Although the FTSE 100's high set on Thursday 26th October of 6,245 still has to be bettered, it is nonetheless a fact that the bulls appear to be in control. It may well be that, over the next few days, we will considerably reduce exposure to UK bear funds, not because our fundamental view has changed but because it is our policy that investment losses should not be allowed to accumulate unreasonably.
Because our fundamental view is unchanged, we propose, for a short period at least, to maintain some modest exposure which, if we are proved to be correct, can be added to. If, subsequently, it is quite clear that our view is misplaced, then the residual holding will also be sold.
Two weeks ago we reported that the Abbey National is now willing to lend up to five times joint incomes. A few days later HBOS brought out their new mortgage offer of loans at 125% of value. Those who take up such an offer will instantly enter the territory of negative equity and in doing so are making a big bet on future price action which may not prove to be a good call.
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In London at the top end, house prices are on a tear, as very wealthy foreigners and bonus-rich City types bid up the price of anything in a good area. Elsewhere in the country it is reported that prices are stagnating. In the event of the Bank of England raising rates further next year, the whole housing area is likely to get very sticky. These markets historically, have tended to be most over-bought' and most dangerous when both lenders and borrowers behave recklessly.
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There are a growing number of buy-to-let properties being repossessed and off-loaded at auction, a clear sign that investors are struggling to meet mortgage repayments. The scale of this is quite extraordinary because auctioneers are saying that about 50% of all repossessions sold at auction are buy-to-lets. This signifies a sharply deteriorating situation because, as a percentage of the market, they account for less than 10%. Low yields and the lack of satisfactory price appreciation must be bearing down on at least some of these investors, especially those who speculatively bought into the market in the last year or so when yields were already too low.
This UK debt situation is moving on, its tentacles stretch into the corporate as well as the domestic sectors. It has been reported that Britain's major corporate lenders, accountancy firms and traditional restructure houses such as Close Brothers, Lazard and Rothschild, are now competing with distressed debt hedge funds to secure expertise ahead of an anticipated crash. These guys live at the sharp end and know what's going on. Their concern is so serious that their anxiety to recruit skilled people is causing them to offer salary and bonus packages rising at a faster rate than for bankers specialising in mergers and acquisitions or private equity. The British Chamber of Commerce echoed this sentiment, warning that Britain's economy is set to slow significantly next year.
Might it be appropriate, following the Democrats' recent success in the US mid-term elections, to ask "Have the rules of the game changed?" Gridlock, they say, is what America has because the President has the power to veto, whilst Congress and the House of Representatives can stymie the President.
The good examples of gridlock occurred in Bill Clinton's time and Ronald Regan's time, they both entered into a period of co-operation and consultation and enjoyed considerable success. But neither of those presidents was as unpopular as George Bush, the danger here is not good gridlock but bad rudderless-ness! The game may have changed because:-
for the first time in twelve years the Democrats are in control of the legislative agenda. For the first time in nineteen years, the Fed has a new chief. For the first time in fourteen years, home sales in the resale market are deflationary. For the first time in seventeen years, a very broad monetary tightening is in process. We are grateful to David Rosenberg, North American Economist at Merrill Lynch, for those thoughts.
Our four financial Horsemen of the Apocalypse remain somewhat becalmed, their respective horses graze peacefully, not yet alarmed in the way we might have expected but still showing sufficient interest for us to constantly watch them.
The white horse - false peace - The Volatility Index (VIX)
The levels of complacency are extraordinary, to be likened to a pedestrian crossing the road without looking. Look at the chart and you will see that from July this year all of the action has been subdued below the eight-week moving average. We have posted a horizontal line at the level of twelve, a strong move above that level and the eight-week moving average might well have important significance. Not a major signal but maybe a wake-up call.
The red horse war and destruction The Philadelphia House Market Index
The US stock market is reckoning on a soft landing with the worst of the housing market already behind them. Some bottom fishers have recently bought house-building stocks, the outcome a rally. Markets neither travel up nor down in straight lines, what we think we are seeing here, is a period of consolidation before the next leg down.
House builder D R Horton's President and CEO, Don Tomnitz, recently said "I'd say we are in the early stages of a down-turn". Bruce Karatz, CEO of KB Homes, said "The current down-turn is the worse that I have seen."
The black horse famine and unfair trade Dow Theory
The Transports still fail to confirm the Industrial's action although it must be said that the Transports are only 169 points away from such a confirmation. Recently the two averages have been moving up in unison and unless they turn down soon, we could get a positive signal. We are watching carefully like a good fly-half, balanced to move either to our right or the left.
If we get a positive signal from this indicator we will look to buy stock markets in Asia and South America. Of course, what we expect to happen is for both averages to turn down time will tell.
The pale horse sickness and death The Inverted Yield Curve
The Inverted Yield Curve is stubbornly pointing to a recession next year and a much lower stock market. A recession is confirmed after two consecutive quarters of negative growth. As we have said before, by the time a recession becomes a fact, the stock market must already have significantly fallen; in which case it needs to get a move on.
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The horses graze and the world waits. Fairytale endings in real life are rare, so the US goldilocks theme continues to be implausible to us. In the real world you get chewed up and spat out! We try to position portfolios to benefit from such an unpleasant experience.
John Authers, who writes "The Short View" in the FT most days, today 16th November, wrote about a measure created by Aronson + Johnson + Ortiz, Philadelphia Fund Managers. They take the 2,000 largest stocks in the US market, buy the cheapest 10% (as measured by the multiple of price over earnings) and sell short the most expensive 10%. This strategy is highly unlikely to lose money and has only done so when the market is truly out of whack. A fall, they claim, in the AJO strategy indicates a major sell off in the works. In early 2000, prior to the stock market problems, it dropped 53%, the AJO strategy has now fallen for the first time since 2000. What this means, they say, is that the dearest stocks are out-pacing the cheapest stocks, which they contend is unhealthy and suggests a correction may be coming sooner rather than later!
By John Robson & Andrew Selsby at RH Asset Management Limited, as published in the Onassis Newsletter, a fortnightly newsletter that gives insight into the investment markets.
For more from RHAM, visit https://www.rhasset.co.uk/
