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PMC $1.77

A good read on market direction

  1. arthur

    7,397 posts.

    Look at the p/e's on the US stocks ??,
    a bit more to go yet



    ---------------------------------------------------
    Third Quarter Activities Report

    PLATINUM CAPITAL LIMITED 2002-04-09 ASX-SIGNAL-G

    HOMEX - Sydney

    +++++++++++++++++++++++++
    COMMENTARY

    The power of low cost money, with the Fed fund's rate at a 40 year
    low of 1.75%, has worked much more effectively than we had dared to
    hope. Not only have we seen a strong rebound in consumer spending in
    the US, but business confidence in Europe has also rebounded; for
    four months in a row now the IFO survey of expectations in Germany
    has been rising. This has been anticipated by the market so, as noted
    earlier, there has been a surge in the value of cyclical stocks.

    The focus has now switched to the prospect of tightening interest
    rates (Sweden and New Zealand have already raised rates). A measure
    of this is revealed in the forward rates which imply rises of 100
    basis points late in the northern summer. As we remain somewhat
    ambivalent about the strength of the recovery we suspect these
    forward rates may exaggerate the actual outcome, although, there have
    been some surprisingly large price rises in several commodities which
    are prima facie in abundant supply eg steel, various plastics, etc.
    Nearly all the companies we visited in March expressed disappointment
    with order levels, with only one out of the 40 companies seeing any
    indication of improvement. De-stocking has been taking place at an
    abnormal rate (see the attached figure of US inventories).

    The piece we wrote last quarter on Enron proved prescient so we do
    not share the general feeling of surprise and betrayal. We have long
    bored our readers with complaints of wholesale transference of
    corporate ownership via vast stock options - which in addition fail
    to be accounted for correctly. We have complained about accounting
    practices, dubious recognition of revenues and worse still, the role
    played by investor relations officers to apply spin at every turn.
    Another matter that gets less than due coverage is the predilection
    of investment bankers to value shares on operating earnings - so
    called EBITDA (Earnings Before Interest, Tax, Depreciation &
    Amortisation). This may suit those pursuing M&A fees but does little
    to inform real investors. The "D&A" part masks all manner of
    accounting iniquities and the "I" part confuses the fact that
    shareholders are the last in line to get free cashflow, the source of
    dividends, retained earnings and the ultimate reason for INVESTING.

    The above comments may not seem important to some but illustrate a
    system that is facing serious imbalances. The Enron debacle and
    revelations of dubious associated dealings highlighted the amount of
    off balance sheet risk that prevails. This risk becomes more real as
    interest rates turn and positions have to be covered.

    It has been the ability of the Government's sponsored enterprises
    such as Freddy Mac and Fanny Mae to cope with massive housing
    mortgage refinancing that allowed the US consumer to fund housing at
    progressively lower rates throughout the economic slowdown and
    simultaneously to free up funds for the purchase of other goods.
    These entities have progressively increased their exposure to
    interest rate risk and credit risk. They are, in fact, monumental
    hedge funds with equity gearing of 64 times through their
    guaranteeing of mortgages against default and their ownership of
    portfolios of mortgages. A high proportion of their borrowings are
    funded short term which at present low rates allows them to make good
    spreads. To mitigate the risk of a rise in rates they are obliged to
    be aggressive users of options instruments. As matters stand today a
    rise in rates need not necessarily cause them great loss but there is
    no telling whether there will be a period of volatile interest rates
    nor is one able to predict the behaviour of borrowers. It is
    difficult to calculate the option premiums they are paying annually
    but between the two of them it could be as high as $4 billion.
    Receiving those fees are investment banks and other institutions. In
    unstable times these interest rate "insurance policies" could become
    credit risks as margin calls mounted.

    The important thing for investors to recognise at this point is that
    the tide may have now turned. Regulation of corporations will become
    more stringent, money will tighten and input prices may be on the
    rise. This is the very opposite of the experience of recent years and
    implies downward pressure on the reported profits of some companies.

    As we look at world markets we continue to be attracted to the values
    we find in Europe. While this economic block may be slower to come
    out of the trough than the US we are reasonably comfortable the
    shares we own are realistically valued. Below is Morgan Stanley's
    price earnings ratio projections for the US, Europe and Japan.

    PROSPECTIVE PRICE EARNINGS RATIOS


    Region
    2002 2003 2004
    Europe MSCI 18.8 15.8 14.9
    US 30.6 24.8 23.4
    Japan 24.1 18.7 17.9


    We are reluctant to follow the crowd and tilt the portfolio
    decisively in favour of cyclicals because of the reservations voiced
    above. We have been adding to companies that are in defensive
    industries because they are attractively priced but somewhat
    neglected as investors chase after cyclicals; this is another way to
    say that the market is already building into cyclicals a fair degree
    of recovery.

    The other fashionable area at present is emerging markets. We see
    Korea as our representative in this arena though we also have some
    money in China and India. Some of our Korean shares have been
    exceedingly strong and as noted above we have tended to sell into
    that strength. For completeness it should be said that we remain
    comfortable with our positions in Japan with the caveat that we
    continue avoiding the Japanese Yen.

    CONCLUSION

    Many markets have already built in valuations which partly reflect
    the anticipated recovery in economic activity globally. Valuations
    are reasonable in some areas but in a broad sense are not compelling,
    particularly as we believe there will gradually be leakage of funds
    out of overvalued sectors such as retailing in the US and some big
    capitalisation names. These remain our area of attention for
    shorting. At this stage we believe that high valuations and
    uncertainties such as rising oil prices and the traumas in the Middle
    East will restrict the scope for a broad and aggressive advance in
    share prices globally.


    K Neilson
    MANAGING DIRECTOR

    MORE TO FOLLOW


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