Tony's Yarrow Investment View - November 2009

Written by Admin, 10 November 2009

The Cosiness Factor

The last few weeks have been exceptionally busy ones. Our clients have been active, there has been a lot happening in the markets, a lot of research to keep on top of, and much else besides. But now, when many people are saying that the ‘suckers’ rally’ is over, that the real problems about to begin, and when the journalists are busily explaining that the reason why they all failed to foresee the rally was because it shouldn’t have happened in the first place, seems as good a time as any to share a few thoughts.


One day in the late seventies, I was walking down a street near Regents’ Park in London, when it occurred to me how much employment Shakespeare had created in the centuries since his death. Actors, directors, publishers, critics, school teachers, architects, construction companies and many others - he has given work to them all. At the time I was working on a farm in Wales, and the thought had nothing at all to do with anything I was involved in, and after thinking round it in the way you do when you suddenly see something from a new angle, I forgot all about it until a few days ago when, in the shower this time, the thought re-emerged in a different form. This time I thought what a wonderful brand Shakespeare is, if only one could invest in it. Here was someone whose psychological insight was so profound that he can speak to millions of people in different countries and centuries, and whose mastery of language was so extraordinary that he coined dozens of beautiful, memorable phrases that are still in common use today, often by people who don’t know they’re quoting Shakespeare.

You can be as sure as you can be of anything that the Shakespeare brand is durable, as it has survived wars, depressions, the industrial and technological revolutions, and endless changes in the way it is consumed and enjoyed. You could almost say that it is the ideal investment. Warren Buffett’s ideal investment, Coca-Cola, a sweet, fizzy drink of far more recent origin, which is rumoured to be bad for the teeth, doesn’t come close, in my view.

An investment in Shakespeare, if you were able to buy the brand in its entirety, would give you the cosiness factor - the sense that however the QE works out, whether the UK stays in recession for another quarter, or not, or whatever else, the quality and durability of the asset will carry you through.

So, fantasy over. We can’t invest in Shakespeare, but what we are trying to do instead is to get as near as possible. We need to invest in things we can believe in, so that if the market treats them harshly in the short term, we don’t get discouraged and bail out. Our research uncovers these opportunities, and we must periodically revisit them, with our critical faculties alive and focussed.


We are all, of course, in the middle of a hopeless economic mess, in the Western world generally, and in the UK in particular. The banking system is full of problem loans and other toxic assets, and is only being propped up by ever larger injections of taxpayers’ money. The government’s finances are out of control, unemployment is rising, and there is no credible plan. The UK is, at the time of writing, still in recession.

On the other hand, the rest of the world isn’t. The numbers suggest that a robust recovery is under way. Most of the economic growth numbers announced in the last few weeks have been surprisingly strong. World trade is recovering. UK unemployment is just below 2.5 million. At the start of this year the consensus figure for the peak of unemployment was 3.5 million. No one now believes it will get that bad - a number nearer 2.75 million seems more likely.

We are at a time of high uncertainty. All we can say is that the consensus forecast is negative (anaemic growth at best, economy dragged back by over-indebted individuals and the need for savage Government cut-backs) but that at the moment the numbers appear to suggest a more positive outcome. In our true British way, we feel it’s ‘typical’ that everyone else in the developed world but us has come out of recession. Actually, the fact that all the others have returned to growth is positive for us.

The outlook for well-managed UK companies looks good, as we’ve heard from a number of fund managers independently of one another over the last few weeks. For one thing, companies all did the same thing when the economy seized up last winter - they cut all the costs they could as quickly as possible. They won’t be in a hurry to take costs back on, and as turnover picks up (companies ran down stock last winter and haven’t finished restocking yet) the extra turnover goes to profit, rather than being absorbed by cost. The weak pound helps UK exporters, and continuing demand from emerging markets helps too.

The Government’s debt level continues to be a source of concern, and the gilt market had a bad week last week, which pushed the yield ratio (gilt yield compared to stock market yield) to its highest level for over a year. I think it will be another year before we can get a better idea of how bad things really are. There will be no strategic decisions made till after the election next June. By then we will also have a better idea of the shape of the recovery.

Interestingly, the fall in gilt prices has brought them near to being investable again. The yield on the War Loan is 4.6% now. At 5.0%, there would be a case for TB Wise Income to build a stake.


The market was due for a correction, and one started, but petered out, and the upwards momentum has resumed. Interestingly, there has been no rotation. The leaders in the new up-leg are the same as before, miners, emerging markets, banks and other financials. Our funds are underweight in financials and not in miners or emerging markets at all. The rest of this blog will be devoted to explaining why we continue to think that - very much against the consensus view - it is right to continue to avoid these areas.

We understand why mining and emerging markets are such a compelling investment story. The ‘migration of economic power from the West to the East’ is something that has been happening for a while, and now the trend is accelerating. The opportunities for investment must be greater in an economy which is growing at 8-10% a year (China) than one which isn’t growing at all (UK). Also, in a world whose population is growing, while at the same time standards of living are, in the aggregate, continuing to rise, demand for resources is growing, and will continue to grow inexorably - as we have seen with the price of oil, copper and many other commodities. These hard metals are also inflation hedges - far more so than paper money, which is being debased before our eyes by the actions of governments and central banks. It’s a long-term trend, so why on earth not invest in it?


Let’s return to Shakespeare for a moment. In an investment of this quality, with a cosiness factor of 10 (where cosiness equals certainty), and as long-term investors, we can ignore the short-term contortions of the stock market. The stock market movements are caused by the actions of many others (including these days the nano-traders, who are in and out of a share in less time than it takes you to blink). These actions are unpredictable by us. They can distract us from our long-term convictions and cause fear-fear of losing money or of performing less well than if we’d done something else.

I spend a fair amount of time looking at charts, because they give me a sense of what other investors are doing, and hence how they’re thinking. When we own an investment, it’s good to know how far it might fall in a bad market. I think of it in terms of apple trees. Let’s think of two assets. One, for example the Brazilian stock market has been performing well for a long time. Everyone knows why - booming economy, rich in commodities, stable political backdrop. Brazil’s Bovespa index has risen a scintillating 620% from its low point in July 2002. The other asset, by contrast, is British Telecom. This share has been performing badly for a long time, so much so, in fact, that despite nearly doubling from its low point earlier this year, it is still almost 90% lower than it was ten years ago. Everyone knows why - the tech-bust exposed the folly of BT’s reckless expansion programme, and forced it to reduce its debt mountain by selling its best assets, including O2 and Yell. Today’s BT has a huge underfunded pension scheme, a shrinking core fixed-line business, a division which has gone wrong ( Global Services) and has had to cut its dividend.

As a result, the shareholder bases behave differently. BT’s apples are mainly patient holders, who are used to bad news but are going to cling on anyway. Bovespa’s apples are of a more recent vintage, and many of them are there for no other reason than because they’ve been told to expect this index to carry on going up. When the wind blows, a lot of the Bovespa’s apples will tend to fall off, while the BT ones are more tightly fixed. How do we know this? By looking at the charts. Bear in mind that last month’s ‘correction’ was caused by a change in market sentiment, rather than by any news fundamentally affecting either of our two apple trees. BT’s shares dropped slightly, before resuming their slow, steady advance. The Bovespa’s dropped 10% straight down, with no support whatever, over a four-day period. Since then, the index has shot back up. Increasing volatility and acceleration are both signs of a maturing trend, and they’re both evident in bubbles. It’s possible to argue that Brazilian (and Chinese, and Indian) shares are fair value, and the trend has a lot further to run. This just happens to be a risk we don’t want to take. I remember in 1980, when the gold price peaked at $800 an ounce, analysts were saying how cheap it was, and how they’d see a rise to $2,500.

Early in 2000, the Dow Jones average of US shares peaked at 11,700, shortly after the publication of a book by two academics called ‘Dow 36,000’, which argued that there shouldn’t be a risk premium for shares because they weren’t risky any more,(!) and with the risk premium taken out, the fair value was 36,000…I also remember the emerging markets boom of 1993, where shares in those markets trebled in the year. That one ended badly, but of course things are different now because the emerging markets are so much more evolved and better regulated. I am sorry to have laboured this point. Following the theory that if it feels like a bubble, it probably is one, and bearing in mind that we can find more opportunities in other areas than we have the cash to invest in, we will be continuing to sit this one out. But it could get painful, as in the final weeks of the internet boom, when investors were selling the best assets in the market (which we held) to top up their internet holdings. Yesterday (November 9th) was a bit like that. People rotate into the fashionable sectors. Good, cheap assets get even cheaper, and we are buying them, and that’s fine.



In the almost two months since the date of my last blog (September 15th) until yesterday (November 9th) TB Wise Investment rose 1.3%, while the UK stock market rose 2.3%, the Active Managed Sector average rose 1.2%, and TB Wise Income rose 2.6%. Wise Income’s performance has been pleasing, and a little bit surprising, whileWise Investment’s performance has been a bit disappointing, and also surprising. The sell-off affected ‘risk assets’ - a rather ill-defined group of assets including the banks, financials, miners and other sectors which might be expected to benefit from an economic recovery, and to be vulnerable to a double-dip recession. What surprised me was that some of the assets which Wise Investment holds were lumped into this category and sold off. For example, British Empire Securities, an investment trust which invests in assets which are being traded below their real value (such as companies which are valued by the market at less than the value of the cash they hold in the bank, or less than the properties they own less all debt). John Pennick, who manages the trust, felt that markets were getting ahead of themselves in the summer, and had raised about 15% cash and government stock in the fund. A perfect defensive holding, you’d think. But while the UK stock market fell 4.6%, the fund fell 7.6% and Wise Investment was able to top its holding up.

Wise Income had a much better mini-correction, falling only 1.3% while the market fell 4.6%, helped partly by the almost 10% cash holding we’d built up (now reduced back to 5%), partly by the corporate bonds, which didn’t go down, and by the property funds which carried on going up. The mini-correction has helped by offering us some good assets on higher yields than they were before. The other 5% cash will be put to work in the next couple of weeks, and once that’s done, the yield on the fund will be back over 6% again. We know of one potential dividend cut, in Henderson High Income investment trust, otherwise most holdings will hold their payments at current levels, while some have the potential to increase.

For the year to date, to Friday November 6thTB Wise Investment is up 27.5% whileTB Wise Income is up 23.7% on a total return basis, with income reinvested. For comparison, the UK stock market is up 20.5% over the same period, and the IMA Active Managed sector average is up 17.6%. The funds are ranked 11th and 19th respectively, out of 125 funds in their sector.


Many of our clients switched out of commercial property funds in July 2007. In June this year we took what appeared to be a premature decision to switch back into commercial property funds from cash. We were able to action this transfer gradually, unlike the earlier one which took place against the background of a collapsing property market and fund prices being moved against investors transferring out.

It seems clear now that the sector has passed its low point, and it was pleasing to see the following headline in today’s Financial Times. ‘Surge in Commercial Property Values’. It went on ‘ A rapid recovery in property values from the deepest slump on record to near bubble conditions (my emphasis) could see returns in the sector turn positive this year, a leading consultancy has forecast’ Near-bubble conditions? Anaemic recovery? An unusual combination…

Please don’t hesitate to contact me or your usual adviser if you’d like to discuss any aspect of this blog.

With best wishes,


This blog contains the personal views of Tony Yarrow as at November 10th, and does not constitute financial advice.

Tony manages TB Wise Investment and TB Wise Income.