Crispen Odey – Why Hasn’t BP Recovered Some of That Lost Market Cap?
"Equities continue to trade badly, but this is no surprise. They have disappointed for 11 years; indeed most indices are where they were 15 years ago. However in a world where the geopolitical outlook is unresolvably bad, shareholders are not only being paid to be patient by high dividend yields but also pricing in a very high margin of safety.
The example I like is BP (BP). When BP suffered from the Macondo rig disaster, the company's market capitalization fell by $120 billion, the company set aside $30 billion in provisions and recently announced actual claims of about $5.5 billion. Has the share price recovered the missing $114.5 billion? Of course not. Presumably investors are pricing in more Macondos and, given that they actually cost just over $5 billion each, they are expecting 20 such explosions. As an investor in the shares today this gives me a great deal of protection — a margin of error. It also convinces me that the stock market is a better historian than it is a forecaster or a mathematician.
So why are markets so depressed? Some European markets are down about 27% this year. First, this is structural. Zero interest rates have an unusual effect in Europe. Compared to the Anglo-Saxon world, Continental European banks are funded through bonds and interbank lending, not deposits. Since interbank and bond borrowing rates have not fallen below 2%, corporate loans in Europe should be at 4.5% not at 2.5%. In fact corporate loan rates have failed to rise in Europe. Lending is therefore unprofitable. Banks are shrinking their loan books. The easiest loan books to shrink are the corporate loan books and that means rights issues for indebted companies as equity replaces debt. All this depresses equities, especially those with borrowings to roll.
The equity markets now act and behave like corporate bond markets. Equities yield 5-6% and many are on earnings yields of 20-33%. They are mouth-wateringly attractive because unlike debt they do not mature.
But the worries that look down on them from on high reflect the fact that whereas Continental European banks were not exposed to the excesses of America and the UK, they are over-exposed to the excesses of Southern Europe. At some point they will need recapitalizing. Rather than dreading this, the default should lead to lending rates rising in Europe, even as banks are recapitalized.
Meanwhile this crisis has brought all shares down. It has brought down UK and US bank shares, despite the fact that since 2008, they have done much to improve their balance sheets. Loan to deposit ratios have fallen by 30% to around 120%, loan margins are up fivefold, provisions have risen sharply and, thanks to retained profits and rights issues, cash equity is up fourfold. They are all strong buys for me.
It may be confusing to find someone who believes that a crisis is on its way but is also happy to buy equities ahead of the crisis. My reason is that the worries have been there for so long, the causes are so obvious and the valuations are so cheap that this is a case of buying early. For me the crisis will bring resolution and with it higher prices.
Little wonder that volumes have been exceptionally light. Despite all of this volatility the only question that clients have been asking us is, "When should we buy the market?"
In the short term everything points to the fourth quarter of this year being strong in the U.S. There is a restocking cycle taking place as the effects of the tsunami recede. Quantitative "oil" easing and commodity price falls are helping consumption growth. The fall in bond yields is feeding through to refinancing of existing mortgages that could add 1.3% to GNP.
So yet again we may be entering a period when markets do not get a Greek default and the US economy strengthens. Cyclicals which have all been sold off will rally and banks, which have led the market down, will catch a bid.
I feel a bit like Sarah Bernhardt who said, "I eat myself to feed my work."