- "We may be heading for a 1930s-style depression."
-- Hugh Hendry
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- Hugh Hendry, Europe's best-performing fund manager, believes
equity markets will fall a further 50 per cent before bottoming.
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- In the last three weeks Mr Hendry says has sold off a
third of his equity portfolio to seek the sanctuary of government bonds.
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- And Mr Hendry's stable of hedge funds is shorting a swathe
of financial and technology stocks from Swiss Life to SAP and Siemens.
"There's some market rubbish being talked about bottom and capitulation,
but I have never heard such garbage," he says. "The market will
bottom when Microsoft trades on 10 times earnings [it's currently 32.2].
Dell is on 40 times earnings, but I'm pretty convinced it will go to 10."
On past evidence, Mr Hendry is well worth listening to. His long-only fund,
the CF Odey European Trust, trounced its rivals in calendar year 2001,
gaining 3 per cent while its closest pan-European rival fell by 8.6 per
cent.
And Mr Hendry has repeated the trick in the first half of 2002. CF Odey
is sitting on a six-month gain of 15.5 per cent, 6.5 percentage points
clear of its nearest rival. The average European fund has fallen 7 per
cent in this period.
Despite this year's rise, Mr Hendry is running scared of equities since
detecting a significant shift in the markets in mid June.
"Up until the second week in June I was up about 22 per cent, now
it's 15 per cent. The last three weeks have been quite difficult."
Until recently Mr Hendry relied on the fact that a 'golden' 5 per cent
of shares will rise even in a bear market. He identified these by following
the flow of liquidity that central banks have been pumping into the economy
by aggressively cutting interest rates.
Rather than flowing into the equity markets, as has historically been the
norm, this liquidity has flooded into assets such gold, property and commodities.
Mr Hendry played this trend by buying equities that were proxies for these
assets, such as housebuilders, property companies, food manufacturers and
tobacco companies. However, in recent weeks the market has turned against
even these stocks.
"I have been consistently 100 per cent invested for the last three
years, but I am now selling stocks," he says.
Mr Hendry admits he is not certain what will happen next, but he is raising
the possibility that we may be heading for a 1930s-style depression, rendering
it impossible to make money from the markets.
"One has to give serious consideration to that now the bear market
has encroached into my golden 5 per cent [of stocks]. And no equity strategy
succeeds with that outcome: value growth, good management, strong balance
sheets, nothing works."
As an example, Mr Hendry says global markets bottomed in November 1929
at an average price-to-earnings ratio of around 10. Caterpillar, the tractor
manufacturer, would have looked good value on a p/e of eight, but investors
who thought so would have lost 95 per cent of their money in the following
three years.
The 1929 example also supports his thesis that bear markets typically bottom
at p/es of around 10-11, with 12 in 1962 the highest on record.
As a result, Mr Hendry has now shifted a little over 30 per cent of his
£125m portfolio into government bonds, particularly those of Switzerland,
where he confidently expects prices to rise as that nation's large financial
sector will be forced to play safe to meet guarantees to policyholders.
This leads us to the wider financial sector, which Mr Hendry believes is
in a terrible mess.
"The integrity of the financial system will be called into question,"
he predicts. "The majority of institutions have been compromised as
they assigned a very low probability to the notion that we could have
three successive years of equity declines.
"I liken it to insurance companies that have written flood insurance
to people living on a delta which has had a drought for 20 years. Now the
drought has ended and they are having to pay for their insurance."
Mr Hendry predicts that many institutions, particularly banks with the
bancassurance model combining insurance products and banking, will ultimately
have to have 'enormous' rights issues to keep them afloat.
The bancassurers are particularly under threat because they are using the
same reserves to support their lending (where risks have risen post-WorldCom
et al) and to underwrite their life insurance funds (where plummeting
stock market returns are threatening solvency margins), he argues.
"Everyone is compromised. When the Financial Services Authority says
there are no [solvency] problems, I don't trust them. When managements
say there are no issues with insolvency, I don't trust them. The biggest
danger is being trusting and naÔve," he warns.
Because of this his hedge funds are shorting the likes of Credit Suisse,
ING, Aegon, Lloyds TSB and, in particular, Swiss Life ("a humongous
short").
Not surprisingly, given his outlook, Mr Hendry is spoilt for choice for
stocks to short. His other big favourite, though, is technology, particularly
German software maker SAP and Teutonic trains-to-telecoms stock Siemens
"SAP will go to Ä50 [currently Ä89.10]. As for Siemens,
a lot of people have been switching to it from Deutsche Telekom, France
Telecom and Alcatel because of a low valuation and defensive posture. But
it is no safer. There is a lot of fudging on some of its numbers and its
largest customer is Deutsche Telekom.
"Anyone who thinks it is safer must be smoking some seriously powerful
narcotics."
Where will it end?
So where will it all end? Mr Hendry argues that the last five years of
gains from a bull market are typically wiped out in the following bear
market.
As markets peaked in March 2000, we need to fall back to March 1995 levels
before reaching the bottom, he believes.
In other words the FTSE 100, currently around 4,430, needs to fall a further
43 per cent to around 3,100. Frankfurt's Dax-30 and the Paris Cac-40 both
need to lose another 50 per cent or so.
This gloomy prognosis tallies pretty well with Mr Hendry's view that markets
p/es need to descend to around 10. The FTSE 100 is currently trading at
18.8.
And no one is likely to be safe. "A lot of people have been buying
GlaxoSmithKline because it now looks statistically cheap, it is a robust
business and it's economically defensive," says Mr Hendry. "But
I think that is bonkers, we are in a humongous downtrend.
"Glaxo is at £13 now, it was at £6 in 1995. I think it
will halve from these levels. I think the people who are buying stocks
now will be selling in 18 months time saying 'I don't understand this
market, but I had better get out.'"
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