Anthony Bolton shares his views on the current state of the market with Jonathan Davis

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Where do you think we are in the market cycle – is the bear market over?

My view until the last few days has been that we were getting there, but I still felt that the bear market needed longer in terms of the extent of the fall and perhaps a little bit longer in time before it was over. I wonder though whether the most recent events (including the collapse of Lehman Brothers, the rescue of the insurance giant AIG and the proposed takeover of HBOS by Lloyds TSB) and the stock market reaction to them haven’t speeded up the end of the bear market somewhat. I am more prepared to think that we might be closer to the end than I had been thinking before.

The bear market started in financials. It then went on to consumer discretionary stocks, then in late spring to industrials and then the final thing to crack were the commodity stocks. I felt very strongly that the bear market would not be over until the commodities had joined in. I would like to see that trend go on for a bit longer before finally calling the bear market over.

The other thing that is still too optimistic are earnings estimates.  The bull market that we went through was slightly different from the one before (the TMT bull market in 1999-2000). That one was very much about valuations. The bull market we went through before the current bear market was less about stocks being revalued to absurd levels, and much more about earnings being well above their historic trend. I think still earnings expectations need to come down a bit more before the bear market is finally over.

Where I’ve been controversial is in the sectors I felt were going to lead the recovery. I thought it would be the financials and the consumer cyclicals.  Obviously there has been little sign that the financials are turning round, particularly after the last few days! I would still be surprised if they didn’t, to some extent, lead the upturn.  Some people think that it will be the commodities that again lead the next upturn.  I’m less sure about that.

The other thing that I’ve been more cautious about in the short term than others is emerging markets.  I have to be careful here, because the only emerging market that I know at all closely is China. On the other hand I think that some of my observations are common to them all.  I feel that investors have been far too sanguine about the fact that emerging markets are somehow safer than Western markets and that they won’t be affected in this bear market.  I think we can now see that this argument is wrong, but because a bit like commodities they have cracked later in the cycle, they’re going to have to have longer to go.  Maybe the first half of next year will be the time to get back into emerging markets.

On China specifically, I really want to see the figures that come out on the economy after the Olympics. I think that people will continue to be surprised by how quickly it’s slowing. I haven’t been there since April, but the exporting sector companies were definitely slowing then and you were just seeing it only at the top of the market, for example in expensive cars.  What you’re seeing now is evidence of a broader slowdown. There was a down year-on-year month for the whole car market in August, for example.  Again you’ve got to be careful because of the complicating factor of the Olympics, which is why I’d like to see a few months of post Olympics data before making that a definitive view.

In general terms, clearly, you’re not a member of the cataclysmic school of investors, who say we are in for a rerun of the 1970s or 1930s?

No, I’m not. I suppose there are two elements to the cataclysmic school. There are some who argue that until the debt bubble has completely unwound, the economy won’t recover in the States and therefore the stock market can’t recover either.  I agree that it may take several goes. You cannot kill the debt bubble in one quick cycle.  In the UK, I’m sure we’ll have a consumer recession, but I don’t think it’s going to be as bad as the early 1990s, for example, because the interest rate swing hasn’t been as hard and unemployment is much better than it was back then.

Sure, the housing cycle is bad, and a lot of Americans look at the UK and say that it’s worse here than it is the US.  I’m not sure about that.  I think there was much more mis-selling of mortgages in the States, and the fact that more of the mortgage sticks to the individual in the UK than in the States will make the downturn in housing shallower, though maybe more prolonged.  In the US, there’s a much stronger argument that things should fall very quickly.

The other argument for expecting a mega bear market is the financial contagion from the credit crunch, and that, I must say, is obviously a very powerful factor. The events of the last few days make one really worried about that.  It is okay to let a Lehman Brothers fail, but I don’t think you can let a Citibank or an AIG fail. Over here, with HBOS (owner of the Halifax), I said that if the speculation on the share price started to affect public confidence in the bank, I would be very surprised if the authorities would sit by and let that happen. That turned out to be right.

You watch investor sentiment very closely; and that does seem to be getting encouragingly worse, in the sense that it is a contrarian indicator?  

Yes. It’s getting there.  I felt the Bear Stearns low in March and the Fannie Mae low in July weren’t quite there on sentiment, but I do think now we’re getting the sort of things occurring that could mark the final low. Many investors are in a state of shock and there is a good deal of fear around.

Does it make you want to be managing money again?

The honest answer is “no, not really”.  Some people have said to me “Anthony, you were very clever to get out when you did,” and “You’ve timed that it all very successfully.”  The truth is, as you will remember, that handing over was a long process and I didn’t have in mind that the end was going to be exactly when it is.  In fact, a little bit of me wishes that maybe I could have gone on for one year, so I could have had the challenge of running my fund in what’s been an incredibly difficult environment this year.  

On the other hand, I’m pleased not to have all the reading and voicemails and all that stuff, which has definitely changed my lifestyle for the better. I still do a few company meetings and the only time I’ve been frustrated not to be running money any more is coming out of a company meeting and thinking it’s a screaming buy and I haven’t got a fund to go and buy the shares for. And yes, before you ask, there have been a few stocks that I have liked even in this environment!

Assuming you are right and we do eventually move into a new bull market, do you have a specific view on what will lead the way out of the bear market?

It’s difficult to be sure, but I still feel that sectors which have become totally unloved, such as pharmaceuticals, are going to do well in the next bull market, precisely because it’s been so out of favour for a while.

What are your thoughts on currencies?

I have always found currencies the most difficult thing to get right.  But on the technical analysis I look at, it looks as if the dollar has bottomed out. We will need quite a bit of consolidation before it starts to rise again. Probably the worst is over for the dollar and within six months or so, it might start to go up again.

How do these compare to the other bad times you’ve been through, such as the 1990/91 recession?

There are some bargains about. A lot of the consumer cyclical stocks, some of the retailers, the media companies and so on, are cheaper now than they were at the low in the early 1990s. One really important similarity is the need to avoid buying poorly financed shares.  You’ve got to buy the shares with the strongest balance sheets at times like this.

Because there will be bankruptcies and company failures?

Yes. We can all see that banks are contracting credit, so there’s going to be less credit to go around. In that environment, the weaker are going to be squeezed.  Ideally you want companies that are well financed and don’t have loans that come up in the next couple of years or so. If there is anything still that can show growth in this environment, it is likely to be given more and more of a premium valuation.

How do you expect the fund management business to come out of this cycle - hedge funds, private equity and alternative assets in particular?

What we see here is a general switch to quality. With unit trusts and OEICs, this is an environment in which it helps to be big, global and have a name and franchise that people trust. I think it’s going to be a lot tougher on the smaller and specialist houses.  

With hedge funds, one of the things that has happened in the last few years is that the big UK investment consultants have discovered alternative assets in a big way. Pension funds and insurance companies have been persuaded to put quite a bit of money into hedge funds  and other alternative assets, particularly in the last two or three years.  

I think they will be disappointed with the returns.  It is what happens every time you see too much money going into an area. A lot of the good hedge funds are closed to new investors, so money’s had to go with the less good talent.  I think that outperformance is going to be more difficult to produce. Everything that’s happened to the prime brokers means that there’s also going to be less leverage around.  In the long-term, it will come back, but cyclically too much money has been chasing this area.

How do you see the outlook for interest rates and inflation?

I would have thought interest rates would come down next year once the inflationary bubble starts to unwind. I have always felt that inflation wasn’t the big problem. It was very much imported inflation and wouldn’t necessarily get into the system because it’s come too late.  With the economy turning down, I don’t think companies will grant lots of big wage increases, so I think it will pass, and come next summer, we’ll look back and see that this summer marked the peak in inflationary pressures. That is another reason that makes me feel the consumer won’t be in such bad shape in a year’s time.





Jonathan Davis
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