Prospects for 2010: Adrian Clayton

Adrian Clayton, Alphen Asset Management reviews how the company has managed money over the last two years, and notes some concerns for 2010.

As an aside, it struck me that we first started writing this newsletter (then "The Appleton Daily View") way back in May 1999. A decade has passed and we now have a healthy contingent of very capable scribes and a readership base that has exploded. Thank you for your readership, and thank you to those that offer constructive feedback and a very special thanks to those that reward our writing toils with investments in the PSG Alphen funds we manage. We are most appreciative.

Alphen's value basis for investing did not help us in early 2008. The utterly overvalued stock market was parabolic with momentum, particularly within the Resource Sector, and we warned consistently of serious bubbles forming. In fact, we warned of many bubbles like housing, the carry trade, small caps, commercial property, etc. However, it took much longer than we had anticipated for the stock market to correct and, when it did, it unfortunately shattered all parts of the JSE including the cheaper companies wherein we had attempted to find refuge.

But within the abyss we sought hope and in late 2008 we began, for the first time since the latter half of 2006, to feel that real broad-based value was returning to our bourse. Company valuations had reached a point where earnings were becoming irrelevant and the risk to equity ownership had diminished radically. At the time, ironically, many market commentators were completely focused on macro-economic factors rather than appreciating that stocks had already discounted Armageddon. The JSE bottomed out at a little below 18,000 and the rest is history.

Since Q4 2008, Alphen's investment performance has been outstanding across our income, asset allocation, and equity funds and we ascribe this performance to the implementation of our view, with conviction, that during this latest market correction many quality companies' share prices did not reflect the deep seated embedded value or corporate DNA that builds within a business after years of successfully operating.

Consequently, our funds are now in a position where long-term and short-term performance is back to where were previously. Various other quality asset managers are in a similar position and our message here is that sound performance or returns, as we have indicated many times before, is not a linear phenomenon but occurs instead in explosive bursts. The objective for the investor must be to find quality managers and appreciate that they operate within cycles that are impossible to predict with any accuracy. Intelligent investing involves staying the course with the stars!

Our views on markets are presently very different to what they were just a few months ago. We are concerned at the speed at which stocks have re-rated and again we are feeling that we are in the midst of the momentum trade in many areas - currencies, commodities and some stocks in particular. This is hostile territory for value seekers. On the JSE we now find few stocks that realistically offer high expected future returns and the potential for sustainable inflation-beating returns from current levels on the JSE over the near term is diminishing.

Our favoured companies at this stage in the cycle are those with astute management and strong balance sheets that are large cash generators and reward investors with high dividend yields: we simply like defensive business models.

Unfortunately, we are not raging bond bulls either, but slowly rising yields are more to our liking. About the only asset class that continues to look attractive, is offshore and we feel that many quality companies in developed markets do offer value, with the added optionality the view that we feel that the rand is overvalued.

In a nutshell, Alphen's portfolios have evolved from highly strung racing whippets intoxicated with the whiff of easy rabbit to safe, steady and much slower Saint Bernhard's, geared for retrieval should an inevitable avalanche disrupt the party.

Now some quick comments on 2010.

Firstly, emerging markets are presently being perceived as „safe havens". They have somewhat better fiscal and monetary disciplines than their larger developed siblings and their growth prospects are perceived to be significantly better. The problem is that this is a consensus trade and asset prices have moved up considerably and currencies have strengthened dramatically.

It concerns us that most emerging markets have not adjusted their economies adequately to deal with the new world. The new world is low and slow and export orientated countries will be facing a diminishing external market. Internal consumption is key for sustaining prosperity during this new interim world order. The problem for the emerging world is not only that they have not had the time to develop consumption based economies, it is also that their currencies have strengthened aggressively on the consensus trade, for some, this has further undermined their competitive edge. Investor expectations for growth out of the emerging world is high, 2010 could be a watershed year.

Secondly, until now most of the focus with respect to the economic fall-out has been on the USA. It is very likely that Europe will be revealing more warts next year and become the new worry area. The EU is a hotchpotch alliance in many ways, particularly as far as financial matters are concerned. Simply put, from a cultural perspective the Italians, Greeks and Spanish have very different mindsets to money management relative to the Germans and French. Fiscal restraint has been lacking in places and the traditional usage of currency devaluation is no longer an option for troubled economies under the one currency franchise model. Watch this space in 2010!

Thirdly, on the global socio-political front a real concern in the year ahead is the failing war in Afghanistan and the continued instability in Pakistan and Iraq. Added to this is the inability of the west to rope-in Iran and Mr. Ahmadinejad. The Iranians seem utterly determined to circumvent UN resolutions and follow a perilous path of nuclear proliferation.

This is going to challenge President Barack Obama's stance of friendly diplomacy and also stands a good chance of undermining sound relations between the US and Israel. The Israelis are certainly unlikely to sit idly whilst Iran covertly builds uranium-enrichment plants such as the one discovered outside the city of Qom.

Then, on the domestic front, we will be watching developments around Eskom, the state of the nation under a strangling rand and the extent to which President Zuma can appease rivals within the tripartite alliance. Tempers are rising in SA politics and, whilst this does carry a real threat to markets, the silver lining is that our nation desperately needs a strong opposition and 2010 may be the year that verbal threats are converted into political activity and the emergence of a serious political opponent to the ANC is borne.

Clearly 2010 is going to be a fascinating year. We really doubt whether markets will deliver glittering returns as they did in 2009. This aside, we look forward to keeping you abreast of market matters in 2010.

The Alphen Angle is an electronic newsletter of Alphen Asset Management. To read more about Alphen please go to AlphenAM.co.za.