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Market commentary March 2008

By March 4, 2008No Comments

SUMMARY. Warren Buffett (the worlds richest man) is energised by recent events, particularly with signs of panic in bond markets. Though more volatility must be expected, people like Buffett know that times such as we are now encountering create rare value for long term investors.

If you or I get involved in a TV or radio phone-in it’s probably so that we can berate a failing football manager or plead for the re-introduction of hanging (if only for football managers). Not Warren Buffet. He rang in to interrupt a CNBC financial news programme to offer $800bn to help out troubled bond insurers. Like you do. Clearly Buffett is hugely energised by the opportunities created by turmoil derived from credit markets.

Such opportunities are not confined to the US, and pricing inconsistencies are replete in this fear-fuelled environment. Take Bradford and Bingley. From the beginning of problems with Northern Rock until end-2007 it had net new deposits of £2bn. Just since the beginning of this year, net new deposits are £1.5bn. To illustrate their confidence, management have increased the dividend. Yet the yield on the shares has recently been around 11%. And one of their corporate bond issues with a 5 year term has a yield of 9.5%. In a feverish marketplace, wracked with uncertainty and paranoia, such value emerges.

There are many sobering assessments of what might lie ahead. Yet in the UK, beyond bonus-less bankers, individuals with over-stretched credit cards and mortgage accounts, and a dormant housing market, the economy is surprisingly steady, and the biggest shock in the most recent UK bank results was that there was no shock.

UK retail sales are up 5.6% year on year, and manufacturers order books are in good shape. Unemployment is not a worry so far, and expected increases in redundancies seem likely to fall most heavily on migrant workers, and these will not appear in unemployment stats. Of course there will be an economic slowdown, and in many cases company profits will not be as high as in 2007. But that happens within the economic cycle, and in itself is not particularly newsworthy. Inflation is expected to tail off later in 2008 and into 2009, and an inflationary wage spiral is highly unlikely.

Yet many share prices (and bond yields) are pricing in something really unpleasant. Those of a certain age will have often experienced times when the outlook appears very problematic, yet with the hindsight of 12 months or so it can be seen that it wasn’t so bad. One experienced fund manager was asked if such a relaxed view was merited. He felt that the chance of some material mis-judgement by the relative optimists was perhaps 1-2%. In the real world the global economy will not be allowed to involuntarily drift into a dark hole. There is already ample evidence of authorities being pro-active, and the US in particular still has a wide range of policy options.

Company directors seem to be reasonably optimistic. The ratio of them buying their own shares is very high (12 to 1), in fact abnormally high, much as it was in the Autumn of 2002 when the bear market moved towards its end, and in Autumn 1998. On each of these two prior occasions analysts and febrile markets were proved wrong within a few short months, and business owners were proved right. Not an infallible indicator, but interesting nonetheless.

A fall back through 5700 on the FTSE 100 will mean that the stockmarket isn’t yet ready to reflect what (in the eyes of company directors) is the reality, and indicate that the index isn’t yet ready to mount an assault on 6500 and beyond. Equally there appear no reasons for investors to panic. In fact the regular “investors flee funds/shares” headlines are highly encouraging for contrarians, with Warren Buffett in the vanguard. With bond prices suggesting that some market participants are already panicking, there is the possibility that bonds and stockmarkets can spike down to lower levels (support for the FTSE 100 index is down at 4600-4800). If so, calm heads that are already buying will be buying more.

Dennehy Wealth