the state of the Global Purchasing
Manager Surveys. For those who aren’t familiar with Purchasing Manager
Surveys, these are widely used by the market because they gauge the relative
optimism of those seeing order flows, etc, and traditionally an index level of
above 50 is taken to mean that things are healthy, as it reflects the fact that
more purchasing managers are optimistic rather than pessimistic. The problem
with recent data is that it suggests that Global Purchasing Manager Surveys
are starting to roll over. In some ways this should be no surprise. In the US, for
example, the key ISM survey has been higher than current levels, only 16% of the
time since 1948, but investors are concerned that the data heralds a slowdown
in the global economy. To explain: in the US the June ISM index dipped to 56.2
from 59.7. Both the new order component and the production component
declined quite heavily. New orders fell to 58.5 from 65.7. Both of those now are
at their lowest levels of the year.
As I intimated earlier, the ISM rarely stays above 60 for a sustained period of
time, in fact in every economic recovery since 1980, the ISM peaked typically
in the 58/60 range and subsequently slipped back below 50 before entering a
more sustained uptrend. But the slippage in the index bears watching. It’s not
compelling evidence that the economy is faltering, but it is highly suggestive. We
await further news.
And crucially, what has unnerved is that the austerity programmes in Europe seem
likely to drag down activity and the brakes being applied in China are also clearly
having an effect. In China the Federation of Logistics and Purchasing - pretty
much the same as the ISM body in the States, or our own PMI kind of body here,
Purchasing Managers Index - said their central index fell from 53.9 in May to 52.1.
It doesn’t sound like much of a fall; 53.9 down to 52.1. But most of the sub index
-- in fact, all of the sub index data is pointing to slower growth and their new order
component, which was 59.3 in April, fell to 52.1.
There was an element of good news in that the input price index has fallen from
72.6 to 51.3 over the last two months and that suggests that producer price
inflation is peaking, and that policy tightening might be stopped, but the reality is
that the new orders are the forward-looking component, and they are the bit that
will concern us most.
The third and final area that I wanted to highlight was US jobs growth and the
related area of consumer confidence. We keep referring back to the US because
it matters. The US consumer accounts for 13% of total global consumption. We
also keep returning to the US because the data there is useful for heralding trends
that may develop in other parts of the world. So it’s quite worrying that the US
economy shed jobs in June for the first time this year. The unemployment rate
remained high and clearly this is adding to concerns that the pace of recovery
could slow in the second half. Specifically, in June, non-farm payrolls, as they’re
called, fell by 125,000 in the month, as 225,000 government workers that were
hired for the 2010 census lost their temporary jobs. Excluding government
workers, private sector hiring rose by 83,000, which was a disappointingly soft
kind of number. Construction hiring was particularly weak, while manufacturing
only posted a modest gain, just 9,000 jobs.
Related to that is the confidence - consumer confidence - because, no surprise,
if you are worried about your job or if you haven’t got a job you’re not out there
spending, and if you’re worried about your house price, equally, you’re not out
spending. So the consumer confidence index in the States dropped back in
June to 52.9 from 62.7. And look at the detail: those who found jobs hard to
get rose to 44.8% from 43.9%, perhaps not a material move but quite indicative,
and those saying jobs were plentiful came through at just 4.3%. As I say, given
the importance of consumer-related spending for the overall economy, the data
suggests that after a solid rebound earlier this year, the momentum in private
demand is likely to moderate in the second half of this year.
Now, these three subjects are not meant to be a definitive statement on what one
should be worrying about, but they will hopefully serve as a reminder to anyone
listening that the problems of debt accumulation have yet to be fully addressed.
As I said earlier, Mark remains solidly convinced that the markets have further
to fall. Will the UK revisit the lows of last March? Well, as I said earlier, it seems
unlikely to those who point to evidence of value but the worry factor remains
firmly in place. Our view, for what it is worth, is that talk of a fresh slump in global
growth - so called double dip - cannot be easily dismissed and I am sure that this
will be a subject that we return to in future calls.
That concludes the formal part of this particular conference call, the 12th in the
series, and we invite any questions that listeners may have.
MARK HOLDEN Great. Well, thank you very much everyone for calling in. It’s nice to get past our
first anniversary of these conference calls. For those of you who may have missed
some of today’s call, or if you want to listen to it again, then a transcript of it will be
put on our web site as soon as possible, and the next conference call will be at 12
noon on Thursday, 12 August. Thank you very much for joining us.
OPERATOR I apologise, sir, there is actually one question just came through now just as you
were on your closing comments. Would you like to take that?
MARK HOLDEN Yes, of course, no we’ll be happy to do that.
OPERATOR That is from Felix of Ambrose Felby(?). Go ahead, your line is open.
FELIX Good morning. I have two questions: one is gold and what do you perceive the
position to be in the next three months or so because I believe there are some
funds that are buying a lot of it still, yet it seems to be rather headline news for
the general punters and there may be a small dip, as you say, because the risk
appetite appeared to come back and it may be a summer lull.
That was my first question. And if I could just go on to the second one, that’s
index linked gilts, what your perception is of those?
MARK HOLDEN Yes, sure, thank you. Thanks for those questions. On gold, gold remains our most
favoured investment and it’s our biggest position. For example, in our medium
risk portfolios it’s about 10% of appliance to the weighting. There is no doubt that
-- when risk appetite returns gold probably travels sideways rather than upwards
and, more importantly at the moment, I think it’s important to look at the way the
euro is performing. That is probably the biggest indication of demand, I think, for
gold underlying because gold has become not the traditional inflation hedge that
everyone used to buy gold for or even a store of value during deflationary times,
but it has become an alternative currency for a lot of people.
If you remember going back maybe five years or so, or any time really in the recent
past, when you had interest rates of maybe 6% or 7% in the US, maybe 7% or
8% in the UK, 4% or 5% in Europe, and gold yielded nothing, then there was
no incentive for people to buy gold. The trouble is, right now, interest rates all
around the world are near zero and so gold is on a level playing field against these
currencies for the first time in many, many decades, and yet at the same time you
don’t have a central bank with a big printing press making more of them. So we
really fundamentally like gold as a currency, and while currency turmoil remains -
and we see that continuing for the foreseeable future - gold will still come out on
top. Now in the very short term, if there has been some easing back of fears about
the breakup of the euro then clearly people may not want to buy as much gold as
they have been doing, but we think this is just a temporary respite. We think that
nerves will return, you know, whether it’s about Spain or Greece or some sort of
default, but we think that the fear of euro default could re-emerge very quickly. I
wouldn’t be surprised to see in the very short term, though, the euro against the
dollar hit maybe 1.30 before it sort of comes back in a sustainable way. And
we’re about 1.26/1.27 this morning having been less than 1.20 not very long ago.
The other thing about the summer, is in the very short term gold tends to go a bit
dull and a bit quiet in the summer, ahead of then having a rally as you go into the
latter part of the year as the Indian wedding season, for example, comes through
and demand picks up for wedding presents and dowries, etc, in Asia.
So I think gold could go sideways for the summer but it could also have a very
big spike if people worry about the euro again. So we’d rather not take money off
the table. We’re happy to buy it on the dips and we remain very positive on the
outlook there. I hope that answers your question on gold.
FELIX Thank you.
MARK HOLDEN On index linked, I think it’s fair to say that anyone who has been following us for a
while knows that we’re very much in the camp that believes that we are ultimately
going to get deflation rather than inflation. If you went back a year when, as I say,
the G20 was in full let’s go for growth mode then there was a huge number of
people, the majority of investors out there, thought that the ultimate end scenario
from printing all this money would be inflation. And clearly, in that environment,
index linked gilts and investment bonds generally around the world, which are
in relatively short supply anyway because governments haven’t issued many of
them, did very well and actually the yields have moved down to levels that we find
very, very hard to bring ourselves to buy. Even if we believed in inflation it is very
difficult to want to fundamentally go and buy index linked gilts from now on.
However, if you’re in our camp and you believe - as we do - that all these austerity
packages that are being put in place for debt repayment that’s going to come
through, clamping down on spending, etc, that has to be negative for growth
and has to be deflationary. Now, there is a fine balance between the monetary
policy stimulus that you’re seeing from quantitative easing in America and to
some extent still here in the UK, but that’s the only things that are really pushing
inflation at the moment; wages aren’t going up, in fact wages are about to go
down in lots of the public sector; jobs creation hasn’t happened. James alluded
to the fact that there are very few private sector jobs being created in America
and everywhere else at the moment, and in fact you’re going to get increasing job
losses as governments cut into that public sector budget.
So we see that as being overall very negative for growth but also, importantly,
deflationary. Now, in that environment, if you believe deflation - like we do - is
going to come through, then we’re much better off, in our opinion, buying
conventional government bonds in countries that have credible debt repayment
programmes, and the UK seems to fall into that category at the moment. So at
the margin we’ve been buying longer dated gilts for our clients. For example, you
can buy 20 year gilts at the moment, near par, with 4.1% yields and yet we have
½% interest rates in the UK, and the equivalent index linked is yielding you sort of
0.5%/0.6% in real terms and it’s a tough call that one. We think, as I say, deflation
is going to come through. Therefore, conventional gilts are actually a better place
FELIX Interesting. Can you hear me?
MARK HOLDEN Yes, I can, yes.
FELIX Very interesting. Because I mean I was talking to charterers yesterday, a chap
called Ian Williams, who was saying they are putting a lot of call options on to
MARK HOLDEN Okay yes. So they’re giving themselves the option to buy them in the future, so
they believe (overspeaking)
FELIX No, I think they think they’re going to go down in value.
MARK HOLDEN Right. I see. They’re using their gilt positions?
FELIX Yes, to write options against.
MARK HOLDEN I mean it really does come down to whether you believe in inflation or deflation.
We just can’t see all of the austerity packages that prevail across the whole of
Europe and the UK now, being anything other than negative to growth, and I don’t
know where -- I mean traditional inflation comes from a shortage of capacity. Well
there’s still excess capacity in most of the world’s economy. That excess capacity
then leads to pricing power for companies but also for employees, because if
companies are able to put their prices up they’re able to justify higher wages for
their employees. At the moment, all companies we see there - and we see two
companies a day typically coming through our offices - none of them are able to
put up prices at the moment. I mean it’s just not the done thing. You can’t do it.
There’s not the end demand. If you do your competitors will keep the prices lower
and win the business. So the ability for companies to put up prices is negligible and
given what’s about to come through in the austerity and the job hunt in the public
sector, and of course the UK is no different from any other countries across Europe,
in that 20% of all employees in the UK are directly employed by the government and
there is another 20% who are indirectly employed by the government. So 40% of
all employees in the UK are potentially exposed to these austerity cutbacks. There
is no way that wages are going up and, therefore, the ability for the majority of
consumers to pay higher prices is just not there.
Now, the danger is that there is some inflation in things like commodity prices,
whether it be oil or copper or iron ore, which comes through as a cost to
companies. Those companies can’t pass those costs on and you get two things:
(1) is you don’t get any inflation; but (2) you get profit warnings because that’s their
margin that gets eaten into or they then have to cut jobs to keep the same margin.
But of course that again compounds the problem because you’ve got more people
being unemployed and there’s less spending power going into the economy. So I --
FELIX What about the more cynical view of the politicians trying to create inflation to wash
the debt away?
MARK HOLDEN I think that’s absolutely what they’ve been trying to do until very recently. If you
go back to - let’s say a year ago - the G20 I think was particularly worth looking
at because a year ago America, Europe the UK were all aligned in saying, “We’re
going for growth. We’ve just put our foot on the accelerator, we’ve printed as
much money as it takes and that’s how we’ll get out of this. We reflate, you know,
equities, property; you name it we’ll try and reflate it”.
The trouble is half of that picture has now gone the other way and gone austere,
maybe at a time when demand isn’t strong enough to take it. That would be our
opinion. And America on its own cannot create global inflation. It can help offset
deflation but it can’t create inflation on its own, it’s not big enough. But if Europe
returned to job creation, trying to push growth rather than paying down the debt,
well the euro would collapse, everyone would sell those peripheral government
bonds, and you would then potentially have a banking crisis. And this is what I think
the central bankers have worked out is that, actually, it’s a fine line between going
for growth which could become bad for your government bonds which would then
inhibit your ability to borrow as a government. If you can’t borrow as a government
you really are up (overspeaking)
FELIX Up the creek.
MARK HOLDEN But you know where I’m coming from?
MARK HOLDEN If you’re the Greek government at the moment you’re still having to issue new
government bonds at 11%.
MARK HOLDEN They can’t afford to do that and the UK, we can’t afford to do that either. Luckily
our gilt market has believed the austerity is going to work and so the equivalent gilt
yields for ten years is about 3.4% at the moment, making it quite comfortable for
the government to borrow money should they want to.
MARK HOLDEN But it really comes down to, I think -- I’ve got three children I think that they’re
doing the right thing. I’d rather have the pain now and not leave the problem for
my children to pay down all this debt. I’d rather take the pain now. It’s not very
palatable for us but I think it’s the right thing to do.
FELIX Where would you buy gold? What sort of level would you be buying gold now?
MARK HOLDEN Well, I mean I’ve been watching very closely over the last week or two and there’s
very strong support comes in at about $1,180 and, personally, I’m happy to be
buying it under $1,200.
MARK HOLDEN I just think that that’s a nice level to be buying it. Although it has come back a bit it’s
by no means sort of broken down in chart terms, or anything like that. And I don’t
believe that the rally in the euro is sustainable. I think that we will return to worries
about Spain’s ability to find their deficit.
FELIX Yes, right.
MARK HOLDEN And I’m not clever enough to tell you, by any stretch of imagination, when that
might be. That might be next week; it might be in a month’s time; it might be in a
year’s time, but when it comes gold will come back into its own. I think it will push
up to new highs.
FELIX Yes. May I congratulate you all on a fantastic quick summary like this? And this is
the first time I’ve joined this little group. Is it Francois’ Marker(?)?
MARK HOLDEN Oh yes, yes.
FELIX A real character and she sort of hooked me in to this, I think, and it’s marvellous to
know you both. Thank you very much indeed.
MARK HOLDEN Well, thank you for your questions.
JAMES FOLLOWS Yes, thank you, sir.
MARK HOLDEN We appreciate that.
MARK HOLDEN Thanks, Felix.
JAMES FOLLOWS Cheers, then.
MARK HOLDEN Would anyone else like to ask any questions? We’re happy to take any more
OPERATOR Once again, if there are any further questions please dial 01.
Okay. No, it doesn’t seem there are any further questions, sir, and as you have
made your closing comments I’ll close the call for you.
MARK HOLDEN Thank you.
OPERATOR Thank you to all the attendees for attending.
MARK HOLDEN Thank you very much everyone.