Rising to the Challenge
Despite China’s wobbly shadow banking system, it’s not time to hit the panic button yet, says Meg Woods of Veritas Asset Management
AGAINST THE BACKDROP of the eurozone sovereign debt crisis, sluggish US growth and an ageing population in developed countries, market levels need to be viewed in a longer-term context than just the golden years of the baby boomers.
The valuation levels to which we became accustomed in the 1980s and 1990s reflected the halcyon baby boomer growth years. It seems we now face a reversion to the longer-term mean. At Veritas we recognise the challenge presented by the economic backdrop in our quest for real returns, ahead of inflation, on a rolling five-year view.
We would first note that the corporate sector as a whole is healthy and balance sheets strong. Aggregate cash levels are significantly higher now than at the peak of the ‘tech’ or credit bubbles.
Furthermore, the valuation of equities is clearly more attractive than that of bonds. The dividend yield on the FTSE AllShare index is now 3.3 per cent to the ten-year gilt’s 2.3 per cent (BoA Merrill Lynch UK Gilts 10-15 Years), and of course dividends offer the prospect of growth over time which interest coupons do not.
It is a backdrop against which our investment approach of investing only in established companies, financially sound with proven management, a moat around the business and the tailwind of one of our global growth themes remains entirely apposite. In the short term equities as an asset class were caught last year in the downdraft of the European sovereign debt crisis and have subsequently rallied as systemic fears eased. However, we are not market timers: calling markets is tough, and few people do it well consistently. Many who sell well fail to get back in again lower down.
Our current three conviction themes, which provide the tailwinds for growth over time, remain unchanged and position us for uncertainty. These are ‘structural growth’ (those pockets of growth where the growth will take place regardless of the economic cycle), ‘scarcity’ and ‘dependable compounders’, those companies that we believe will dependably deliver compound growth over the years.
Asia remains a long-term structural growth theme. Growth in China is decelerating from an unsustainable 11-12 per cent to 8-8.5 per cent as a result of Beijing’s prudent guidance of the tiller. Inflation, having risen disproportionately, is now falling. Given continuing Western economic fragility and with inflation moderating, monetary policy has shifted from stimulus withdrawal to a slight easing.
The current ‘panic button’ issue is China’s shadow banking system — trust companies that disintermediate credit from the regular banking system to finance riskier businesses. However, these are all part of China’s financial structure — Beijing is ahead of the West in ring-fencing its commercial banks! Trust company assets total $600 billion, or 7 per cent of loans in the formal banking system, and they are not permitted to leverage their investments. Local governments, again a part of Beijing’s structure, do in many instances have ‘non-performing loans’ (interest not being paid) — because these loans were made at the behest of Beijing to finance infrastructure projects such as schools, which do not pay interest.
Some property developers have over-extended themselves and a correction is due. The China story is not without its warts, but, with a savings-rich population upgrading their lifestyles, it seems to us it has significantly fewer warts than the Western world.
Our scarcity theme continues to embrace such diverse resources as property in land-constrained countries such as Singapore, and orbital slots for satellites, benefiting from the growth in bandwidth usage on the back of high-definition television, videos on demand and mobile data.
Another scarcity theme relates to the oil servicing sector, benefiting from the long-term spend required to keep the world adequately supplied with oil and gas. Non-conventional sources are being developed, such as oil sands and shale gas; refinery upgrades are required to meet increasing environmental legislation. All these call for greater engineering and support services — significantly, regardless of shorter-term fluctuations in energy prices.
Veritas Asset Management (UK) Ltd, 6th Floor, Elizabeth House,
39 York Road, London SE1 7NQ
020 7961 1600; veritas-asset.com