There are so many disturbing aspects to the financial crisis
that it is difficult to focus.
In the finance industry itself, it’s as if whole
organisations are paralysed in a hopeless pessimism. Notwithstanding the
self-fulfilling nature of this gloom, as the rest of the world starts to slide
down the same slope, there are still pockets of light which deserve wider
recognition. The first is that many markets have probably overshot fair value
on the downside by a wide margin.
The credit markets, for instance, have
spreads near 100-year records, according to an interesting study by Deutsche
Bank strategists in
The study – ‘Fundamental Credit Special: 100 Years of Corporate Bond Returns
Revisited’ – is a revision of a report first published in 2005, around the time
of the peak of the
housing bubble. Believers in mean reversion (and shouldn’t that be everyone?)
would have seen that there were tough times ahead for investors.
As one
long/short manager said last month as the Australian ban on nonfinancials shorting
was just lifted, “If you could have shorted
wouldn’t be in this mess.” The latest Deutsche Bank study says: “Three years
later, and in the midst of a once-in-a-lifetime credit crisis, much has
subsequently changed in valuations relative to very long-run averages.”
If all
asset classes revert to the mean over the next 10 years, the worst place to be
will be in US treasuries, where real (after inflation) returns have been
positive for four decades after four decades of negative returns between 1940
and 1980. Following the sell-off of the last two months, US treasuries are now
the best performing asset class over the past 25 years, beating equities,
credit, property and oil. “This really is an amazing statistic in what is
widely seen to have been a golden age for investing in risk assets,” the
Deutsche report says.
While it continued in
for a few more years, the golden age for equities ended in the
1999. This decade (with slightly less than eight years gone) is actually the
worst for US equities real returns in 110 years, with minus 5.1 per cent till
the end of October. The 1930s were actually positive, with a 2.18 per cent real
return. But the 25 years to 1999 were so good, that the
for it to reach its long-term mean. The study concludes: “…the extreme stress
in the cash credit markets, with spreads at around all-time (100 year) wides,
has left the asset class with the most to gain from mean reversion.
Double-digit
annual returns are a realistic possibility over the medium term, even as
defaults pick up…” The second pocket of light is
as bright as it seemed a few months ago, but it is still shining. While the
country needs to grow at around 8 per cent a year to stave off a spike in
unemployment, which it now appears will not be achieved, it is still likely to be
the fastest growing economy by a wide margin.
The other emerging markets too, battered
even harder than the western stock markets, are still expecting positive growth
rates, which makes their stock markets look much more attractive than those in
the west.
importance is much more than as a purchaser of Westernproduced resources; it is
increasingly important for global financial markets. According to Anthony
Fasso, the Asia Pacific chief executive for AXA
and AXA Investment Managers:
“The investment centre of the world is no longer
and it is certainly not
Exchange has US$1.8 trillion, including about $500 billion in Freddie Mac and
Fannie Mae, plus US treasuries, while the sovereign wealth fund China
Investment Corporation has $170 billion (down from $200 billion when launched
last year) and the pension fund National Council of Social Security Fund has
about $70 billion.
Fasso says AXA works with most of the government funds in
‘sovereign wealth fund’ because they tend to be very different. “It is
generally quite difficult to draw direct comparisons between them,” he says.
“The same holds true for the Chinese agencies, whose mission and objectives
tend to be quite diverse.” There are also the state-owned or controlled
entities which include Sinopec, Chinalco, Bank of
These are the companies most interested in making strategic investments
internationally, especially in industries such as energy and resources. But
financial services are not generally seen as strategic. Fasso says: “Chinese
investors tend to view financial services firms as a means of obtaining access
to technology transfer and training. Some acquisitions or strategic stakes in
financial services firms have been more in the nature of a ‘trophy’ prize than
representing a strategic interest.”
Unfortunately, Fasso does not believe that
is going to get more than its fair share of Chinese investment, particularly in
the financial services arena. “As for recent announcements by the Australian
and Chinese authorities on allowing Chinese investors to invest in Australian
securities or funds, I have a stark message: do not expect much.
is only a small component of the MSCI and there are more wellestablished mechanisms
to invest in global and regional securities than via an Australia-domiciled
fund.”
A final pocket of light is that Australian super funds are at least
saying the right thing: their liabilities are generally very long term,
notwithstanding short-term problems due to switching and currency hedges, and
this is a great buying opportunity. They will be investing again soon, really.
