In the near term we are concerned with the implied expectations of global markets, both credit and equity (see below) and continue to adopt a defensive posture. But this defensive stance is largely represented in stocks that should benefit in absolute terms when the market rotates away from some expensive cyclicals. Many are the more utility-type names which have very high and defensible yields and earnings streams that are, in large part, guaranteed by regulation. What is wrong with a sustainable 13% yield in a strong currency, especially when the stock(s) are at or around decade lows? Even with our negative view of bond yields, this is way too cheap. And all this in an economy (Australia) which has few of the ailments referred to above. We can also find value in utilities elsewhere in the region and are attracted to some of the consumer staple and media stocks which have been left behind in the rush to add ‘early’ cyclical exposure. Korea is well stocked with these names, which look cheap in absolute terms and spectacular relative value when one factors in the huge moves seen recently in the export-oriented stocks, which are facing clear headwinds from the strength of the Won and yet have been the recipient of massive foreign buying in recent weeks as Korea has been upgraded to ‘developed’ status by FTSE. Sadly the same dynamic is less obvious in Taiwan where the domestically orientated names offer only modest value as a result of investor enthusiasm over the better relations with Beijing and the likely increase of Chinese investment.

Technology is a sector where the bulls are definitely in the ascendant, but offers little to us in terms of compelling value. At the turn of the year we were keen on some of the large ‘survivors’ – TSMC and Samsung inter alia. The rationale was simple – the weak players would go bust, and the industries would oligopolise with positive long term implications for profitability for those remaining. The trade turned out to be a profitable one, but sadly the rationale no longer holds. In DRAM, Qimonda did go bust – but the Taiwanese producers were bailed out just in time by rising stock markets allowing them to issue enough stock to survive and to continue to depress industry returns. In the foundry sector, TSMC is still pre-eminent, but the recent merger of Singapore’s Chartered with the Arab sponsored Global Foundries is a longer term negative as the competition is now larger and has deeper pockets. In general, there is little in mainstream technology which interests us now. Valuations seem to be assuming a reasonably robust recovery (see below for our view on this) yet competition is still rife. Where we do find opportunities are in companies with secular growth AND intellectual property which should prevent excessive competition. LEDs are one area of interest, with e-ink and battery technology there too, although picking the long-term winners from the devils in disguise is tough in such a nascent industry and we are waiting for some of the hype to fade before putting significant money to work.

With markets roaring ahead and economists muttering about strong growth in the Western economies, one feels a little churlish in pointing out the Panglossian nature of these pronouncements, but we do feel compelled to dwell on a few of the less positive economic issues that seem to have been temporarily forgotten by the newly emboldened investor. First and foremost, it’s Government. Yup, the institutions that belatedly saved the world economy by spending your children’s taxes have run out of cash and the ability to write credible IOUs, otherwise known as bonds. Ponder on California letting convicts out of prison early because they cannot pay the wardens anymore if you think ongoing debt issuance will be painless – and that is while Central Banks are artificially depressing rates. The official prognostications for deficits are scary enough, yet we know they are predicated on a politician’s make-believe world where growth recovers and interest rates and hence debt service costs remain low. Stimulus programmes for housing and autos are already winding down, but companies are talking of ‘renewed momentum’ – at least in the prospectuses for their recently de-mothballed capital raisings. How many extra cars and houses through the cycle will be sold by these programmes? Give yourself a pat on the back if your answer was ‘none’. Demand has merely been borrowed from 2010 as consumers have done a back-of-the envelope DCF calculation and worked out that $4,500 today is a good deal if your car needed replacing in the next year or two anyway. Spending cuts will be massive – think double digit percentages, just to pay the increased unemployment benefit bill, let alone all the other stuff like public sector wage rises and pension bail-outs. Public sector strikes are coming. Tax rises will also be very painful as they will have to be levied on consumption and/or the average earner. Corporation tax in many jurisdictions is history. For example, Merrill Lynch apparently has 160 years of tax losses in their UK operation, and they will not be alone in not having to worry about tax for the foreseeable future. The few companies that are paying a lot of tax are heading rapidly to domiciles with a lower impost. High earners have already been targeted, but there are not enough of them to plug even a small fraction of the whole – and in many cases are amenable to relocation if they are not bowled over by our superior weather. These factors apply in the U.S and Europe equally and when combined with a monetary backdrop which can only get tighter (we do not believe electorates will wear negative nominal interest rates) presents a really massive impediment to fast growth. So consumers will have to save less and spend a lot more. That’s all right then. Good job no-one can remember the great crash of 2008 anymore.

We have been amused of late to hear some of the pontifications from CEOs, (particularly but not exclusively) in the property and banking sectors, on the recovery prospects for their industries. In most cases they allude to better times ahead, assume low interest rates for the foreseeable and are therefore…..selling assets and de-gearing. Suspicious minds might be tempted to ask which part of ‘buy low and sell high’ is so difficult to comprehend. Yet the market now lauds their strategy and shareholders lie supine as remuneration committees once again trample roughshod over what is left of their equity’s value. The revolving door in boardrooms keeps spinning as it appears that the sole relevant qualification for a large company board seat is a record of abject failure in another large institution. Wouldn’t it be worth expanding the gene pool away from the current crop of corporately in-bred dinosaurs? Just a thought….

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