MILTON NEWS
Spring 2008 Issue
Dear Client
You will not need me to tell you that the last several months have been very challenging for worldwide markets. Despite anticipating some of the problems we have seen, certainly we have not been unscathed by the volatility which has gripped conditions, resulting in declines in values for investors everywhere.
It is not a pleasant time for investors or for ourselves as advisers and managers, when apparently rational previous decisions can appear foolish because of a fall in value afterwards, in the face of deteriorating overall sentiment.
Likewise, whilst it can seem easy imagining the lifeboats we might have acquired sometime ago in the face of the impending storm, that is not helpful when now we must steer our ship through present troubles and concentrate our efforts upon that course. When we arrive at a safe port we might well decide to acquire more lifeboats then but potentially, they may be far too expensive and to over-burden ourselves with too many of them when everyone else is panic buying them is unlikely to be the best thing to do after the storm has abated.
In no way do I want to be glib about any investor who has seen a fall in the value of their capital, wherever it is held and conversely, we cannot change what has already happened but must try to react appropriately in the face of new information and circumstances. Within this newsletter, we have endeavoured to interpret conditions as we see them, as well as potentially empowering you to assess if there is anything that you can do to mitigate the impact upon you personally.
Please be reassured that we are reviewing matters constantly and adjusting our investment priorities to reflect conditions as we see them. We must not be like a rabbit in the headlights nor throw caution to the wind. That has never been our strategy in the face of previous adverse market conditions which we have weathered. Potentially, the duty we are now trying to discharge could be one of the most important we pursue for each of our clients and we believe it is imperative that we continue to fulfil that responsibility in as positive a way as we possibly can. It is not vain hope which reassures us that our experience and qualifications suggest we shall be able to ride this horrible storm for every single client. As difficult as it may seem, please entrust time to us to monitor and respond to the current conditions for you as we see wisest. The best investment anyone is likely to be able to make at present is time. I encourage you to persevere.
I hope you find the comments helpful; we do not like it when any of our investments fall in value and in some respects, the conditions demonstrated by the markets are as bad as those in the trough of 2002/3 in many instances. It is not a time to panic, in our view. I recommend that you take time to read the investment comments within.
Yours sincerely
PHILIP J MILTON DipFS CFP FCIB FPFS
Chartered Financial Planner
Fellow of The Personal Finance Society
Investment Market and Economic Assessment - What can you do?
From being remarkably enthusiastic in the face of growing perils, the sub-prime crisis in the States has given pessimists reason to savage most share prices. Euphoria has been replaced by an irrational fear and a minor down-grade in a company’s prospects becomes reason for its shares to be slashed.
What can you do? Whilst we have no special view of the future, for reasons I shall deal with later, in our view it is certainly not time to panic with your investments. We cannot alter the past. Selling investments which have fallen is unlikely to be very sensible, for many reasons. Consequently, if you are planning a capital project and might need access to capital, if you can defer the liquidation it could prove to be very sensible indeed. Naturally, not everything has fallen so this is a generalism but it is imprudent selling into a market which does not want to take your stock and where market-makers have widened spreads between buying and selling prices against you. For the courageous (or perhaps just the wise) it is time to consider spare cash reserves and see if there is scope to subscribe funds to very depressed stocks (even if they may become cheaper still) because best opportunities are available when pessimism is at its highest.
If you are taking regular income from your investments but do not “need” it or have accumulated a surplus of cash to carry you a while, perhaps you can allow the income to be reinvested by your manager to buy some of those depressed holdings, to help your account recover its value more quickly. You might do this for only a temporary time but it could have a significant impact upon the recovery potential of your investment.
In some respects, the best thing which investors can do is not to worry in the short-term. Checking prices and values every day does not help and emotionally, putting your investments in a bottom drawer and forgetting about them for a while might be the best thing rather than try to force the wrong decision at the wrong time because of depression from what seems incessant bad news. Indeed, psychologists have shown that human beings are not hard-wired to make decent long-term decisions. Instant gratification beats long-term self interest though there is much evidence that disciplined contrarianism beats short-termist trend-hopping. After all, as J M Keynes noted, “the investment winner is not the judge who votes for the most beautiful woman in the pageant but the one anticipating correctly the choice of all the other judges”. Of course, in the long run real value prevails because if the stock market and investors do not see it, a competitor will make a bid for the whole company because it knows it can make a trading profit from the underlying business.
You could also establish a regular monthly investment into your holdings, acquiring more value at these lower prices. It is a good way of drip-feeding surplus income into your investments.
I am not trying to depress you about current conditions but unless markets stabilise shortly, investors will find their next half-yearly reports make disappointing reading. For our clients, they are assured that we are doing our best during these very difficult times and we need to rely upon all the experience we have gleaned over the last twenty-two years of investment management to try to rationalise our views on conditions. It is never easy and now even harder.
We do not enjoy noting to clients that their holdings will be lower than previously although unfortunately, we cannot carry the risk responsibility for them either. We do not like referring to earlier warnings of market-linked investments falling as well as rising and indeed that sometimes individual components can become valueless but we must keep our perspective throughout. We shall always try our absolute best but we cannot produce miracles against conditions as bad (or worse) than the most difficult conditions that have ever existed sometimes. Extreme conditions cannot be a big stick to mar the need for rational decisions in the face of the pain we all endure.
If we exclude mining and oil stocks from the FTSE 100, the index would have fallen by something nearer to 25%. Since 1 January, to date of writing the index has had its poorest opening since the index was created in 1983, with more stocks dropping by 20% since then as fell by that in the whole of 2007.
In fact, investors need to assess things from a perspective of rationality because it is very easy to begin to believe that these past awful months project a trend but they do not. Some analogies may be helpful here. The first reminds us that businesses represent assets and profit-making from ordinary, day-to-day trades. So, if we understand that, let us say that a particular share at £1 represents simple “cash in the bank”, let us say a Pound coin. Sometimes investors can get carried away and pay £2 or even much more. What we now have is a situation in our view where investors are selling Pound coins for 50p. They may feel relieved after the selling deal is done, especially as the lunatics in the asylum might still sell these Pounds for even less but in the end, they will revert to £1. Indeed, meantime investors continue to receive ‘interest’ on their investment by dividends from it. What is wise?
I am reminded of the Property traumas in the early 1990s. People were selling houses at the bottom of the market as a way of coping emotionally with the pain of prices which had fallen. Whether this was negative equity or, I recall one client, who was concerned that their legacy to the grandchildren would evaporate! Was this wise? When the value of houses was so low that it paid to borrow money to buy them to rent them out (a ‘business profit’), was the decision to sell rational? Since then the average house has almost trebled (and is now too high) and rents have continued to rise regularly.
The dreadful flooding in parts of our Country reminds me of another analogy to the markets recent performance and agriculture.
When floods strike, financial distress takes hold as existing crops are jeopardised. Prudent farmers are the ones who recognise the costly but extremely “freakish” nature of what has occurred and wait for the rain and water levels to subside, even purchasing neighbouring land at discounted prices. Farmland will once again yield healthy crops for market (initially in potentially greater quantity as a result of the extra moisture and nutrients that the flood waters deposit) when conditions return to normal. Shortages of supply will push profits higher too, in the short term. Stock market investments will do likewise.
Farmers who panic and sell their farmland during, or at the start of the flood, will receive very depressed valuations as a result of the initial uncertainty. Who wants to buy? The waters could rise further. In hindsight, this, as it does now, represents the worst possible time to sell, particularly where monies are not required or can be accessed from other sources. If you think that the whole world will be flooded then no assets will have value and governments will have gone bust, in the theme of the blockbuster film “Water World” (an extravaganza which lost buckets full of money apparently).
Of course, some farmland is more prone to flooding than others and the differing risk profile can also be applied to investments and this is not always obvious till afterwards. For absolute security, one should deviate no further than ordinary deposit accounts which can be likened to farmland at the top of a mountain. During times of flooding, you should be unaffected but equally, in “normal” conditions, the land is much less productive due to climatic conditions and fertility. At the other extreme, those farmers with land exclusively in the valleys (who ordinarily have an excellent harvest with profits to match) will lose their entire crop and may be completely ruined by the flood (forced to sell sodden land at depressed levels). The key is to strike a balance and spread risk, both in farming and investing.
Unfortunately, like many others, we have suffered some ruined “crops” as a result of the flood and some investors may enquire why we too had acquired land in the valleys in the first place. The reason for this is that overall, this is the most productive area and where the best results are achieved. This will continue to apply in the future too.
Nevertheless, our philosophy of employing diversification throughout all of our discretionary managed strategies by acquiring “attractive land in favourable locations and at differing heights”, both as a risk mitigator but also as an opportunity-seeking vehicle, has and should continue to yield generous results into a future of more normal conditions.
We have tried to think of a particular analogy to help investors understand how, as investment managers and financial advisers, we perceive market conditions are (and have been for some time). This is not to be patronising but the following might help. Let us say that somebody goes to his doctor with a leg complaint. The doctor provides qualified and experienced advice on the necessary treatment. However, the condition deteriorates and the patient begins to panic. Despite absolute reassurances from the professional that the worst thing that can happen is the loss of the leg (an eventuality that had not changed from inception) and that the patient’s death would not arise, the patient goes away and begins to panic and demands instant amputation. The professional tries to encourage patience for the treatment and possibly revisions to that treatment to take place because there is, in his mind, little extra to lose because the total loss is limited to the leg. Despite this, the patient becomes even more worried and arranges a private operation and secures an amputation with resultant permanent disability.
There is now no scope whatsoever for potential repair of the leg and return to full health and despite the many years where the patient may have had high regard for all of the skills of the doctor (as demonstrated through many other personal treatments and good experience over that time) the relationship and trust have been destroyed. The patient feels that the doctor did not understand the importance of the issue for him yet the doctor’s own best interests were only in looking after his patient and from an impartial and qualified perspective. If the doctor had given in to the constant pressure from the patient for the leg to be removed, that would not have been the best or right thing to do despite the growing adversity the Doctor faced. That said, the doctor has no magic wand but has capacity to take a divorced view of the issue, something which the patient, at that time, was unable to rationalise because of pain or fear. The doctor would have taken all of that into account when making the assessment and reminding the patient that in the meantime he would still be able to walk.
I do have absolute sympathy with every investor. I hope it goes without saying that had we felt conditions would have been as bad as they have been in some instances then we would have taken more action to avoid this experience. Whilst it is of no consolation to clients, market influences not only affect my own investments in the same way but the Company’s revenues are affected adversely and morale becomes low in the face of such awful conditions. I do feel an onerous burden of responsibility - not only for what has gone before but perhaps even more importantly now, what action must we take at this stage both in relation to existing investments and also new capital and any investment changes and income reinvested. This latter action is possibly the most important of all in that if it means buying into seriously depressed conditions then we are acquiring some tremendous bargains for the time when normality returns.
For any client, we can only offer our best. We have sophisticated structures and systems in place to help us achieve our objectives for our clients and in the face of the market carnage, these have responded acceptably although as with all investors, we have not been insulated by the severity and volatility of the conditions.
Within this update, I am repeating reasons why we feel optimistic about the future in that economic reality has lost connection with investor psychology in the short-term - to a far greater extent than normal tolerance expects.
It is imperative to recognise that a valuation on one day is simply a short-term snap-shot only. If your initial reasons for investing have not changed and certainly our sensible-term views are now very positive, history suggests it is absolutely not the time to be exiting markets.
Our Systems and Response
We have always believed in as much diversity as possible - not only in buying funds which in themselves hold many individual components but by a global spread of investments. However, over latter months these have not provided protection from a tidal wave affecting most markets and sectors. We have always held some fixed interest investments and other ‘dull’ holdings, too and generally, values of these have increased or remained unaffected by market movements so proportionately, the average client’s exposure to them has increased as the value of their share element has declined. For Balanced Portfolios, as an example, this means that the profile has now become of reduced market risk as a consequence.
Fears from America have caused dramatic declines in good quality banks such as Barclays and Royal Bank of Scotland Plc here. To experience a drop of the best part of one-third in a matter of weeks is disquieting at best and it is something which can become infectious to other stocks as well as disturbing long-term investors’ views of their share holdings, possibly encouraging them to sell at the most unsuitable of times. Inevitably, prospective buyers sit on their hands too and accumulate cash because of the uncertainty in the short-term.
The Future
It is obvious to state that uncertainty will continue. Fears over further provisions against sub-prime debt in America, worries about the property market here at home and potential of a slowing economy weigh heavily on investments. That said, markets always anticipate the future and usually over-react to it and indeed during the last recession in 1990/91, bank shares performed strongly because they had been over-sold beforehand. I remember that well.
I agree with the following statements of fact and prediction:-
“Corporate profitability across most of the world is at an all-time high. Equities are cheaper than treasury bonds have been for more than twenty years”. “Quality stocks as measured by the relative valuation of companies with different credit ratings have never been so under-valued as at present”. Both of these quotations are within separate articles in the Financial Times of 14 January 2008.
In December, the rate of interest at which banks lent each other money hit an extreme level of 86 basis points above LIBOR. Curiously, it has now returned to 11 basis points over, which is where it was before the credit crunch in the autumn. This demonstrates two things. It points to continuing reductions in interest rates generally (which is very good for the economy and the consumer with debt), let alone expectations for the Bank of England and the US authorities to reduce interest rates to avert recession and boost investment confidence. Second, it demonstrates that institutions have been stock-piling cash and the sums involved are very significant indeed. At such times of acute pessimism, often a rapid return to “normality” can happen, seeing marked improvements in share prices because there is such limited availability of stock. The market is very tight indeed at present. Indeed, in America, ten year treasury bonds were paying 5.25% last January yet are now down to just over 3.5%.
History
Over the last 130 years, the compound annual return from shares has been approximately 7% pa - as well as over the last twenty years. Simplistically, these returns are roughly the dividend income on shares, plus inflation, plus 2.5% economic growth. This means that over the next ten years, investors should double their money (a compound return of 7.2% pa). This is not a prediction but rationalising very long-term history (through some really dreadful times too) against averages. If a market has fallen dramatically (and it could continue in the short-term), then likelihood for a sizeable upward correction becomes more inevitable. However, from even the most pessimistic of predictions, you can see that the compound result to investors is very acceptable - particularly with deposit rates so banal.
Since 1918 the figures have been even better - an average of around 8% pa after inflation with cash averaging just 2% pa.
Examples of bemusement - just have a look at the current values of the below companies. Recognise that some of them have extensive debt but draw your own conclusions in terms of which ones you believe seem expensive and which ones you believe could be a little cheaply priced - for the whole business. Remember too that in the last twenty years, there had been fears that both BP and Next could have gone bust. See where they are now!
Woolworths £120 million BHP Billiton £33 billion
Blacks Leisure £50 million BP £110 billion
Debenhams £500 million Royal Dutch Shell £130 billion
Sainsbury £7 billion Exxon £130 billion
Next £3 billion Google £105 billion
Tesco £33 billion IBM £70 billion
BT £22 billion Microsoft £170 billion
Rio Tinto £61 billion Nestlé £90 billion
We have also seen rapid expansion of a new form of investor. High oil prices have boosted middle eastern government funds and other sovereign investors have begun to be more aggressive in their investment policies. There are other significant sovereign investors across the globe keen to diversify away from fixed interest bonds and they are using the opportunity of depressed prices to take big stakes in some US banks, for example. This trend will continue and grow, underpinning share values. It includes the Chinese, too.
Here at home we must not forget that companies representing the “British stock market” continue to be profitable in themselves in general terms and are distributing very good levels of dividends which investors continue to receive. The income yield net of tax on the FTSE 100 is over 4% at present and whilst some companies might cut payments because of unique conditions, others will increase them too so this is a good rate of income from the real profits of businesses with which you and I trade every day.
There have been inflationary fears following the rapid rise in many natural commodities, including food stuffs and oil. In theory, this contradicts fears of recession because one of the first losers of any economic slow-down is base commodities, because demand plummets. This is advantageous to us all in that it cuts costs and reduces inflation concerns.
Throughout the recent problems, leading companies have continued to buy-in and cancel shares in significant quantities. This even includes Barclays. Even if US banks need to raise cash, many of the largest companies continue to have substantial cash flows, including the oil and pharmaceutical giants.
Remaining at home, whilst in the short-term prices will react to daily sentiment, the majority of companies representing the “stock market” now operates within rather boring sectors which would not be so adversely affected by any major economic downturn. Whilst banks’ profitability could suffer, prices have already fallen quite heavily (and potentially excessively) but oil majors account for approaching 20% of our market and the rest is represented by the big pharmaceutical and telecommunications’ firms which are very cheap compared to previous high points. A few very large food and consumer product groups such as Diageo and Unilever at fair prices constitute most of the rest and whilst I believe mining stocks are over-priced and riding for further hefty falls, the impact would not be particularly significant to the index itself.
Company profits have been increasing strongly and the investment “return on equity” is at one of its highest ever levels. Part of this has been through gearing but it suggests there is scope for companies to remain healthy and generate profits even if margins are lower as a reflection of more cautious consumers and underlying economies.
Business Lessons
We must never forget that shares are businesses. Businesses function to produce a profit for owners as well as payment of tax and the building of reserves for future development. In the short-term, share prices can lose track of business values and their future potential. In 1999/2000 this happened to the upside. We now believe it is the reverse. Whilst we cannot say that sentiment will not drive prices lower in the near term, at some point the realities of business values and their profitability will be reflected by market values. That is not simple optimism but rational thought, represented either by investment flows or corporate activity which will unlock values represented. Some of this is happening already. Indeed, directors have been buying shares in their own companies and at escalating levels. Very few sales of shares by directors are taking place.
Remember, too that at the bottom of the markets in 2002/3 that newspaper headlines chose to reflect the even more pessimistic ‘view’ at the time that the market would continue falling heavily. The FTSE 100 hit 3287 in March 2003 and I recall some pessimists suggesting that value would not return until it fell to as low as 1800. However, uncertainty disappeared with the actual invasion of Iraq and a semblance of normality materialised, seeing the index double in just over three years, principally because the companies themselves had not seen any interruption to their normal business activities of trading with you and me. Remember that in February 2003 we went out on a limb by encouraging investors to buy as heavily as they could - a recommendation in the face of great adversity.
Pessimistic contagion spreads to other sectors and stocks and volatility usually means declines and sometimes dramatic ones. However, in our view, at these levels for many stocks, it does not become unexpected for there to be substantial and rapid increases too when panic is replaced by reassurance and then enthusiasm on a feeling that the sense of fear was much overdone. Markets hate uncertainty and price shares accordingly. Actual bad news from which recovery and improvement can start is much more manageable.
In 1987, the crash was exaggerated by computer selling programmes. This time round I believe part of the problem is an excess of “short-selling” where speculators including hedge funds choose particular target companies where they sell shares they do not own, hoping to buy them back at a cheaper price later. They pay money to long-term investors to borrow their shares to do this but I have expressed my concerns in dialogue with the Shadow Chancellor because it creates a disorderly market and can cause the implosion of companies which in themselves were otherwise totally stable. The extent of this activity with certain companies will create the inevitable price drop because typically, buyers of that company’s shares are on strike anyway and it appears to be a one-way “gain” for these speculators. However, real pain is being inflicted upon long-term shareholders, the market and its confidence.
History
Apparently, since the Second World War there have been nine US recessions and inflation-adjusted stock prices fell by an average of 20% from the peak month for economic activity to the month in which it bottomed. That said, markets have predicted far more recessions than there have ever been and at this point, market prices are pretty good value anyway.
History has shown us that stock markets have always recovered from periods of low performance. So, whilst it can be tempting to “cut your losses” and sell up, it is likely to be worthwhile to ride out the tough times and fix your sights on the bigger picture - a sensible timescale.
Volatility
The growth of information flows across the world has increased volatility, in that short-term collective sentiment can be converted instantly into pessimism or optimism within world markets. Bear markets are followed by bull markets and the greater the decline then likelihood increases of a dramatic increase when the confidence coin flips over - which it will and without degrees - it is all or nothing. A swift bounce of one-third could happen and for those out or waiting on the side-lines for matters to clear, they will miss that opportunity. Whilst the decline in 1973/4 was greater than the current drop, the UK Stock Market rocketed by a massive 130% in early 1975. Volatility will be here to stay for a while, yet erratic movements can be in favour of the investor as much as against although the lower the fundamental value then the greater the likelihood of upward movement.
Whilst we are now very optimistic from these levels, we must always remind investors that market-based holdings cannot ever be relied upon to produce steady and reliable growth over too short a period of time. Market listed investments and the income from them can fall as well as rise, particularly in the short term. Therefore, it is advisable to hold such investments for a minimum of five - ten years, over which periods stock market returns have shown themselves to be historically superior and broadly predictable through both good and bad times. Additionally, sufficient patience must be given for the odds to work in investors’ favour.
Market Stupidity
Let me demonstrate a stupid over-reaction to recent results. Shares in Northgate Information Solutions responded well to the Company’s latest results’ expectation yet after analysts expressed concern over levels of corporate debt (particularly following a recent attractive trade acquisition) the share price almost halved within a matter of days. The shares fell as low as 42p but a few days later, it was announced that a private equity fund, KKR, had agreed a bid at 95p a share. Obviously, stock market analysts were wrong totally but investors were still selling at those lowest levels because market price at any and every point is agreement between buyer and seller at that time.
Take another example. Until recently, Premier Foods Plc was extolled as a fantastic, well-managed growth company with recession-proof brands. Its results were quite acceptable but again, worries about debt levels and a large selling order of shares saw the price plummet. This is a company which is generating good profits and paying a high level of dividends yet in the year the shares have fallen from £3.36 to as low as £1.26. Which price was/is wrong? Whilst we have none for clients, I know where my views lie.
Another such victim is McBride, a rather boring, household products’ company which once owned Wrafton Laboratories locally. We have made money from this company before but with little news, its shares have fallen from a high of £2.64 this year to as low as 88p. It really does have dull and dependable products and sound profits and I am tempted to add these back to strategies where the dividend yield is over 6% net of tax at present. Whilst in theory investors in the company might think it ‘rational’ to sell before losing any more money, is that really a sane view? I say absolutely not but cannot guarantee a floor.
Other Investment Gurus’ Views
Legg Mason’s renowned Bill Miller has tipped the US Dollar to rise against all the leading currencies. We tend to agree. Following the plunge in share prices, he has been buying financial stocks and house builders. Legg Mason manages $1 trillion. Anthony Bolton of Fidelity has started to take a tentative position in some bank stocks. Warren Buffet built a cash stock pile with the intention of using it for good-value opportunities. Plenty are beginning to abound and he is moving.
Investment Trends
Over the last year, investors have benefited if they have been invested in gold and mining stocks generally. They have also done well from emerging markets including China.
We are very cautious of both of these areas. We should have liked to have had greater exposure than we did and not to have exited our Templeton fund when there was further progress in front of us but we were not greedy. That said, we do believe that the risks represented by emerging markets are now acutely under-appreciated and when developed markets offer such extremely good value, these extra risks should be avoided. Even gold and other metals are over-valued at present, in our view and when corrections arise in them, declines can be savage and swift.
In some respects, present prices of these sectors/markets remind me of the technology bubble when, at the worst point, 40% of the world stock markets were represented by media, technology and telephony. In theory, anyone who had 40% of their shares in those sectors would have been following a medium risk remit because of just that. Investors will be interested to learn that we did not do that because we felt that was very high risk instead. Property has not been dissimilar!
Remember, the US is a $9.5 trillion consumer while China stands at just $1 trillion and India $650 billion. Whilst these figures will change in the future, they are the present.
The Long Term
There are many positives which will apply to the market in due time. Short-falls on pension funding are forcing people to save more and the majority of this capital will find its way into markets. The level of inheritances rises year on year, boosted temporarily by the exorbitant values of properties which are sold for capital to be available for investment. Society becomes more affluent and that enables greater spending, business activity and also capacity for greater saving. People are living longer and whilst this has negative financial implications, it also has many positive ones in that people will invest for longer and have their capital producing returns for a greater time. The lower levels of global poverty are also moving forward and this creates economic benefits as well as new generations of prospective investors.
Our Economy
The Pound has been falling and indeed since November it has fallen by 9% against the Euro which is almost as much as we suffered on “Black Wednesday” against the Deutschemark. The French economy is now bigger than ours and we have slipped into sixth place as opposed to the fourth place we held ten years ago. (A lower currency can help economic regeneration, incidentally).
Japan
At last we see the Japanese Yen has begun to recover against Sterling in particular and this has limited our recent losses from a drifting stock market. The market’s 11% drop last year was the worst performance of any major market yet despite all of this, there remain grounds for optimism with economic growth expectations much better than the potential recession affecting other developed markets. Company profits have been good and share prices have been very low, representing extremely good value at these levels. Apparently 40% of Japanese stocks trade at levels under their book value whereas the world average is 2.4 times. Dividend income for investors is rising rapidly, too, up by a quarter alone in the six months to last October.
Neuro-economics - Helping Us Understand Our Reactions, to Avoid Irrational Behaviour
There is a new science of neuro-economics combining neuro-science, economics and psychology. Within one twenty-fifth of the time it takes to blink an eye, upsetting financial news can activate the amygdala, a part of your brain which generates emotions such as fear and anger.
The bad news can come in numerous forms - a newsletter like this, a newspaper or TV headline or a check of one’s investment values. It has now been proven that falling share prices ignite the same circuits in your brain which respond to the snarl of a lion and even simply reading the words “stock market plunges” in a sentence will raise your pulse, increase blood pressure, tense muscles and speed breathing. Consequently, if you make a snap decision immediately after receiving frightening investment news, automatically you will be propelled towards selling, even believing it is a reasoned judgement despite instead being gripped by a primordial fear.
Consequently, the initial impulse to be informed continuously about your investments in times of turmoil makes personal trouble for you as your brain will send more danger signals, denying patience to wait out troubles which are likely to be temporary. Professional investors with billions under management react in the same way.
The science also suggests that our minds look for trends even if they are not there. We like to perceive that random events create patterns as apparently it only takes two iterations of a stimulus for our brain to form an automatic and uncontrolled anticipation of another repetition. Often the news we see (and stock market chartists beware here!) is nothing but “noise”.
In fact, psychologist Paul Andreasen has found that investors who received frequent updates on their stocks earned half the returns of those who had no news at all, I suppose because we like to perceive trends and react to them, as opposed to acting rationally when assessing fundamental prospects of the underlying investment.
The science has also revealed that expectation is more powerful than experience (the chase better than the catch). Hoping for a gain is much more emotionally intense than earning one and expecting to lose money feels even worse than losing it turns out to be. The threat of a market crash is more upsetting than the pain the actual crash will cause you. Most fund managers are no different to individual investors. As they are now, they stock pile cash and low producing Bonds during bear markets as opposed to investing in shares as they cheapen and instead pile-in at the peak when really prices are far too expensive. We dislike a loss far more than we like a gain, too.
This new science reminds us that our brain contains emotion and not a pure, rational computer. We need to keep a careful check upon our actions in the face of particularly bad or good experiences and we should train ourselves to distrust obvious and natural feelings in favour of fundamentalism and rational behaviour. Minimise contact with anything which can draw our attention to falling market values (because it is doing ourselves no good) but go for a long walk or see a good film. Not only will you be happier but in the long run it is suggested you will be much wealthier, too.
Reaction
At inception of each client relationship, we have endeavoured to explain the methods which we should look to follow in relation to investment management. We have explained our philosophy and this is updated regularly within newsletters and news-sheets as well as in individual correspondence and letters attached to half yearly reports. We have explained about diversity afforded by our systems.
I hold over twenty-nine years’ experience within financial markets and over that time have secured some high level qualifications - as have many of the staff. However, the last few months have reminded us that some of this is something of an irrelevance. During these dreadful conditions we hope that clients will have at least some reassurance that we do have anchors based upon sound foundations and that however difficult the past that this pedigree will still count for something. We have a high quality staff base with an orientation of service as opposed to product sales. We respond to communications and queries to the best of our abilities. We hope that we have a professional business standing and a reputation for integrity upon which we have built since the business was established in 1985.
We endeavour to communicate with all clients even through challenging conditions and however difficult, we hope regular updates are appreciated. We hope that our comments are seen as being honest and that the advice we dispense is based upon our best understanding of conditions and circumstances at the time. We continue to believe in common sense and the perception of value within investments and that in the end, this strategy will continue to be vindicated as it always has been in the past for markets. Many organisations stop communicating with investors because they do not know what to say or are not prepared to face inevitable concern and negativity. As unpleasant as it is, surely that is the responsibility we have?
Investment Points/Truisms
It goes without saying that the current very difficult conditions are causing us all great distress. We cannot change what has happened but I believe, too, we need to consider some history to enable you and us to assess the future. This might be best achieved through some bullet-points.
1. The price of any share on any market at any time is the agreement of sentiment between a buyer and seller. For every buyer there is a seller and vice versa. There is not a list of “good shares” or “bad shares” or “sensible advice” and “foolish advice”.
2. Most money of investors is held within the biggest companies. This means that at any point, most experts have most money in those largest companies. “Clever experts” do not have their money somewhere else and nor are “foolish managers” holding just stocks that have fallen the most.
3. What has happened over recent days, weeks or months does not predict a “trend”. Trends finished yesterday. Sometimes, a trend can present an idea of what is to follow (particularly if a stock or market has been pursued aggressively by chartists who follow such activities slavishly). If pound coins are being sold for 50p, after having fallen from £1.50 (which can happen when considering assets on the stock market) it does not mean they will fall to zero or conversely that infinity is the top price.
4. Remember that shares represent real businesses with which you and I trade every day. If these businesses are making profits then they have a business value but in the short-term the stock market can seriously over or undervalue them. In the end, “value will out” or another trade buyer will take over the firm because it will be able to make a profit from the transaction.
5. Hindsight - We are all clever after the event. We can use charts to suggest what we may or may not have done yet there is scant evidence to demonstrate that chartists are perfect. We use charts when they help back a fundamentalist view but not as a solution to all investment decisions. If chartists were so perfect, they would have retired very wealthily many years ago because they would always avoid losses and just make profits. They would definitely not be continuing to interact with private clients. Charts are not self-fulfilling other than if lots of other chartists are doing the same thing with a specific stock.
6. Stop Losses - Stop losses are not a rule we follow slavishly. If a good value “pound coin” falls to 50p, investors should be considering buying more of it rather than selling those they still have left. However, if chartists have been pursuing a stock on the back of momentum rather than fundamentals then obviously, stop losses can create self-fulfilling prophecies. We are fundamentalist investors based on “value”. We are not momentum investors for its sake alone.
7. The biggest losers are those who crystalize losses. They may be happy as they see the market continue to fall further but certainly they fail to re-enter the market at the lowest levels. In the last trough from 2002/03, many “clever” investors who had exited certainly never re-entered the markets other than when they began to feel that they were missing-out on good profits when the index doubled in the ensuing three years. Conversely, as managers, if we think a bigger loss will follow then we shall take action to sell stocks to avoid further loss, to buy-in later.
8. Any apparent lack of selling activity by us does not reflect a lack of ongoing active management. We monitor all stocks all of the time and if our view at that point is to maintain the status quo then that is an active decision. Selling something to make a loss to give an impression of greater management activity is negligent if it goes in the face of our views for that stock or market, however uncomfortable preserving the status quo is to us.
9.Selling a stock just because it has made a profit is not wise in itself either. If the stock has fulfilled our expectations (or more) then we shall sell, either in full or in part. We review these things all of the time. Sometimes we shall sell a stock which has held its value (or fallen less) to buy something which has fallen more. Emotional attachment to a “price” of any asset and personal experience and history with it is no friend of the investor.
10.Even if an investor is fearful of market conditions, to liquidate all of a very diversified investment strategy is unwise. Some of those holdings will be rock solid and indeed will have risen in value as they reflect a safe-haven in the face of adversity. Selling everything cannot be the right course of action. Selling things which have made a loss is also unlikely to be wise because the decision instead has to be what will fall less in the future and what is likely to rise more rapidly.
11. Investors need to remember that investors often do the opposite to what is sensible. They sell things on weakness and invest more at the time of confidence. The reality is that risk is often highest when at its lowest and lowest when it is highest. The “Pound Coin” analogy applies.
12. Volatility is very unpleasant but for investors, it is an opportunity to add value if they have the courage. Volatility can be as positive as it is negative but in the end, stock markets rise, because of the characteristics of the businesses they represent, in a commerce system.
13. We take investment positions based upon our views. We have been out of mining stocks, property and emerging markets for some time as we have felt these investment areas have been over-blown and riding for a dramatic fall. We have made excellent profits from these sectors in the past but surely, it is right for us to reflect our real views for investors by acting as we believe is appropriate. Yes, we might have missed profits but is it right to chase after these against our convictions? We shall buy and hold investments which we believe are “cheap”, representing good value. We are given the discretion to do what we believe is the best thing for clients at each and every time. There is no ulterior motive.
14. Even New Star, the retail investors’ dream company, has had a torrid time. CEO John Duffield’s secretary has been quoted as asking how low can New Star Plc shares go, irrationally having little perception of the real value of the underlying business and its income flows.
History
Our Firm was established in 1985. We started managing money on a discretionary basis in 1987 and since that point, funds have broached £130 million. This is not on the back of a slick selling machine but by the service and results which encourage investors to stay the course, through thick and thin.
Qualifications
Amongst our staff, we have three highly qualified Directors (and two others), a Chartered Accountant, including high level investment management skills and Advanced Planning Certificates. The Firm is regulated as one of the highest levels by the FSA in testament to its capabilities and the Company has grown in employees and business size. It is not a “one man band” and can satisfy locum requirements for discretionary fund management.
The Past - Property
We were trying to encourage people to buy property in the early 1990s because it was so cheap. We were calling the top in the late 1980s. We have been calling the top for commercial and residential property again for some time (some might say too long). In 1999, our Christmas newsletter stated our serious concerns at stock market levels. The FTSE 100 peaked on 30 December 1999. We were telling people to avoid the technology sector in total and our investment philosophy reflected that. We profited handsomely from that yet suffered none of the losses which saw the NASDAQ fall by over 80%.
During 2002/03 we did suffer as did most investors, as the FTSE 100 fell 52% from its peak. However, in February 2003, one month before its trough, we issued our strongest ever buying recommendation in our newsletter reiterating the obscenely low valuations and the best comparative buying opportunity for over seventy years.
How prudent is it to sell after a bad event? Not only might you be selling when market-makers have widened spreads against you but you are incurring costs and are unlikely to benefit from the market bounce. Bull markets follow Bear markets - don’t ever forget that.
Adviser Direction
The Firm and its owners have invested in exactly the same philosophies and stocks and the investment management success over the longer term is a reflection of that policy however painful recent experience is. This is not blind confidence but we have always felt that it is imperative to prove that your personal adviser reflects his views by his own practice and personal confidence and inevitably those capabilities by investment ability and actual achievements.
If your investment adviser ever tells you he has never suffered pain by an investment which has not worked as planned then it is time to change investment adviser. The job is not a perfect science despite some people suggesting, with only hindsight as a guide, that it was “obvious” afterwards. Some of the same investors suggesting this are those who believe there will never be a colossal slump in property. Is it not better we forewarn them with our views so at least they can take a balanced perspective? Some advisers suggest we shouldn’t do that because it might alienate our client. How daft - it is truth after all and our judgement (which might not be right or timely) but it is negligent not to share our honest view if it helps our client judge their plans. That said, the fundamentals for shares at these price levels are now exceedingly sound and occasionally, like now, they become unaligned with reality. In our view, investors who respond by panic reaction when the damage has been done already are unlikely to be doing the most sensible thing.
I hope you find the above notes helpful in your assessment of the current situation and in terms of our endeavours to manage clients’ capital at this most difficult of times.
Year End Planning
Invaluable ISA allowances for 2007/08 finish on 5 April. For eligible investors, application forms are attached. Whilst conditions may dissuade people from investing, best opportunities arise usually when conditions are the most depressive. For investors with larger holdings, they should ensure their allowances are used each and every year to secure maximum tax benefit in due time. ISA rules will change from 6 April and for more information concerning how this may affect you please contact us.
Capital Gains Tax
New rules apply on 5 April. For short-term investors, they will gain usefully because the tax charge will drop to 18%. However, despite the unwieldy lifetime allowance for longer-term holders of assets (particularly farms and business property) they could lose heavily because the 105% inflation allowance from 1982 disappears and the tax charge which would have been a maximum of 10% goes up to 18%. The changes have some benefits (particularly in the calculation) but otherwise are ill thought through. So, if you have any assets you have held for a long time you might need to consider selling them and losses might be more tax valuable before 5 April too.
Transact Pensions - Ongoing Dialogue
For those investors for whom we manage funds on a discretionary basis, please do remember to keep us appraised of your ongoing intentions to ensure that we may continue to act in your best interests.
For example, if you plan to draw benefits from your pension within the next few years, it would be helpful to communicate this to us as early as possible to enable us to manage your strategy accordingly. This may involve a gradual switch into cash as and when the timing is considered appropriate and opportune. Equally, if you know that withdrawals of capital are likely to be required from your other managed accounts within the next six to twelve months for example, again your interests will be best served through early notice. Many thanks.
Trimstone Manor Hotel/Old Custom House
After a significant refurbishment and improvement programme, we are pleased to announce that the Hotel will be reopening soon and with a top-quality Chef and Manager following an extensive selection process. In my spare time (what spare time!) I shall be able to write a book already on the experiences of acquiring an Hotel which needs such significant works undertaken to it, ranging from adequate water purification programmes and plumbing through to rewiring, fire alarm facilities and general amenities but once everything is in place, we believe it will be a very attractive venue in a beautiful part of North Devon.
As far as “Old Custom House” is concerned, plans for The Strand are moving forwards and we have to be enthusiastic about the development of the area as a necessary café quarter of the Town. We are sure that the Restaurant will be back with a solid foundation of key and capable staff to look after customers’ requirements.
Two Moors Festival
A very wide selection of applicants has entered this year and the weekend programme of 2/3 February’s intensive. Some excellent performances from youngsters across the South West continue to be seen!
Philip J Milton & Company Plc - Nominated Charity 2008
Following our extensive fund raising for the NDCS in 2007, we have decided to nominate the North & East Devon Prostate Support Association for 2008.
The Charity offers support of an emotional and financial nature to sufferers of Prostate cancer, their families and carers and has been in force for five years. If you would like to support us please contact Mrs Sandra Wonnacott at the Office for information regarding fund raising!
For further information about the North Devon support Group please contact Mr Roy Quastel, The Sidings, 3 Bridgehill Garth, Topsham, Exeter EX3 0ER, visit: www.nedpsa.org.uk or email nedpsa@aol.com.
We are one of the main sponsors for the 2nd Parkwood Leisure Junior Badminton Tournament held at the North Devon Leisure Centre on 2 February 2008. The Tournament is for boys and girls for all age groups for singles, doubles, open and novice. Although you have missed 2008, for next year’s Tournament please contact the Secretary, Mr Dennis Blackmore at blakewellboy@hotmail.com.
A LITTLE ABOUT PHILIP J MILTON & COMPANY PLC
Founded in 1985 and incorporated in 1996, Independent Investment Consultancy Philip J Milton & Company Plc is the largest and longest established truly independent member of the FSA and its forerunners in North Devon. Following a successful career working specifically in the field of investment and personal financial planning with a leading clearing bank, Philip Milton left to fill a growing niche in the North Devon area by forming his own Company. Rapidly the Company gained a reputation for integrity and professionalism offering a comprehensive range of specialist investment and financial planning services mainly in the local area but also as far away as Australia and New Zealand.
In 1987 the Company became the first North Devon-based firm to offer its own in-house Personal Equity Plans and remains the only truly independent PEP and ISA manager in the area. An unrivalled Pension Fund Management service was added in 2001. During the summer of 1991 the Company moved to Joy Street, Barnstaple, buying the secure premises previously occupied by the Nationwide Building Society. A second site, at 3 St Peter’s Terrace was purchased in 2001 too.
In March 1993, the Company purchased the investment goodwill of a local investment adviser. Later that year the investment and financial planning clientele of a firm of general insurance brokers were added. In late 1996 the discretionary PEP funds of a Tiverton Firm were secured, then bolstering total funds under management to £28 million and now at having breached £130 million. In November 1996, Philip J Milton & Company Plc was established with an authorised share capital of £1 million, endorsing the Company's long term commitment to its clients. The Company continues to look to expand its quality of operations and in 2000 “Milton Investment Management” was launched as its bespoke portfolio management service as well as being available for the clients of other professional financial advisers across the country. In September 2004, the business of Directors’ Financial Programs Ltd of Epsom was added to the fold.
The Company provides investment and financial planning advice to a growing range of other professional advisers and continues to expand upon its strong foundations. The Company is regulated at one of the highest available categories, giving wide powers as to the type of investments on which the Firm can advise and deal. These include: collective investment vehicles such as Unit Trusts, Investment Trusts, Offshore Funds and Investment Bonds; stocks and shares; full discretionary management of client portfolios (with an independent custodian which administers billions of investors' funds) and Personal and Inheritance Tax planning, Executorship, Probate and Will services and Private Accountancy.
After Hours
A real letter sent to David Milliband MP.
16 May 2007
Dear Secretary of State,
My friend, who is in farming at the moment, recently received a cheque for £3,000 from the Rural Payments Agency for not rearing pigs. I would now like to join the "not rearing pigs" business. In your opinion, what is the best kind of farm not to rear pigs on, and which is the best breed of pigs not to rear? I want to be sure I approach this endeavour in keeping with all government policies, as dictated by the EU under the Common Agricultural Policy. I would prefer not to rear bacon pigs, but if this is not the type you want not rearing, I will just as gladly not rear porkers. Are there any advantages in not rearing rare breeds such as Saddlebacks or Gloucester Old Spots, or are there too many people already not rearing these?
As I see it, the hardest part of this programme will be keeping an accurate record of how many pigs I haven't reared. Are there any Government or Local Authority courses on this? My friend is very satisfied with this business. He has been rearing pigs for forty years or so, and the best he ever made on them was £1,422 in 1968. That is - until this year, when he received a cheque for not rearing any.
If I get £3,000 for not rearing 50 pigs, will I get £6,000 for not rearing 100? I plan to operate on a small scale at first, holding myself down to about 4,000 pigs not raised, which will mean about £240,000 for the first year. As I become more expert in not rearing pigs, I plan to be more ambitious, perhaps increasing to, say, 40,000 pigs not reared in my second year, for which I should expect about £2.4 million from your department. Incidentally, I wonder if I would be eligible to receive tradable carbon credits for all these pigs not producing harmful and polluting methane gases?
Another point: These pigs that I plan not to rear will not eat 2,000 tonnes of cereals. I understand that you also pay farmers for not growing crops. Will I qualify for payments for not growing cereals to not feed the pigs I don't rear?
I am also considering the "not milking cows" business, so please send any information you have on that too. Please could you also include the current Defra advice on set aside fields? Can this be done on an e-commerce basis with virtual fields (of which I seem to have several thousand hectares) In view of the above you will realise that I will be totally unemployed, and will therefore qualify for unemployment benefits.
I shall of course be voting for your party at the next general election.
Yours faithfully
A few funnies....
One day, a man came home and was greeted by his wife dressed in a very Sexy nightie. "Tie me up," she purred, "and you can do anything you want." So he tied her up and went golfing.
A woman came home, screeching her car into the driveway, and ran into the house. She slammed the door and shouted at the top of her lungs, "Honey, pack your bags. I won the lottery!"
The husband said, "Oh my Gosh! What should I pack, beach stuff or mountain stuff?" "Doesn't matter," she said. "Just get out."
Marriage is a relationship in which one person is always right, and the other is a husband.
A Polish immigrant went to the DMV to apply for a driver's license. First, of course, he had to take an eye sight test The optician showed him a card with the letters 'C Z W I X N O S T A C Z.' "Can you read this?" the optician asked. "Read it?" the Polish guy replied, "I know the guy."
A wife was making a breakfast of fried eggs for her husband. Suddenly, her husband burst into the kitchen. "Careful," he said, "CAREFUL! Put in some more butter! Oh my GOD! You're cooking too many at once. TOO MANY! Turn them! TURN THEM NOW! We need more butter. Oh my GOODNESS! WHERE are we going to get MORE BUTTER? They're going to STICK! Careful . CAREFUL! I said be CAREFUL! You NEVER listen to me when you're cooking! Never! Turn them! Hurry up! Are you CRAZY? Have you LOST your mind? Don't forget to salt them. You know you always forget to salt them. Use the salt. USE THE SALT! THE SALT!" The wife stared at him. "What in the world is wrong with you? You think I don't know how to fry a couple of eggs?" The husband calmly replied, "I just wanted to show you what it feels like when I'm driving."
Fifty-one years ago, Herman James, a North Carolina mountain man, was drafted by the Army. On his first day in basic training, the Army issued him a comb. That afternoon the Army barber sheared off all his hair. On his second day, the Army issued Herman a toothbrush. That afternoon the Army dentist yanked seven of his teeth. On the third day, the Army issued him a jock strap. The Army has been looking for Herman for 51 years.
I was in a bookshop the other day, and a sign said 'A third off
books', so I bought 'The Lion, The Witch'.
Why is there only one word for 'thesaurus'?
A man came up to me in the street and said,'give me two pronouns'.
I said, 'Who? Me?'.
Double negatives are a no no.
Why does 'monosyllable' have 5?
Shakespeare walks into a pub. The barman says, 'You're bard'.
Avoid cliches like the plague. They're old hat.
Who needs rhetorical questions?
What do we call Santa's little helpers? Subordinate cl....
A man entered a punning competition. To give himself a better chance
of winning, he sent 10 to the judges. He hoped one would win, but sadly, no pun in ten did.
PLEASE NOTE
The comment contained within this newsletter is the opinion and copyright of Philip J Milton & Company Plc. No outside institution is employed specifically to provide comment which is based entirely upon the Company's independent view of worldwide markets and economies at the time of publication. The values of market investments and their income can fall as well as rise. Any performance/prices quoted within are based on details at the time of writing and specific clarification and individual comment is necessary if action is being considered. Please note that some of the ancillary products such as accountancy and executorship services are not regulated by the Financial Services and Markets Act 2000. The value of your home is at risk if you do not keep up repayments on a mortgage or other loan secured upon it (written details are available on request).
