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Elite LWM East-West Value Fund
Positive Yet Cautious Returns
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April Performance Update
In March our cautious investment strategy (as of March 31st we were still holding 67% in cash) meant that our returns, although positive, were behind those of major markets. However, we still maintain a performance lead on all major global markets.
Full details on the fund including stock and option positions can be found in the latest factsheet which is available here.
In this report, we look at current global markets and attempt to answer the burning question - is the recent rise in equity prices sustainable?
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Elite LWM East-West Value Fund Performance Compared to Major Markets as at March 31, 2009
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Misplaced Optimism?
In the past 6 weeks, global markets have risen strongly from the lows that were hit in early March, typically rising in the region of 20-30%.
Is this a sustainable rally, based on improving fundamentals? Or is this merely the latest in a series of 'suckers' rallies', where those prone to optimism are lured back into the market by a combination of apparently low prices and improving prospects, only to see their hopes (and their bank balances) dashed as markets once again plunge?
As always, only time will tell. But we continue to believe that the evidence points to a rather more sanguine reading of global economic matters than appears to have taken hold of late.
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The Green Shoots Theory
There is, undoubtedly, some evidence for optimism.
Housing markets in the UK and US have started to show signs of bottoming out. In the UK, prices rose in March. Estate agents have reported increasing numbers of new potential buyers for 5 consecutive months. The number of new mortgage loans increased. In the US, housing sales rose in February. Valuations in the US now look more in line with historical norms (but in the UK are still significantly above).
Many of the biggest (surviving!) banks have recently released results showing an unexpected level of profitability. The scale of these earnings and general optimism that we have seen the worst has caused the US financial sector to nearly double in the past 6 weeks.
Much of the continued fall in various countries' GDP has been as a result of firms slashing inventories. This cannot continue and a boost is expected - purchasing manager sentiment is improving. In the US, vehicle sales rose in March.
In China, real GDP growth, although the slowest in more than a decade, seems to have bottomed out at 6.1% year on year for Q1 2009. The government's stimulus package seems to be having a positive effect - bank lending and steel prices have increased. Property markets in major cities are showing signs of improvement. A rebound in China's economic dynamism could well prove a valuable prop for global economic activity.
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The Eye Of the Storm?
But for those trying to be objective, the green shoots are visible only against a dire, dire backdrop.
Much of the optimism is centred on indicators that suggest not that things are getting better, but that they are getting worse more slowly.
The nature of this downturn, a combined banking / credit / housing crisis, plus its globally synchronised nature, makes it highly likely that this downturn will be deeper and more prolonged and that eventual recovery will be gradual.
Unemployment continues to rise in almost all economies. The increasing impact of job losses and ongoing job uncertainty will depress consumption and house prices. This will mean that companies are more likely to lay off staff and that the capital adequacy ratios for banks continue to cause problems. Consumers are responding to this uncertainty by spending less and saving more. Although increased saving (i.e. deleveraging) is exactly what is required for sustainable long-term recovery, in the short term it will only exacerbate the pain.
Protectionism, despite protestations to the contrary at the recent G20 (which was little more than a PR success) is on the rise. Tit for tat trade subsidies and tariffs will further hamper trade and enhance inefficiency. At the same time, a lack of political leadership in the likes of the UK and US will mean that the difficult decisions and policies that need to be taken and adopted cannot be achieved as no political administration has the courage to stand up and say what is really required nor what the consequences will be.
Look behind the surprisingly pleasing profit figures from some of the big banks and things do not quite stack up. Indeed, profit has often only been possible as a result of accounting changes that quietly came into effect in the first quarter of this year and which allow banks more discretion in using their own valuation methods when assessing the value of assets on their balance sheets. Whilst there is some logic to a relaxation of mark to market rules the danger is that this re-introduces one of the key factors that got us into this situation in the first place.
And whilst markets have recently been euphoric, the bond markets have been telling a darker tale. As noted in the Economist:
"[In March] the corporate-bond market saw 35 defaults, the largest number of non-payers in a single month since the Depression, according to Moody's. The default rate is now 7%, up from 1.5% a year ago, and the rating agency predicts that it will reach 14.6% by the fourth quarter."
And there is still so much credit card, sub prime, Alt-A and prime debt (not to mention home equity lines of credit, car loans etc) still to sour.
So whilst there are genuine grounds for some optimism, the very real danger is that we are currently in the eye of the storm.
We believe that further, sharp falls in stock markets around the world are highly likely.
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The Good News!
In this as with any crisis, indiscriminate fear will lead to the prices of companies, both good and bad, being savagely marked down.
We do not invest in markets per se - we invest in a portfolio of the 25-35 best value companies from around the world. We are now seeing some superb businesses that are available at unbelievable prices. More than 70 years of history have shown that buying such companies at depressed prices will provide investors with wonderful returns over the longer term.
Our focus on companies that have little or no debt and operate in sustainable markets means that we invest in companies with no real existential risk. Whilst thorough research is essential, one can now uncover solid companies that are trading at incredible discounts to their true value and that can be purchased at prices that could well prove to be once in a lifetime opportunities.
Not only do these companies offer the possibility of tremendous stock appreciation, they also tend to provide attractive dividends. Also, our focus on companies with strong levels of cash and low levels of short-term debt mean that these companies are more able than most to keep paying (or even to increase) their dividends.
But, whilst we see the current market as offering tremendous opportunity, we also recognise that just because a company is extremely undervalued does not mean that it may not fall further before ultimately bottoming out.
As a result, we are extremely selective about the purchases that we make. Also, we combine two purchasing strategies to keep risks to a low level whilst enabling us to exploit ongoing market volatility.
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Our Purchasing Strategy for 2009
The Elite LWM East-West Value Fund began purchasing stocks in January 2009.
Because in January we were (and remain) extremely cautious about global economic fundamentals, we adopted a strategy to average into markets over the first 6-12 months of 2009.
To do this, we are employing two complementary approaches.
The first approach is to use pound-cost averaging. Each month we purchase on average 1-3 stocks that we have reviewed and that we consider offer unmissable value. These are companies that our research says have no risk of failure. For us, the risk associated with purchase is not that we buy too early and a company falls further before recovering, but that the stock price appreciates massively and we fail to buy at all at such an incredible price.
An example of such a stock is Canon from Japan. At the time of purchase, Canon was available at the same value as its net tangible assets. It offered strong and resilient earnings, a dividend of nearly 5% and almost zero debt. Its price was vastly lower than its own historical levels. We bought Canon in anticipation that it offered the potential for a rise that could be in the hundreds of percent, whilst at the same time having the security of a near 5% dividend yield.
The second approach involves writing (selling) covered puts. This means that we guarantee that we will buy these stocks for a defined period (typically 3-6 months) at a price some way below the current market price (typically 10-30% below the current price).
These are stocks that we have reviewed and consider excellent value, but for whatever reason we are not prepared to purchase them at the current price. Reasons for this could be that we feel that they are likely to fall further given current market conditions, or that we already have exposure to this sector and do not want to increase our exposure at the current price level.
When we write a put we accept a premium income for providing the guarantee. This income is typically 5-25% of the current stock market value. The greater the ongoing volatility in the stock, the higher the premium that we can acquire.
Disney offers a good example of this. We reviewed the stock and felt it offered exceptional value. However, we felt that there was too much of a risk that it could fall further given the current climate. We therefore wrote (sold) a put on Disney at $12.50 expiring in October.
We received approximately 6.5% for providing the guarantee. To us, this is a win-win situation. If Disney falls to below $12.50 we will pick up a great company at an unbelievable price. (Our net price would be $12.50 minus the options premium of $1.25). If we do not pick up Disney we still get to keep a 6.5% premium that has been earned in only 6 months.
By combining the above two approaches we move gradually into the market whilst reducing the overall level of risk to our investors. If markets fall further, the cash that we hold, plus the dividends and options premiums that we receive will dramatically reduce losses to our clients.
If markets are horizontally volatile, the dividends and options premiums are likely to mean that we outperform (with lower volatility).
If markets rise strongly (we believe any rise will be short lived as it will not be sustainable) then we will lag but the dividends and options premiums (plus capital appreciation on the stocks that we have purchased) should still mean that we post positive returns.
We believe that this purchasing strategy makes the Elite LWM East-West Value Fund ideal for investors who are looking to take advantage of the turmoil affecting global markets but who feel that putting all of their money into the market at this time represents too high a risk.
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Lowes Wealth Management (LWM) is the
exclusive provider of investment advice to the Elite LWM East-West Value Fund.
The objective of the Fund is to significantly outperform all major markets
whilst maintaining a comparatively low level of investment risk.
The Fund uses a classical value investment
strategy which has been employed by Lowes Wealth Management since October 2005.
Over the period the strategy has outperformed all major markets with lower
volatility.
Kind Regards,
Justin Lowes
Lowes Wealth Management
www.loweswealth.com
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Important Notices:
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by Lowes Wealth Management ("LWM") as part of its internal
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LWM makes no representations as to accuracy or completeness. LWM is not
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