He is the most exuberant fund manager I’ve interviewed since the credit crunch began. His fund is down 24.7% over the past year. He had a dreadful October. But Rod Sleath is more excited about investment opportunities today than at any other time in his career.
Sleath runs the Collins Stewart Continental Europe Focus fund. It’s a small fund – just £23m under management – that was launched in April 2003, the last time markets were as dismal as they are today.
He has done a lot of research into market behaviour. He has examined market earnings multiples in the early 1990s downturn, the 1970s and even the 1930s. His conclusion? Even if we are about to enter a recession equal to the severity of the Great Depression, investors need not be too worried.
“We think a very major recession is already priced in,” he says. “I think the upside to present value today is around 130%. That may sound ridiculous, and I don’t want to sound like a blind optimist, but you’ve got to look at the facts. Europe is now trading on seven times historic earnings.”
Sleath says we are probably closer to an early 1990s-style recession than a 1930s-style depression. If you take the peak earnings before the early 1990s recession, then look at the next peak five years later in the mid-1990s, what you see is a 33% rise. If we replicate that, and assume the market moves to a level of 16 times earnings, then that implies a 29% compound growth in share prices for the next five years.
That may be optimistic. But apply the same logic to a 75% fall in earnings (that’s what happened in the 1930s), and Sleath projects that five years later, investors would still enjoy returns equal to 13% compound.
I remind him of Japan. Some 18 years on, it hasn’t quite turned around, has it? “Japan was trading at much, much higher multiples when it crashed,” he says. “In Europe, valuations were not outrageously expensive when the market started to fall – it was closer to 16 times.”
“This is the buying opportunity of the century,” he proclaims. So what is he doing to take advantage of it?First, this is a focus fund, so it only has about 30 stocks and a lot of conviction positions.
Logically, if you say we might be approaching trough valuations (even if trough earnings may be some way off) then you should switch into deeply cyclical stocks.
Sleath agrees, but only so far. “Buying the market as a whole will give you excellent returns. Quite clearly we are in a recession, where earnings will fall for some time, probably for the next six to 12 months and maybe even for the next 18 months. But the equities market tends to trough about three to six months before the lowest point in earnings.
“So, yes, you are going to make lots of money from deeply cyclical businesses. But the problem is that the stockmarket is particularly bad at valuing companies that are making losses. We have decided to avoid businesses which are deeply, deeply cyclical.”
The sector where Sleath is most enthusiastic is European insurance companies. “Valuations are outrageously cheap, particularly in the property and casualty area.” He holds Allianz, Zurich and Axa. “Insurance is our largest sector position. We are buying at valuations last seen in 2003, even though the insurers are now in a much stronger position than they were then. Even with the rights issues of 2003, somebody buying then tripled their money over the next four years.”
ING, a Dutch savings bank, is also part of his insurance theme. It is known in Britain for its savings account but it derives half its income from insurance. In a grim October it fell in value by nearly half. It has had the benefit of government capital, although Sleath thinks it probably didn’t need it. “Even with the dilutory effect of the government capital, you should see it go to 200% higher than where it is today.”
Sleath is also seeking out businesses where he reckons there is a chance of growth over the next three years, even if they are in a cyclical part of the economy.
“There will be companies where earnings fall much less than the market expects,” he says, and points to Siemens, a German conglomerate, as an example. Over the past year it has fallen from nearly €110 (£92) to below €50.
“It’s our largest single holding in the fund. I like the fact that it is restructuring internally and cutting costs while it has an excellent balance sheet. A lot of its earnings are not that cyclical, especially in health and power generation.”
Sleath reckons that Siemens is at the start of a positive long-term cycle in orders for new power stations. It’s also why he has a smaller position in ABB as well.
Atos Origin is another of his cyclical plays. In May it was trading on the Paris Stock Exchange at €40 but it has since slumped to below €18. Yet Sleath says the market is ignoring the fact that about 60% of its revenue is from contracts with predictable, recurring revenues. As an IT services business that went through the 2000-03 post dot-com bubble, Sleath says we can rely on it to survive this downturn too.
But what really excites him is that Atos has a credit card data processing division on which it is rumoured to have had approaches that value it at more than Atos’s entire market value – even though it is little more than 20% of the company.
Sleath tells an upbeat story when there is gloom almost everywhere else. But is Europe really the place to be when traditionally it is America and the Anglo-Saxon economies that go first into recession – and pull out first as well?Maybe that will not be the case this time. Although continental European banks were caught by the same credit crunch factors as American and British banks, European consumers are nowhere near as indebted as their Anglo-Saxon counterparts.
“I don’t expect the recession in Europe to be as deep as that in the US or UK,” he says. Yet valuations on European stocks are lower than on American stocks. Relative valuations versus America are close to all time lows. It’s time to buy Europe.