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Wildebeest investors and the dangers of the herd

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You can learn a lot from observing animals in the wild — if you have time and patience. As a decidedly impatient sort, I find it easier to watch David Attenborough on television, where the distinguished naturalist compresses years of research and months of on-site filming into an hour or so.

Don’t get me wrong. I love a hike in the Scottish Highlands as much as anyone, especially now when the pandemic makes such trips impossible and therefore more tempting. However, even on the longest walk it’s hard to spot a fraction of the fascinating fauna shown in a single episode from Sir David.

Among his favourite themes is herd behaviour — the way animals stick together when it seems irrational — at least in the eyes of the rational human observer. For example, wildebeest plunging into a foaming river to get to the other side, even when they see those entering the water first dragged away by the current.

It’s an image that finance experts have often applied to the markets, especially at times when investors seem to be throwing logic aside in pursuit of a fast-flowing stock surge.

Wildebeest figure prominently in a report this week from Rothschild’s bank, which says that investors often exhibit the same “herding behaviour” as animals, seeking “the safety and comfort of the herd”. In a boom, they pile in together into overvalued markets; in a bust, they collectively panic and dump stock.

Rothschild’s timing is no accident, coming amid growing warnings of a global investment bubble, notably in US tech stocks. Veteran fund manager Jeremy Grantham, co-founder of the GMO investment company, warned this month of a “bubble that is beginning to look like a real humdinger”.

Mark Warner, senior portfolio manager at Rothschild, said: “People see their neighbours getting very rich and they want to do the same. It’s extremely difficult to restrain yourself from herd-like behaviour.”

The report includes some fascinating science, including a Leeds university study which tracked people who had been asked to walk about in a large hall. A few were given secret instructions to follow a specific route. Although participants were forbidden to communicate, the “uninformed” ended up following the “informed” in a snake around the floor. And they did that with no benefit in sight — the comfort of following others was enough reward.

Rothschild cautions that even professional investors fall for the lure of the herd, even when they know they are breaking their own investment rules. Some do so knowingly, buying overvalued stocks in a boom in the belief that others will drive prices even higher.

Now, professional investors are far from agreed that we actually have a market bubble today, even in high-priced US tech stocks. Howard Marks, founder of Oaktree Capital and just as experienced a fund manager as Mr Grantham, this week rejected suggestions that it was time to switch out of tech and into lower-priced, out-of-favour shares, such as financials and energy — the so-called value stocks.

Criticising traditional valuation models, which generally say value stocks are cheap now and tech is super-expensive, Mr Marks said: “Investing on the basis of rote formulas and readily available fundamental, quantitative metrics should not be particularly profitable.”

So what has all this to do with the retail investor? Clearly, if the professionals were 100 per cent sure that tech was in bubble land, those stocks would already be collapsing.

Instead, there is widespread uncertainty. For the moment, worries about high asset prices are offset by the confidence generated by the huge injection of ultra-cheap money by central banks into markets and, in tech, the sense that a entrepreneurial revolution is creating unmissable opportunities.

In a clear sign that the bulls aren’t ready to concede, Affirm, a US consumer finance start-up, saw its stock almost double on its stock market debut on Thursday, giving it a $23bn-plus valuation.

With so much cash around, many well-off households in the UK and other developed countries are well-placed to invest — having mostly seen their savings rise in the past year, as Covid-19 has led to cancelled holidays and entertainments. While the pandemic has left the poor worse off, the rich are in a stronger financial position.

As returns on bank deposits and safe bonds are negligible, the opportunity cost of holding equities is limited. So stocks remain in fashion, even when they trade at historically high price levels.

Moreover, even in equities there are still safety plays. The UK market, which has underperformed because of Brexit and because of a lack of tech stocks, is widely seen as ripe for recovery. Alexander Wright, a Fidelity fund manager, recently told an FT panel that the UK was “the best-value market globally”.

More generally, past precedent shows that investing in equities makes sense as a long-term strategy, as long as you are in a position to ride out a sell-off that might last a year or two. Tom Holmes, managing director of Salisbury House Wealth, a London-based wealth manager, says: “Equities . . . have outperformed all other asset classes”, returning 12.4 per cent a year in the UK since 1925, compared with 6.6 per cent for global bonds and 4.9 per cent for cash.

Rothschild recommends picking stocks on the basis of careful analysis of individual companies. It is currently backing Ryanair (on travel recovery hopes), US cable television companies (stay-at-home entertainment), and London-listed construction equipment rental group Ashtead (good management coping well with the pandemic).

Still, retail investors need to take care in today’s markets. If you think that global equities are near a likely peak, it may be a good time to break with the herd and take profits, especially with “risk-on” assets such as tech stocks — even if you believe prices may have a little further to climb.

A surprise shock could come from anywhere. Andrew Slimmon, of the investment management arm of US bank Morgan Stanley, says that the moment the US Federal Reserve hints at ending easy money policies, “sky-high valuations” will be hard to justify. He also warns in a report that investors don’t seem to be taking account of geopolitical risks. “When they do come to the surface, expect to see panic.”

Private investors are generally less well informed than professionals and, typically, in no position to move as quickly. Unless you are willing to sit in front of screens night and day, you will rarely have a good sense of market direction. You will be the wobbly-kneed weakling of the wildebeest herd, easily taken by the torrent.

Stefan Wagstyl is editor of FT Wealth and FT Money. Email: stefan.wagstyl@ft.com. Twitter: @stefanwagstyl





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European stocks stabilise ahead of US inflation data

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European equities stabilised on Wednesday after a US central banker soothed concerns about inflation and an eventual tightening of monetary policy that had driven global stock markets lower in the previous session.

The Stoxx 600 index gained 0.4 per cent and the UK’s FTSE 100 rose 0.6 per cent. Asian bourses mostly dropped, with Japan’s Nikkei 225 and South Korea’s Kospi 200 each losing more than 1.5 per cent for the second consecutive session.

The yield on the 10-year US Treasury bond, which has dropped in price this year as traders anticipated higher inflation that erodes the returns from the fixed interest securities, added 0.01 percentage points to 1.613 per cent.

Global markets had ended Tuesday in the red as concerns mounted that US inflation data released later on Wednesday could pressure the Federal Reserve to start reducing its $120bn of monthly bond purchases that have boosted asset prices throughout the Covid-19 pandemic.

Analysts expect headline consumer prices in the US to have risen 3.6 per cent in April over the same month last year, which would be the biggest increase since 2011. Core CPI is expected to advance 2.3 per cent. Data on Tuesday also showed Chinese factory gate prices rose at their strongest level in three years last month.

Late on Tuesday, however, Fed governor Lael Brainard stepped in to urge a “patient” approach that looks through price rises as economies emerge from lockdown restrictions.

The world’s most powerful central bank has regularly repeated that it will wait for several months or more of persistent inflation before withdrawing its monetary support programmes, which have been followed by most other major global rate setters since last March. Investors are increasingly speculating about when the Fed will step on the brake pedal.

“Markets are intensely focused on inflation because if it really does accelerate into this time near year, that will force central banks into removing accommodation,” said David Stubbs, global head of market strategy at JPMorgan Private Bank.

Stubbs added that investors should look more closely at the month-by-month inflation figure instead of the comparison with April last year, which was “distorted” by pandemic effects such as the price of international oil benchmark Brent crude falling briefly below zero. Brent on Wednesday gained 0.5 per cent to $69.06 a barrel.

“If you get two or three back-to-back inflation reports that are very high and above expectations” that would show “we are later into the economic recovery cycle,” said Emiel van den Heiligenberg, head of asset allocation at Legal & General Investment Management.

He added that the pandemic had sped up deflationary forces that would moderate cost pressures over time, such as the growth of online shopping that economists believe constrains retailers’ abilities to raise prices. Widespread working from home would also encourage more parents and carers into full-time work, he said, “increasing the labour supply” and keeping a lid on wage growth.

In currency markets on Wednesday, sterling was flat against the dollar, purchasing $1.141. The euro was also steady at $1.214. The dollar index, which measures the greenback against a group of trading partners’ currencies, dipped 0.1 per cent to stay around its lowest since late February.



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Potash/grains: prices out of sync with fundamentals

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The rising tide of commodity prices is lifting the ricketiest of boats. High prices for fertiliser mean that heavily indebted potash producer K+S was able to report an unusually strong first quarter on Tuesday. Some €60m has been added to the German group’s full year ebitda expectations to reach €600m. Its share price has gone back above pre-pandemic levels.

Demand for agricultural commodities has pushed prices for corn and soyabeans from decade lows to near decade highs in less than a year. Chinese grain consumption is at a record as the country rebuilds its pork herd. Meanwhile, the slowest Brazilian soyabean harvest in a decade, according to S&P Global, has led to supply disruptions. Fertiliser prices have risen sharply as a result.

But commodity traders have positioned themselves for the rally to continue for some time to come. Record speculative positions in agricultural commodities appear out of sync even with a bullish supply and demand outlook. US commodity traders have not held so much corn since at least 1994. There are $48bn worth of net speculative long positions in agricultural commodities, according to Saxo Bank.

Agricultural suppliers may continue to benefit in the short term but fundamentals for fertiliser producers suggest high product prices cannot last long. The debt overhang at K+S, almost eight times forward ebitda, has swelled in recent years after hefty capacity additions in 2017. Meanwhile, utilisation rates for potash producers are expected to fall towards 75 per cent over the next five years as new supply arrives, partly from Russia. 

Yet K+S’s debt swollen enterprise value is still nine times the most bullish analyst’s ebitda estimate, and 12 times consensus, this year. Both are a substantial premium to its North American rivals Mosaic and Nutrien, and OCI of the Netherlands, even after their own share prices have rallied.

Any further price rises in agricultural commodities will depend on the success of harvests being planted in the US and Europe. Beyond restocking there is little that supports sustained demand.

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Amazon sets records in $18.5bn bond issue

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Amazon set a record in the corporate bond market on Monday, getting closer to the level of interest paid by the US government than any US company has previously managed in a fundraising. 

The ecommerce group raised $18.5bn of debt across bonds of eight different maturities, ranging from two to 40 years, according to people familiar with the deal. On its $1bn two-year bond, it paid just 0.1 percentage points more than the yield on equivalent US Treasury debt, a record according to data from Refinitiv.

The additional yield above Treasuries paid by companies, or spread, is an indication of investors’ perception of the risk of lending to a company versus the supposedly risk-free rate on US government debt.

Amazon, one of the pandemic’s runaway winners, last week posted its second consecutive quarter of $100bn-plus revenue and said its net income tripled in the first quarter from the same period a year ago, to $8.1bn.

The company had $33.8bn in cash and cash equivalents on hand at the end of March, according to a recent filing, a high for the period.

“They don’t need the cash but money is cheap,” said Monica Erickson, head of the investment-grade corporate team at DoubleLine Capital in Los Angeles.

Spreads have fallen dramatically since the Federal Reserve stepped in to shore up the corporate bond market in the face of a severe sell-off caused by the pandemic, and now average levels below those from before coronavirus struck.

That means it is a very attractive time for companies to borrow cash from investors, even if they do not have an urgent need to.

Amazon also set a record for the lowest spread on a 20-year corporate bond, 0.7 percentage points, breaking through Alphabet’s borrowing cost record from last year, according to Refinitiv data. It also matched the 0.2 percentage point spread first paid by Apple for a three-year bond in 2013 and fell just shy of the 0.47 percentage points paid by Procter & Gamble for a 10-year bond last year.

Investor orders for Amazon’s fundraising fell just short of $50bn, according to the people, in a sign of the rampant demand from investors for US corporate debt, even as rising interest rates have eroded the value of higher-quality fixed-rate bonds.

Highly rated US corporate bonds still offer interest rates above much of the rest of the world.

Amazon’s two-year bond also carried a sustainability label that has become increasingly attractive to investors. The company said the money would be used to fund projects in five areas, including renewable energy, clean transport and sustainable housing. 

It listed a number of other potential uses for the rest of the debt including buying back stock, acquisitions and capital expenditure. 

In a recent investor call, Brian Olsavsky, chief financial officer, said the company would be “investing heavily” in the “middle mile” of delivery, which includes air cargo and road haulage, on top of expanding its “last mile” network of vans and home delivery drivers.



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