Tony Yarrow's Investment View - July 2009

Written by Admin, 07 July 2009

Torpor Descending

It looks as if we are at one of those opportunity points where good assets can be bought very cheaply, if one is a patient investor who is prepared to take a few bumps along the way. This blog will attempt to explain why.

Our conclusion comes partly from studying price charts, which show the aggregate of investors’ buying and selling behaviour. The charts tell us what investors think is going to happen, which is sometimes very different from what the commentators, whose views we read in the papers, think is going to happen.  What the charts are telling us at the moment is quite intriguing, we believe.

Already the stock market is on its third big move of the year. The first one was a sell-off, concentrated in the areas that investors were most worried about, banks, insurance companies, property developers, and the like. Then there was a big rally, lasting almost exactly two months, in which the UK stock market rose around a thousand points, or 28.5%. This rally ended on May 8th. There followed a period of trading sideways, and more recently, downwards.

Markets rarely change direction. Shares will normally move in the same overall direction for a couple of years, or longer, and property markets change direction even less frequently. It looks as if the low point the stock market reached in early March was a major turning point, with a major turning point imminent in commercial property, after the collapse of the last couple of years.

Although they don’t change direction often, stock markets don’t move upwards or downwards in a straight line. The upwards trend is marked by high and low points, with each significant high point being higher than the previous high, and each significant low point being higher than the previous low point. Rising highs and lows in an up-market, and falling highs and lows in a down-market. So, which one are we in? The low point so far was 3512 on the UK stock market, on March 3rd. The best proof that the market is now in an uptrend would be a significant low point, significantly higher than 3512, indicating that a new uptrend has begun. That hasn’t happened yet, and of course it may not do so, but meanwhile there are quite a few reasons to think that it will.


Generally, markets tend to move faster when they are going in the ‘primary’ direction. When the primary direction of a market is upwards, the upward moves happen quickly, while the downward moves are slow and protracted, just as we’ve seen in the last few months. After rising 27% in two months, the stock market has fallen 6% in the last two months, indicating that investors are more reluctant to sell, and that the primary direction is probably up.

This pattern is seen not just in the UK, but in almost all world stock markets. In Brazil the Bovespa index rose 42% between March 2nd and May 8th. Since then it has fallen 1%. In Japan the Nikkei 225 index rose 30% between March 3rd and May 8th, and has risen a further 3% since then.

During the March-May rally, the shares of smaller companies performed better than big ones. Smaller companies are generally seen to be riskier than big ones, so it seemed likely that when the rally ended, the market would fall back, and smaller companies would suffer correspondingly. In fact, the opposite has happened. The UK stock market Small-Cap has risen around 1.6% during a period in which UK stock market has fallen by a similar amount. Both of TB Wise Income’s UK smaller company funds, and all ten of TB Wise Investment’s, have done better than the overall market during this period.


Along with the generally firmer tone, investors don’t seem to be able to get enough of certain things, in particular Japanese shares, technology shares and smaller company shares in all markets. Where two of these themes combine, their appetite is even greater. AXA Framlington Japanese Smaller Companies, which Wise Investment holds, is up 21% since two months ago, while Herald Trust (small technology companies), also in Wise Investment, is up 9.5% over the same period. This isn’t typical bear-market behaviour.

There are other positives, too. The gilt (government stock) market has picked up over the last month. The move isn’t conclusive, and the gilt market is somewhat distorted at the moment because of government buying through the QE programme, but usually moves in the gilt market precede moves in the same direction in the stock market. Also, the ratio of directors buying shares in their own companies to those selling remains strongly positive, as it has been for almost a year. The ratio remains stuck at around five purchase transactions to every sell. When directors begin to think that the shares in the companies they manage are no longer cheap, they will stop buying them, and we must sit up and take notice.

The Dividend yield ratio revisited

The dividend yield ratio expresses the relationship between the income produced by an investment in gilts, and the yield that could be obtained from investing the same sum in a basket of UK shares. When the number is 1, the two asset classes pay exactly the same yield. At 0.5, shares pay twice as much as gilts. At 2.0, gilts pay twice as much as shares. Today, after reaching a low of 0.67 in March, the number is 0.95, which means that shares pay slightly more than gilts, in the aggregate.

So, what does that mean and is it important? The yield ratio number has been above 1.0 for almost the whole of the last sixty years, until last October. In the mid-to late 90’s, the ratio was between 2.0 and 2.2 consistently for several years. This was explained by the fact that companies increase their dividends over time, while gilt yields are always fixed, so investors were prepared to accept a much lower starting yield from shares. During the late 90s, shares were very over-valued, though a surprisingly large number of people didn’t notice that this was so at the time. Today, many dividends have been cut. A yield ratio of 0.95 tells us that investors think that in the medium term, fixed gilt yields are a marginally better bet than potentially rising (or falling) dividend yields. Companies cut dividends as a last resort, and it is normal to cut dividends to a level the directors believe can be sustained in a more hostile environment. We may not be at the end of the dividend-cutting cycle, but we should be a fair way through it.

For the longer term, we believe that a reasonable trading range for the dividend yield ratio would be 1.25-1.75. Investors should pay a premium for the tendency of dividends to rise, though the premium paid in the 90’s, with the benefit of hindsight, was excessive. Assuming gilt prices stay unchanged, the UK stock market would have to return to 6600 for the yield ratio to be in the middle of our ‘reasonable’ range. The yield ratio number looks too low. It would go up if share prices rose. It would also go up if gilt prices fell, or if companies continued to cut their dividends.


Selectively, shares continue to be our favourite asset class. The good ones look very cheap at current prices. If summer torpor is descending, and markets fall any further, there will be an opportunity to buy good companies and good income streams at the best prices Mr. Market may be going to offer you for a long time to come.

Commercial Property

We are in the process of writing a letter to our clients suggesting that the time to go back into commercial property funds may have come. The letter is going to all Chipping Norton clients who switched out of property on our advice two years ago. We expect to send it out on July 8th or 9th. The letter can also be found on the Wise Investment website, if you are interested. Your adviser will be happy to discuss the pros and cons of commercial property with you.

Looking Ahead

The recession in which we find ourselves is unlike anything that anyone of working age has experienced. We don’t know how it’s going to play out, so it’s important to keep our eyes and ears open, and pick up whatever clues we can.

We are still living in a capitalist world. Recent events have uncovered major flaws in the system, but there isn’t another viable one to hand.

The main distortion is the trade imbalance between the consuming countries in the West, and the producing countries in the East and South. This distortion still exists.

The banks went bust because they lent too much money into a worldwide property bubble, which is in the process of unwinding. They got involved in sub-prime because they needed higher-yield products in a low-yield environment. Regulators still need to work out how to treat the banks. Governments can’t afford another round of bail-outs, so independent banks which are ‘too big to fail’ can’t be allowed to continue. There is a huge ‘moral hazard’ involved in the ‘too big to fail’ culture, which encourages banks to take as much risk as possible. If it comes off, they make a fortune. If it fails, they get rescued. A simple, effective plan is needed to prevent 2007-8 from recurring. We have yet to see it.

It’s possible to surmise what the rescued banks’ plan is. There is little evidence that they have used the taxpayers’ money for the intended purpose of lending to individuals and businesses. They appear to be trying to maximise the profit on every transaction they enter into, including renegotiating existing ones, with the aim, presumably, of repaying the government as soon as possible, building up the extra capital that they will be required to hold in the new more regulated world, and then carrying on more or less as before. The much-publicised £10m salary package offered to Stephen Hester, the new Chief Executive of the Royal Bank of Scotland, suggests that the bankers’ world view hasn’t changed a lot over the last couple of years. My guess is that they have alienated their customers more than they realise and will find the next few years challenging. While the banks are desperate to escape from the Government’s clutches, individuals and small businesses are equally desperate to escape the banks’ clutches. Once free, they will be reluctant to come back, and I suspect that the structure of the banking industry will look different in ten years’ time, full of new entrants not carrying the baggage of 07-08.

The level of government borrowing is a matter of continuing concern. The UK government’s fool-all-of-the-people-all-of-the-time promise to go on raising spending shows how little they, too have learned.


Despite these challenges at the macro level, it is clear that good businesses can survive and prosper in this environment. Consumer demand hasn’t stopped, but it is changing rapidly. Many companies are better suited to the new environment than the old one. Others are changing fast. This is a time of opportunity as well as challenges. The market doesn’t price in any future rises in profits or dividends, and in this respect it may be surprised.

Also, we expect interest rates to stay low for a long time. No one wants to take the blame for pushing a weakly recovering economy back into recession by raising interest rates too soon, so having cut interest rates far too late last year, the Bank of England is likely to repeat the policy error, and raise them too late as well. Interest rates could stay at or below 1% for a couple of years. It’s easy to overlook the reviving effect that interest rates this low have on economic activity. Over the next couple of years, cash is likely to find its way out of deposit accounts, and into the stock, fixed interest and property markets.

We expect to see higher rates of inflation than for the past couple of decades, though it is impossible to say how much or when. Higher inflation may seem to be a strange thing to be predicting in the middle of a serious recession. However, when you come to think about it, the two most significant facts about the world economy are these. First, the human population of the world is steadily rising, and in the aggregate, though certainly not true in places like Zimbabwe and Somalia, material standards of living are rising too. The pressure on resources can only grow, and their prices will rise, which is inflationary. Second, there is a recession, with higher unemployment, capacity under-utilisation, and a property slump. This is deflationary. The second of these factors, though of major significance, is temporary-recessions are - while the first one is permanent. So, it seems likely that inflation will re-assert itself in due course. Also, a bit of inflation would help to erode the real value of governments’ huge debts, so perhaps they will be a bit less vigilant than has been the case since the 70’s.


The figures quoted below are as at July 2nd.


For the year to date TB Wise Investment is up 12.3%, while the stock market (UK stock market) is down 1.9%. The fund is 8th in the Active Managed sector over this period, out of 126 funds. In the month since June 1st, TB Wise Investment is up 1.9%, while UK stock market is down 5.6%. TB Wise is 5th in its sector over this period, out of 130 funds.

The better performance this year has begun to erode the major losses made earlier, but there is a long way to go. Anyone who invested in the fund between the beginning of July ’05 and the middle of October ’08 has lost money, a situation we are very keen to put right.


For the year to date TB Wise Income is up 3.42%, making it 52nd in the Active Managed sector, out of 126 funds. Since June 1st, the fund is up 1.0%, compared to a 5.6% fall in the UK stock market. Over this period the fund is 8th in its sector, out of 130 funds.

TB Wise Income pays a 7.0% yield. To the best of our knowledge, this yield is genuine, and sustainable. The valuation of dividend-paying assets is still extremely depressed, though some have begun to recover. We added to our holding of the Standard Life Property Income trust earlier this year at 28p. At today’s price of 48.5p, the new holding has made a gain of 73%, but the fund is still yielding 10.0%, despite having cut its dividend to a level the board believes is sustainable, and more than covered by rental income. Our property funds have begun to catch the whiff of recovery, but many other holdings are still at fire-sale valuations. One or two holdings, which have gone wrong, are unlikely ever to recover their pre-crash levels, but we have added to others which we believe could double in value and still be cheap. In the end, it’s nicer to be paid 7.0% than almost nothing in a deposit account, and we expect investors to re-discover some of their appetite for income-paying assets over the next couple of years. As managers, we will do all we can to protect the income, and eventually enhance it, and hope that the capital values will follow.

We are most grateful to investors in our funds for your continued support during this most difficult time.

If you have any comments or questions arising from this blog, please call or e-mail me at

This blog contains the personal views of Tony Yarrow as at 7th July, and does not constitute financial advice.

Tony manages TB Wise Investment and TB Wise Income.