Sustainable global market growth?

The global markets are up, especially in Shanghai and Brazil. But should we be rushing out to invest or is this just a temporary phenomenon? And what exactly is a good investment now?

Get your skates on. The Shanghai market is up 30% since the start of the year. Brazil is up 15%. Even Russia is recovering. Have we become so obsessed with what’s happening in our own backyard that we are failing to spot the opportunities across the globe?

Christopher Lees of JO Hambro Capital Management (JOHCM) thinks so. He runs the firm’s recently-launched Global Select fund and says the period of maximum correlation between developed and emerging markets may have already passed.

“When we launched in October virtually everything, including emerging markets, was in freefall. So we had a zero weighting in emerging markets and materials,” he says. “But the correlations – and the panic – peaked on November 20. After that we felt we could go back into China and Brazil.”

But is this just a temporary phenomenon? After all, forecasts on the Chinese economy suggest its growth rate may fall this year towards 6%, fabulous by western standards but possibly not enough to prevent social tensions spiralling.

Lees is sanguine. “Is it sustainable? Compare our government bailouts with theirs. The Chinese are paying for their bailouts with real cash. We are paying for ours with debt. I think we can start putting more back into emerging markets.”

His favourite in China is sohu.com, one of the biggest internet providers in the country, with a range of services such as real estate portals and social networking. But it is not immune to global gloom: its Nasdaq quote fell from a high of $90 in June last year, to $42 (£29) last week. But it fell much less steeply in the post-Lehman sell off than the market, and since mid November, it has stabilised.

Perhaps what gets Lees most excited is the opportunities that he reckons come from country risk. It became fashionable during the long boom to focus on stock risk rather than sector or country risk. So you examined, say, the energy sector globally and chose between Exxon, Petrobras, BP or Gazprom.

But that style of analysis was fatally flawed, as it failed to take into account country risk. Just look how much Russia fell out of favour. It didn’t matter that you found the best stock with the best fundamentals. Russia just wasn’t the place to be.

As a global manager, Lees is keen on reinstating country risk as a yardstick by which to organise a portfolio. And right now he sees the biggest risks in Europe and North America.

He says that for a UK investor, the correlation between Europe and North American markets is simply too high – instead “you make money by allocating east versus west.”
Perhaps his most contrarian position is in Japan. Some of the numbers coming out of Japan at the moment are horrific. Exports fell by 49.4% in February, with shipments of cars to the US down 71%. That towering current account surplus is disappearing fast. The yen appears to be painfully overvalued, and the International Monetary Fund is forecasting a 5.8% decline in the country’s GDP this year.

But what excites Lees is that Japan is the country which has seen all this before. It knows about zombie banks. It knows about deflation. It has lived with it for two decades.
“When we launched this fund, one of the likely scenarios we had outlined for markets was what we termed ‘the Japan roadmap’. We were talking about Japan as it was during the 1990s – a post-bubble economy littered with zombie companies and zombie banks. Over this decade, the return on equity totally collapsed in Japan and only relatively recently has there been an improvement. It is now clear to us that we are headed down this path in the West.”

Lees peppers his conversation with the phrase “mean reversion”. He says that correlations are not static and that nearly all fundamentals mean-revert. The Tokyo market recently hit a 26-year low, which suggests it will start to mean-revert.

But what on earth would you buy in Japan right now, especially if you think the yen is about to weaken? Lees likes some technology stocks, such as Nintendo, and (rather bravely) Japanese real estate trusts.

“During February, we purchased shares in Nintendo. In part, this reflected our discomfort with the consensus long position in the yen. Having previously positioned the portfolio to benefit from a stronger yen (that is: lots of Japanese domestic mid-cap stocks and zero exporters), we began to feel that the knee-jerk relationship of weak markets translating into a strong yen no longer made sense.”
As the yen weakens – and personally I reckon it’s ripe for a radical shift – then exporters such as Nintendo should benefit disproportionately.

But Lees says investors should learn from the long bear market in Japan – and what it tells us about possible future market behaviour in post-bubble Britain.

“In the Japanese bear market you have had to radically change your investment strategy. You have had to trade a lot more as markets rotate and grind.”

The investment in real estate ties in with a wider JOHCM belief in the value of commercial property assets. Its veteran UK equity income manager Clive Beagles has started to buy UK real estate through companies such as Segro and construction group Kier, while European manager Rod Marsden is keen on building materials group CRH.

“Yields on commercial property are pricing in extraordinary potential default rates,” says Beagles. Do we really think ultra blue-chip tenants such as government offices in Westminster are really going to fail to pay? Then why are investors demanding yields of 8-10%?

“The key thing about real estate is that unlike the banks, it is supported by real assets,” says Lees.

Each of the senior managers at JOHCM, a boutique that doesn’t impose a house view, believe that we are past the point of maximum bearishness. The ‘Baghdad Bounce’ of March, 2003 was the trough of that particular cycle – yet in the months before, there were sectors that were already recovering. JOHCM sees such signs today, across the globe. Has the Obama bounce already begun?


JOHCM Global Select