Investment Letter February 2015

In the famous outlaw film of 1969, Butch Cassidy and the Sundance Kid, two anti-heroes of quite distinct personalities combine forces. The early scenes of the film are filled with tales of derring-do, laddish behaviour, drunkenness and opportunistic heists. By virtue of their charm – and the contrasting blockheadedness of the authorities – the pair have the audience entirely on their sides. As the film progresses, in response to their success in holding up his trains, E.H. Harriman of the Pacific Union Railroad begins to pursue them down in a more determined fashion, employing a mythic tracker to do so. One begins to sense a certain fatality in each attempted evasion. In the end, they are cornered by the Bolivian army in a barn and make a futile effort to shoot their way out. The film closes with a frozen frame and a volley of gunshots.

The determined but ultimately futile efforts of Mr Tsipras and Mr Varoufakis are brought to mind. Some distinctions need to be made immediately: our Greek anti-heroes are entirely sincere individuals, with no trace of criminality. This should be made clear.

However, if we allow for this imaginative construction to persevere, anti-heroes they plainly are. They have been conjured out of the despair of the Greek people, they preach an alternative agenda and run enormous risks. The arcs of these two stories are synchronised: from the early euphoria to the drawn out end. The E.H. Harriman character is played by Wolfgang Schäuble.

As none of the European agencies wish to bear the blame of precipitating the end game, it will come a little later. If insolvency becomes an inalienable fact, Greece will have little option but to erect capital controls. This action will be the probable trigger for Greece’s exit from the euro.

The interregnum, to borrow a word, between now and those eventualities occurring will provide some breathing space for equity markets to behave constructively. As well they might given oil has retreated from US$100/bbl. to US$60/bbl.

And to those that say this dividend from lower energy costs will not be spent I say: phooey. History says it will be.

Here we have an ally in Terry Smith of Fundsmith who makes the point that in every case where the oil price has halved, the global economy has boomed and every time the oil price has doubled, the economy has struggled. Oil and its by-products are a pervasive cost, for consumers and industries alike. A recent trip to central Florida, land of the big truck, suggests we are on track here as the trucks just got bigger.

The other manifestation of note has been the cooling, perhaps temporary, of the strength of the US dollar: travel mate of the ardent deflationist. The tempering of the dollar’s rise has allowed other themes to prosper.

Notable amongst these is the shift in favour of cyclical shares in developed markets and the geographic shift toward Europe. Global investors have begun to curb US exposure.

Given the institutional stampede out of Europe in the second half of 2014, European equities have stood to benefit from reallocation flows from the US on any flag in its bull market. The euro itself offers some value. There are some early signs of economic revival within the region.

Will they prove a wonderful investment? Probably not.

For European equities cannot be said to represent outstanding value. In the past few years, the good companies with well installed franchises never became materially cheaper than their global peers. It never happened. For optimism toward Europe to become full throated, it requires the earnings cyclum interupptus to resume. The possibility of this happening cannot be denied. And so, if not wonderful, they are a plausible investment for the pragmatic investor who likes mean reversion to do the heavy lifting.

Cause or effect, we seem now to be locked into a psychology where further dollar strength will reactivate deflationary narratives but dollar weakness or a range bound dollar allows other stories to propagate.

The article that follows was written by Fergus Shaw and addresses valuation risks in global healthcare stocks.

James Spence
Managing Partner

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By |2015-02-27T15:05:23+00:00February 27th, 2015|Investment Letters|

About the Author:

James is a co-founder of Cerno Capital and lead manages a number of the firm’s collective and private portfolios. After qualifying as a chartered accountant in London (Coopers & Lybrand, 1989) he relocated to Asia. Between 1991 and 2004 he worked as an equity analyst, head of research, and latterly as an equity strategist at WI Carr, Paribas, HSBC and UBS, based variously in Hong Kong, Singapore and Jakarta. James graduated from the University of St Andrews, Scotland with an MA in Philosophy & Logic in 1986. James is a Member of the Chartered Institute for Securities & Investment.