Kokkie Kooyman: Now is the time to invest in developed-country banks

In a presentation last week, Kokkie Kooyman, (pictured) fund manager of actively managed, long only international funds with Sanlam Investment Managers presented a compelling argument for investing in Bank of America, Scandanavian Bank Den Norske and Bristish based Lloyds TSB. And Kooyman should know. His fund the Sanlam Global Financial Fund has turned in a compound return of 13%, compared with a -1% turned in by the MSCI World Financial Index.

Equity performance in the foreseeable future will be more muted

Kooyman started his presentation reminding his audience that equity returns of the recent past have been an historical aberration.

In the chart below, (sourced from Credit Suisse) the red/ochre bars show that the long term performance (from 1900 to 2008) of stock exchanges around the world, ranged between about 1.5% to about 6.5%. The dark blue bars show performance in the eight year period between 2000 and 2008 and the grey bars show the period between 1990 and 1999. During the grey bar period, all countries outperformed their long term averages, some reaching performances in excess of 15%.

Table 1: Real equity returns around the world in recent periods and over the long run: 108 years vs past 20 years

This pattern is also apparent when comparing 20 years return-cycles from 1700 to the present for the UK Stock market,' said Kooyman. 'Average returns for twenty year periods had real returns of between -2% and +4%. The period between 1980 and 1999 is the only twenty-year period in the history of the UK stock market that enjoyed an average real return of between 8 and 10%. It is important to recognize that those of us aged 50 or so have a sense that the recent twenty year period is normal, whereas performances around the world have in fact been far from normal in historical terms. We have to lower our equity expectations for the next decade or so,' he said.

We all know the origin of the present crisis; In the US in a period of ultra-low interest rates, houses were built for everyone, on debt priced to assume that house prices would continue to rise. This resulted in excessive borrowings. During this period, US consumers went on a spending binge, and personal saving measured as a percentage of disposable personal income went into deficit in 2005 for the first time since these personal savings rates were first monitored in 1946.

How long will it take for the excessive leverage to unwind?

The question posed by the chart below is: How long will it take to undo the excesses which took at least ten years to build up? 'We all know that this story has ended in tears', said Kooyman. 'The developed market growth prospects look bleak'.

Some expected responses to this situation are the following:
- The US and the UK will have budget deficits of between 10 and 15%. There will be pressure on the state to curtail state spending, due to their need to balance their budgets.
- Funding requirements will push up tax rates.
- There will be a reverse of the Reagan/ Thatcher pro-growth policies. Government policies are more likely to lean to socialism, big government spending plans will destroy growth and productivity.
- Personal savings rates need to be rebuilt and gearing reduced.
- Funding requirements will push up interest rates.
- There is a high risk of large US$ decline and later higher inflation.

'But we see that housing starts, which have reached the lowest levels since 1959, are beginning to turn, which could provide a short term ease for unemployment figures, and fool us for a while,' said Kooyman.

Source: BCA Research, Special Report, Inflation and Deleveraging: A Turning Point in the Debt Super Cycle?

On the other hand, emerging markets look stronger and feel safer

Analysts have projected emerging market growth at 7% , compared with developed market growth of 2% per annum for the next three years. Emerging markets have
- Low budget deficits
- Low debt levels
- Low consumption levels
- Healthy banking systems
- And more importantly, positive population growth and increasing income per capita.

All these trends lead to increased spending, growth, increased wealth and higher stock markets, said Kooyman. Emerging markets also have the advantage of low wage costs.

'Between 1980 and 2009, capital investment measured as a percentage of GDP has trended upwards in 'Developing Asia', ending in the region of 39%, while it has been trending downwards in the G7 countries, ending at about 22%. It is likely that the stark differences in income per capita in the developed world, compared to the developing world, market cap of the developed world versus the developing world and so on, are likely to disappear over the next few decades', said Kooyman.

So on the one hand we have a region where there is increasing productivity, higher relative capital flows, increasing wealth per capita and a low starting debt to GDP ratio and on the other, a region where populations are stagnant or declining, and the rate of future growth is under review. Is it therefore a given that we should focus on emerging markets?

'Not so', says Kooyman.

Table 2: Imbalances between the developing markets and emerging markets are expected to disappear

Table 3 (below) compares the shows that the emerging banks took less risk between 2001 and 2007. It was the developed market banks that increased their risk via higher gearing, that ultimately led to their downfall in the 2008 period. In other words, emerging market banks gave higher loan growth at higher risk.

Table 3: The emerging market banks took less risk

Good investment returns are made where you have low expectations.

According to Kooyman, good investment returns are made when and where you have low expectations. At the moment, there is a compelling argument to be made for investing in the 'bombed out' banks of developing countries.

Table 4 below, which shows compound returns of $1000 investment, dividends re-invested over two time periods, between 01 and December 07 (six years to 'pre-crash') and the second set of data which shows performance from Jan 01 to December 08, which include the fall in value during the October/November 2008 period.

The table shows that developed market banks were 'out performed' by their emerging market peers during both time periods, and that returns through the period remained positive in the case of emerging country banks. 

Table 4: What happened after the previous crisis?

Table 2

So where are the current opportuties?

Table 5 below compares the Price/NAV ratios of nine banks in different geograhic regions in December 2001, December 2007 and July 2009, and the compound return made over this period in US$.  

In December 2001, the P/NAV ratios of Itau, SBI, BCA Garanti and TSKB were lower and therefore more attractive than the P/ NAV's of Barclays and JMP. However in July 2009, this situation has reversed, with Barclays and JPM offering more potential for higher compound returns. 

Table 5: Do you look for growth or low ratings?

In January 2001 it was the developing country banks such as Itau (Brazil) SBI (India) BCA (Indonesia) and TSKB (Turkey) which had the low ratings and gave high loan growth at lower risk. Now, it is the developing market banks which are showing their investment potential with their low ratings.

'We don't know when these banks will re-rate, it may be a long time, all we know is that they are 'bombed out' right now and deserve our attention,' said Kooyman.