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Rushbrook and Fisher are at odds - again

Saturday 30 June 2007 12:19AM

A good place to start is with the latest Annual Report from Personal Assets, the idiosyncratic (and often misunderstood) investment trust managed in Edinburgh by my old friend Ian Rushbrook. Every year for what seems like forever Ian has been warning us of the perils of being too bullish and the folly of ignoring the malign effects of excessive cheap credit.

After four years of  bull market, however long in the tooth, one has to say that this has not turned out to be a good call. True, Personal Assets is explicitly marketed as a vehicle for private investors who are interested in capital preservation, and the trust has continued to churn out modest positive returns for the last few years. But there is no question that the board's ultra-conservative strategy towards equities has cost it money and caused the trust to lag its preferred performance benchmark, the FT All-Share index over rolling three-year periods.

If you didn't know better you might call Personal Assets a hedge fund, since it is heavily focused on absolute returns, albeit one that rarely uses conventional leverage. Ian and his colleagues all have substantial holdings of their own money in the trust, which is clearly a positive, but underlines the fact that investors should always take note of the manager's age and personal attitude to risk before committing money to a fund of this kind.

Here is an extract from Ian's comments in this year's Annual Report. The full version can be in the Market Comment section of this site. You will quickly recognise some familiar themes. When the credit bubble unwinds, Ian will no doubt once again be regarded as a prophet in his own land, as he was in his youth. For the moment he remains the voice of experience against which one's own bullish tendencies can always be reliably measured.

"The second question — ‘What might be the catalyst for a substantial fall in financial markets?’ — is impossible to answer. If the world is fortunate, the catalyst may turn out to be, as ‘chaos theory’ suggests, a butterfly fluttering its wings in Peking. On the other hand, it could be as extreme as Israel’s being driven to eliminate Iran’s nuclear weapon capability. We will know only after the event".

"However, the more that liquidity expands, the higher the risks increase for investors. Inflation, too, worries us more and more. Global inflationary pressures keep rising, leaving economies vulnerable to any unforeseen (and unforeseeable) market crises. In the US, core inflation at 2.4% has been well in excess of the Fed’s ‘comfort’ range of 1% to 2% for some considerable time".

"In the UK, the RPI has risen from 2% to 4.5% since January 2000 and the CPI from 0.8% to 2.8%. Never mind that inflation is still in single digits and seems low compared to the double-digit levels we all remember — what is important is the direction and pace of change. These increases are serious".

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For a different, and more positive view of what lies ahead, you should look to the latest quarterly market commentary from Ken Fisher. If Rushbrook has been on what seems like permanent bear market watch, then Ken is at the other extreme. I cannot remember a time since 2002 when he has not been fundamentally bullish; and of course his market outlook has tended to be vindicated over those five years.

What I have always liked about Ken's approach to the markets is that it is always (a) richly supported by factual evidence and data; and (b) uncompromising in his views. He is the kind of market commentator who regularly crosses the road to pick a fight, quite often crossing swords with another veteran scrapper in the public prints, the amazingly vigorous Jeremy Grantham (star of the last Independent Investor conference).

Of course, having trenchant views about the outlook for markets does not guarantee that you will be right, but it certainly helps to inspire confidence. Ken's comments invariably focus on the year ahead, which guarantees that they will be topical, if nothing else. He is a firm believer in using the value of the ratio between bond yields and earning yields as a basis for forecasting the market; and spends his time (as he tells us in his new book The Only Three Questions That Matter) on putting widely held market beliefs to empirical tests.

In his latest market forecast. Ken reiterates his view that what we are seeing this summer is a market correction, not the start of a bear market. In his experience, he says, bull markets rarely end with a bang: instead they gradually deflate. Sudden market downturns, in his view, are therefore very unlikely to be the start of a bear market, a trend that is well supported by historical evidence.

Between October 1990 and March 2000, Fisher points out, the FSTE All-Share and MSCI World index suffered declines of more than 2% 30 and 37 times respectively. Yet in none of these cases did the reverse have any significance in terms of subsequent market performance. What bear markets need to flourish, he argues, are euphoric sentiment and negative fundamentals that are being largely ignored by the market. Neither condition, he argues, applies at the moment.

With earnings yields at least 2% above 10-year bond yields, the outlook for equities still remains positive. Despite the worries about the fallout from the sub-prime mortgage market in the United States, which has effectively holed two Bear Stearn hedge funds below the high watermark, corporate bond spreads in the wider market have until recently remained very low by hisotirc standards. This is hardly a sign of forthcoming market trouble (although it is fair to say that they have risen quite sharply since Fisher's comments were drafted).

At the same time, according to Guy Monson, the CIO of Sarasin Chiswell, a number of technical indicators also suggest that equities (or more specifically, large cap stocks) are attractively valued. For example, the ratio between the dividend yield for large cap equities in the UK and short term interest rates is still at very low levels, a traditionally bullish sign. 
 
Meanwhile the ratio between global government bond yields and large cap global equities is at a level that has not favoured equities as much as it does today since the mid-1970s. Yes, corporate profitability is at a peak and may well start to decline, but the extraordinarily low relative valuations placed on large cap equities still makes them look good value even after allowing for that factor. Both Guy Monson's chart and Ken Fisher's market outlook are posted in the Market Comment section.
  
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This positive feeling, for what it is worth, is also my view, although I am not unaware of the risks to this apparently rosy view of the world. In the Sunday Times today, for example, the veteran investor Jim Slater is quoted as saying that he is nervous about the current state of the markets. He sees a risk of a big private equity deal going wrong and causing collateral damage. 

For those who want to explore a more negative view further, I can recommend the latest market commentary from the iconoclasts at Bedlam Asset Management, who argue persuasively that four growth markets in particular - buy to let, hedge funds, share buybacks and private equity - are all vulnerable to rising interest rates.That this is so is undeniable. This item too is posted in the Market Comment area.

That means, in my view, that those who take a gloomier view will surely be right at some point quite soon. But has that time yet come? My instinct still says no. The summer weakness in stock markets is more likely to be a buying opportunity than an opportunity to cut and run after four years of a robust bull market that nobody in the markets, to my knowledge, expected to run as long or as strongly as this one has done.  Next year however is another matter.
 
 

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