View from the Road
At this time of the year, our clients have some time post financial year ends to meet with fund managers.
It is always useful to hear how our clients are seeing life and the markets; a few interesting points came out. I have highlighted, and briefly tried to address to these in more detail: –
1. Bonds remain surprisingly strong despite improving growth forecasts
2. London is more bearish than the Regions
3. We were asked about Johnson Matthey at virtually every meeting
4. We are yet to find a person that thinks MiFID II is a good idea
1). Bonds remain surprisingly strong despite improving growth forecasts
A fair bit of financial theory is based on the relationship involving the disparity of yields between bonds and equities, risk premium etc. It used to be considered a strong metric in comparing valuations. Additionally, bond markets also used to provide a useful indicator of expected inflation. That was before QE. Like our clients, we have spent many a moment considering what bond markets are telling us now.
We suspect we are overanalysing things: maybe bond markets are telling us just that there is a large price insensitive buyer? In addition, UK pension funds bought £31bn into gilts in 2016. I suspect the actuaries were more interested in duration risk, rather than valuation! The following two charts (please see document below) are worth considering. The 1st is the yield on 10 year US bonds. It appears to show the end of inflation!
From a yield premium of over 4% in 2012, Junk Bonds now yield less than Average Euro STOXX Index. Apart from my previous comments re a price insensitive buyer, it is hard to make sense of this.
As ever, we do not claim any visibility on forecasting when bubbles burst, but this is clearly madness. Historically, we know ‘Booms’ can carry on for quite some time, but we must recognise participants are no longer partaking on any fundamental basis.
2). London is more bearish than the Regions
After several meetings across the UK, we note that London wealth managers are more bearish than other parts of the country. Key points highlighted, that markets ‘have had a good run and valuations are more demanding. We do not disagree, but note that many of the more cautious were holding significant amounts of cash and are looking to buy on weakness.
Whilst we agree that several sectors are discounting a fair amount of earnings recovery, at Saracen we manage conviction portfolios with typically less than 50 holdings. We can still find selective value and markets are a long way from ‘irrational exuberance!’
3). Johnson Matthey
To our surprise, we were asked about this business at virtually every meeting. One client described it as a marmite stock, except that nobody actually liked it! This is usually very bullish!
Key factors raised were the decline of diesel vehicles, electric vehicles not requiring catalysts/exhausts, autonomous vehicles and the decline of car ownership. These are all valid points. As we recently purchased the shares, we have explained our reasoning more clearly below.
4) Yet to find a person that thinks MiFID II is a good idea
Answers on a postcard….
Graham H Campbell & David Keir
Joint Fund Managers
TB Saracen Global Income & Growth Fund
Johnson Matthey has 5 divisions, namely; Emission Control, Process Technology, Precious Metals, Fine Chemicals and New Businesses. The products either increase energy efficiency, use resources more efficiently or remove harmful impurities from gas, allowing businesses to meet emission targets. Management seem to have a long-term focus, while measuring success in a consistent and reasonable manner: focussing on return on sales, return on capital etc. The balance sheet is also sensibly managed and there have been regular special dividends to shareholders.
The business is built on adding value to customers, through collaboration and technical leadership. It typically holds no. 1 or no. 2 positions in key markets.
Emission Control, which last year accounted for 60% of operating profit, is the main concern for investors. While there is a long-term threat to combustion engines driving vehicles, in reality there is no sizeable capacity to manufacture electric vehicle under construction, or charging infrastructure to make their use a practical reality for many users. There is uncertainty over the leading technology and manufacturers have been unwilling to invest until this has been proven.
We do not have our ‘head in the sand’ over this and new technologies will steadily drive market share. However, the regulatory environment will remain favourable.
To put this into context, Euro 6c (platinum filters for direct injection cars) will take effect for new models from September 2017 and for all models from September 2018. JMAT estimate that there will be an implied value uplift of 100% per vehicle. Pollution is no less of an issue in emerging markets and tightening regulation will also substantially increase the catalyst value per vehicle.
In short, it’s not all bad news and JMAT is likely to see steady progress in other divisions and the New Businesses Division (exposure to new battery technologies) moving to profitability. In our opinion, the shares offer good long-term value.
Graham H Campbell
Chief Executive Officer, Saracen Fund Managers Ltd and Co-Manager of the TB Saracen Global Income and Growth Fund