Why I Am Optimistic

The UK death count from the Covid-19 virus is now 25,785 and continues to grow, albeit at a slower rate. There is a lot of bad news about the economy still being reported – new car sales have fallen to the level last seen in 1946 and according to the Daily Telegraph the state is now paying more than half of all adults. The same dire economic picture is also seen in the USA and most other countries. But I am still optimistic for the following reasons.

Apart from being a naturally optimistic person, which is a required attribute for any entrepreneur, the medical scene is looking better for several reasons. Below is a chart issued by the Government today which shows the daily number of confirmed Covid-19 cases.

Reported Covid19 Cases 2020-05-05

It is clear that the spread of the disease is falling rapidly and hence the “R” (reproduction) rate is probably less than 1. If the same conditions persist then the disease will gradually die out. Emergency “Nightingale” hospitals are already closing because of a lack of patients. With fewer new cases, the spread of the disease declines. Tracing of infected people and ensuring they are isolated, plus the new phone App to help identify contacts, are two ways the Government hopes will assist in this process. That’s ignoring the potential vaccines or medical treatments on which a lot of money is being expended worldwide at present. It has even been suggested that taking Vitamin D supplements might avoid the worst symptoms of the disease.

But the Government is concerned that if the “lock-down” restrictions are relaxed to enable people to get back to work then the virus may stage a resurgence and we will be back at square one.

Bearing in mind that the current very severe restrictions are causing enormous financial damage to the economy and costing the Government (and by implication, you and me) billions of pounds in paying the wages of furloughed staff and providing loans to companies, the question is how to make a rational decision on when to relax the restrictions and by how much. One way to look at this is how much you value a life. If you know what that value is then you can do some calculations to see what the cost might be and whether it is justified to relax the restrictions.

The Government already has that figure. For example, when calculating the benefit of road safety measures a figure of about £2 million is put on the benefit of saving one life. That is a somewhat optimistic figure though because it not just includes the cost of lost economic contribution and the cost of medical treatment but also what people say they would pay to avoid the loss of life, i.e. it’s a subjective figure to a large extent. However, it is a good starting point.

In the case of Covid-19 deaths, many of the cases are of the elderly or those with existing medical conditions who cost the state money rather than contribute. So the loss might be much less than £2 million from a Covid-19 death. Maintaining the existing strict lock-down might actually be causing some deaths from lack of attention to the early symptoms and treatment of some diseases such as cancer.

You can see therefore that it might make some sense to do some calculations on the impact of relaxing the restrictions to enable the majority of people to get back to work even if it means the deaths might increase. I won’t even attempt to do such a calculation but the Government should.

Those people who are particularly vulnerable could of course choose to continue to self-isolate but there is no reason to have a lot of the economy shut down. It would also be wise to have a phased relaxation of the restrictions so that meetings of people in confined spaces are still banned until the picture is clearer.

There would still be some sectors of the economy that will be severely affected. So restaurants other than those providing take-aways would need to remain closed and hotels be very restricted. Even if they opened they might have few customers. Airlines and trains would also suffer and it’s perhaps no surprise that Warren Buffett has sold all his shares in airlines. He had acquired stakes of about 10% in American Airlines, Southwest Airlines and United Airlines in 2016 which rather surprises me as surely he used to say these were typically bad businesses. I would guess he lost a few billion dollars on that punt. It seems most people don’t expect airlines to recover for at least a couple of years and aircraft leasing companies are in major difficulties as are aircraft and engine producers such as Boeing and Rolls-Royce. Nobody will be buying new planes for a while.

But a lot of the economy can surely get back into action over the next few months if the Government makes some sensible decisions which is surely good news for investors – so long as you are selective about the companies you hold.

In conclusion the panic should be over. We are not all going to die from Covid-19 although a few of us might do so. But in comparison with the normal hazards of living it may not be significant. For example, about 6,000 deaths happen each year from accidents in the home which is many times the figure for accidents on our roads but little attention is paid to the former mainly because the cost of preventing them would be very high and they do not attract much public attention. Average UK deaths from common influenza are 17,000 but it can be as high as 30,000 in some years.

The Government just needs to take some rational economic decisions on lifting the restrictions.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Warren Buffett’s Shareholder Letter and Market Comments

Warren Buffett has issued his annual letter to shareholders in Berkshire Hathaway. It is usually worth reading for his market insights.  Last year was not a great one performance wise – annual percentage change in per share market value up only 11%. If you look back over the last 50 years of the company, and he publishes the whole track record, it is obvious that he has not been achieving the large outperformance against the market in recent years as he was up until the year 2000. That’s probably simply a reflection of the size of the company now and his inability to acquire controlling interests in good companies of late with the stock market being so buoyant.

The letter covers how the company uses insurance company floats to finance the business and the future as both Buffett and his partner Charlie Munger are now both very old.

Buffett has some interesting comments about how boards of directors have changed over the years. But he says: “The bedrock challenge for directors, nevertheless, remains constant: Find and retain a talented CEO – possessing integrity, for sure – who will be devoted to the company for his/her business lifetime. Often, that task is hard. When directors get it right, though, they need to do little else. But when they mess it up,……”

He also says this about remuneration committees: “Compensation committees now rely much more heavily on consultants than they used to. Consequently, compensation arrangements have become more complicated – what committee member wants to explain paying large fees year after year for a simple plan? – and the reading of proxy material has become a mind-numbing experience”.

Obviously he is referring to US companies primarily but the same applies to UK companies. He also has some negative comments about boardroom pay (which is even more gross in the USA than UK) and how the independence of non-executive directors is undermined by their pay, while he was happy to accept $100 per year for one directorship in the early 1960s. How times have changed!

You can read the full shareholder letter here: https://www.berkshirehathaway.com/letters/2019ltr.pdf

As I write this the markets are still falling sharply for the second day. Having been through several market downturns, I am not too fazed by the biggest ever one-day drop in my portfolio value. There will probably be some momentum in the downward trajectory as recent stock market investors will realise it’s not a one-way bet investing in shares. Shares likely to be affected by a worldwide pandemic are also particularly sharply down while there is general feeling that the long-running bull market must come to an end sometime.

But I am a dedicated follower of fashion as nobody knows how long the impact of negative news will last, what steps Governments might take to keep the economy afloat and stock markets bouyant, or what will be the emotional reaction of investors. So in general I will be selling shares as the market declines until the outlook appears more positive and when the bargains appear.

Having loads of cash is always a good thing to have so as to take advantage of opportunities as they arise.

Needless to say, this is not investment advice. You may choose to take a different path and you need to make up your own mind based on your investment strategy, long term objectives, what proportion of your holdings are in ISA or SIPPs and your tax position.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Woodford, Buffett Bot and FRC Survey

There was a very good article in the FT on Saturday on the “rise and fall of a rock star fund manager”, i.e. Neil Woodford. Essential reading for those who have lost money in his funds. A tale of hubris and obstinate conviction it seems. They report that lawyers are looking at a possible claim for investors but I cannot see any obvious grounds. But lawyers like to chase ambulances. Panorama are also covering the Woodford debacle on Monday.

That well-known phrase “Where are the customers’ yachts” comes to mind. While Woodford and his associates have made millions from his management company, the customers have lost money. That is an issue that the FCA might wish to consider but I cannot think of any immediate solution.

Another article in Saturday’s FT was on a Buffett “App” which would imitate the value investing style of Warren Buffett. Neil Woodford was once known as Britain’s answer to Buffett in the deadwood press but that is now being forgotten of course. This new App from Havelock London is aimed to imitate the investing style that is claimed to be the source of Buffett’s above average long-term performance.  They claim that App will focus on long-term value rather than short term performance which is the approach of most such “quant” investors. This was the marketing pitch of Woodford’s Patient Capital Trust in essence as you can tell from the name.

But in my view this whole approach that you can pick out sound investments by clever analysis of the historic financial numbers or of other metrics is simply misconceived. I have explained why this is so in my book “Business Perspective Investing (see https://www.roliscon.com/business-perspective-investing.html ). One reason why Buffett was so successful, which is obvious if you read about his career, is that he looked carefully at the business models of the companies in which he invested and such matters as the barriers to competitor entry. Yes you can cover some of his analysis by looking at return on capital or other metrics of a company, but that’s only half of the story. You need to understand the business from the perspective of a business analyst.

The Financial Report Council (FRC) have just published a survey on “The Future of Corporate Reporting” (see   https://www.frc.org.uk/news/october-2019/future-of-corporate-reporting-survey ). As the announcement says: “Respondents views will inform the FRC’s project which seeks to make recommendations for improvements to current regulation and practice and develop “blue sky” thinking. A key aim of the project is to challenge the FRC to think more broadly in responding to the recommendation by Sir John Kingman to promote greater “brevity, comprehensibility and usefulness in corporate reporting” moving forward”. So this is something all investors who read company reports should look at. It should take no more than 15 minutes to complete they assure us. I completed it in not much longer.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

Warren Buffett and FCA Review of RDR & FAMR

 

There was an interesting article on the career of Warren Buffett in the last FT Weekend magazine. It was a wide-ranging interview with the renowned investor who became one of the richest persons in the world by making investments which consistently outperformed the markets over the last 50 years. At aged 88 he still claims to be having fun by working at investment.

But in the last ten years he has fallen behind the S&P index. The reason is primarily because he has to look now for enormous deals to soak up the $112 billion in cash the Berkshire Hathaway fund holds and there are not many such opportunities now available. In addition he has to compete with leveraged private equity funds who currently have access to very low cost money and who are willing to pay high prices for good assets.

The last paragraph of the article contains the usual pithy and wise quote from Buffett as to why investors enjoy the game: “If you played golf and you hit a hole in one on every hole, nobody would play golf, it’s no fun. You’ve got to hit a few in the rough and then get out of the rough….That makes it interesting”.

The Financial Conduct Authority (FCA) yesterday published a call for comments on the Retail Distribution Review (RDR) and the Financial Advice Market Review (FAMR) – see: https://www.fca.org.uk/publication/call-for-input/call-for-input-evaluation-rdr-famr.pdf .

They would like some input from consumers on how the past changes to regulations on advice to consumers and how advisors are remunerated have worked out. Do you consider financial advice is accessible and affordable? If you have views on this subject, please let the FCA have them.

Other news from the FCA is that “dawn raids” as part of investigations is at a ten year high at 25 last year. It also has more investigations open at the end of the year, at 504 which is a 20% increase on the prior year. This suggests that enforcement action is increasing which is surely what is required. There are way too many financial frauds and abuses in the modern world.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Words of Wisdom from Warren Buffett

Warren Buffett has published his latest annual letter for investors in Berkshire Hathaway (see http://berkshirehathaway.com/letters/2018ltr.pdf). These letters are always worth reading for their insight into how a successful stock market investor thinks. I’ll pick out a few highlights:

Berkshire’s per share book value only rose by 0.4% in 2018 but he assigns that to the need to write down $20.6 billion on his investment holdings in unlisted companies due to new GAAP accounting rules using “mark-to-market” principles. He is not happy about that change.

He expects to make more purchases of listed securities as there are few prospects for mega-sized acquisitions. But that is not a market bet. He says “Charlie [Munger] and I have no idea as to how stocks will behave next week or next year”. He just buys shares in attractive businesses when their value is more than the market price.

At the ages of 88 and 95 for Warren and Charlie, they are not considering downsizing and becoming net consumers as opposed to capital builders. He quips “perhaps we will become big spenders in our old age”.

He comments on “bad corporate behaviour” induced by the desire of management to meet Wall Street expectations. What starts as an innocent “fudge” can become the first step in a full-fledged fraud. If bosses cheat in this way, subordinates will do so likewise.

He criticises the use of debt which he uses only sparingly. He says “at rare and unpredictable intervals, credit vanishes and debt becomes financially fatal”. It’s a Russian roulette situation in essence.

He’s still betting on the commercial vibrancy of the USA to produce investment returns in the future similar to the past. He calls the nations achievement since 1942, when he first invested, to be “breathtaking”. An S&P index fund would have turned his $114.75 into $606,811. But if it was a tax-free fund it would have grown to $5.3 billion. He also points out that if 1% of those assets had been paid to various “helpers” (he means intermediaries), then the return would have been only half that at $2.65 billion. He is emphasising the importance of avoiding tax if possible, and minimising what you are paying in charges.

But if you panicked at the rising debts in this world and invested in gold instead the $114.75 would only be worth $4,200. Clearly Warren believes in investing in companies and their shares as not just a protection against inflation but as the better investment than “safe” assets. He suggests the USA has been so successful economically because the nation reinvested its savings, or retained earnings, in their businesses.

The moral for private investors is no doubt that you should not spend all your dividends but at least reinvest some of them, or encourage companies to reinvest their earnings rather than pay them out as dividends. But you do need to invest in companies that reinvest their earnings to obtain a good return.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Why I Still Won’t Invest in Banks

I do not hold any bank shares at present, and have no plans to change that policy. But I thought it would be worthwhile to look at the results announced by Lloyds Banking Group (LLOY) yesterday for the third quarter. That particularly is so now that the revelations about the HBOS takeover are coming out on a daily basis.

The announced results were positive. The prospective dividend yield on Lloyds is now near 6% and the p/e is about 9, which is all that some investors look at. But I learned from my experience of investing in Lloyds and RBS before the financial crisis of 2008 to look at the balance sheet.

The latest figures for Lloyds Banking Group show total assets of £810 billion and liabilities of £761 billion, which you might consider safe. But if you look at the asset side there is £161bn in “trading and other financial assets at fair value”, i.e. presumably marked to market. They have £27bn in “derivative financial instruments”, which Warren Buffett has called “weapons of mass destruction”, and £480bn of “loans and receivable”, again probably marked to market.

Shareholders equity to support the £810bn of assets is £49bn. Which does not strike me as particularly safe bearing in mind what happened in the financial crisis. For example, that small bank HBOS, which Lloyds bailed out, eventually wrote off £29.6bn alone on their property loans after everyone suddenly realised that their lending had been injudicious and the loans were unlikely to be recovered in full.

In addition, banks can conceal their assets and liabilities as we learned at RBS and more recently in the Lloyds case. Indeed tens of billions of loans from Lloyds and others to HBOS were concealed and hidden from shareholders in the prospectus with apparently the consent of the FSA.

So I follow the mantra of Terry Smith of Fundsmith who said in 2013: “We do not own any banks stocks and will never do so” having learned from my own experience that it is a very risky, and cyclical sector. I am not convinced that improved regulation, and better capital ratios have made them “investable” when one can invest in other companies with far fewer risks.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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