Three long, lean years. The very fact you are reading this means you have already survived the worst...
Three long, lean years. The very fact you are reading this means you have already survived the worst bear market since 1929 in terms of duration and fall from peak to trough. Does the recent rally mean we can draw a line under the bear market? Are we in a bull market now?
A couple of strong months most certainly do not make a bull market. Indeed, our house theme of the Ice Age has as its key conclusion that the secular bull market in asset values of the 1980s and 1990s is over.
However, this has become a more widely accepted view over time and three years of falling markets have taught investors, relying on momentum, to sell the rallies as mechanistically as they once bought the dips. We don't believe the rally is unjustified, as the bears would argue; indeed, we have hardly seen much of a rally at all so far.
Since early 2003, we have argued the worst of the post-bubble correction is over. In the tech, media and telecoms sectors, we became overweight late last year because we felt the wrecking ball of the bear market had left some real jewels among the rubble ' quality companies with difficult markets, priced for bankruptcy. Even so, we were wrong-footed by the recent rally. Why?
We looked at the economic horizon and could not see the conditions necessary for a rebound in economic activity. So we sought out blue-chip companies like Ericsson and Zurich Financial Services that had new management, credible new strategies, strong core franchises and were trading on valuations that assumed things would get worse forever.
Although these stocks have stood us in good stead in the rally, the real leaders of the market move were stocks like Ahold, up 156% in local currency terms from 10 March to 16 May, Delhaize, up 109%, and Commerzbank, up 70%.
These stocks have one thing in common: they were priced for serious default risk, which has eased sharply.
The deluge of liquidity from the US Federal Reserve has caused yield-starved investors to drive down spreads on high-yield corporate bonds. This, in turn, has allowed some huge re-financings to take place in Europe over the past two months, with the markets scarcely missing a beat.
Even companies that did not raise capital benefited from the improvement in access to capital markets. These stocks were not rallying because of hopes for an economic recovery, hence the indifferent performance of mining and metals, forestry and paper and so on. The market is not crazy, it is pricing in the surging euro on a real-time basis.
Are we buying large amounts of Ahold in the European funds? The short answer is no. Cheap finance can certainly reduce default risk, which has happened already, but cannot reverse strategic mistakes, serious fraud or deeply flawed business models.
A strong economic recovery could help remedy these problems but we do not see it on the cards. We continue to focus on stock specifics and selectively adding to stocks such as ZFS and Ericsson, both of which we initially bought after successful rights issues had eased solvency concerns.
Worst of the post-bubble correction over.
Serious default risk has eased sharply.
Huge re-financings have taken place.
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