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Sanditon's Rice: It feels like 2007 all over again

Sanditon's European equity manager has significantly increased his cash weighting as he becomes increasingly worried about the economic climate.

 
Sanditon's Rice: It feels like 2007 all over again
 

Chris Rice has almost doubled the cash position in the TM Sanditon European fund because he is concerned the business cycle is close to tipping point.

Rice, who has been employing his business cycle investment process for the best part of two decades, is seeing a pattern emerge that is similar to 2000 and 2007 - two periods when exuberance preceded a major market dislocation.

 With this in mind, the fund manager has raised cash to around 13% of the assets in the Sanditon European fund.

Rice (pictured below) highlights a number of leading indicators that emphasise how ebullient things have become. ‘The short interest on the S&P 500 is at its lowest since before the financial crisis,’ he said.

In addition, he said the expectations for US equity returns amongst private investors are as high as what he describes as 'some of the most famous moments in history'.

‘Also volatility is at a 30-year low, and the only time valuations were more expensive in recent times was in 1999. When you are on low volatility and high valuations, there’s a big risk of large falls,’ he explained. 

Rice expects the ‘cycle itself to become the enemy’, with higher US base rates likely to be the catalyst for a turn in sentiment. While he believes a 20% correction for equities would be healthy, he differentiates between the current climate and previous market peaks.

‘I wouldn’t call this a bubble because bubbles are investor-led. Yes, there are pockets of bubbles, like internet disruptors in the US and the Fangs [Facebook, Amazon, Netflix and Google], but it’s not quite on a scale of 1999/2000,’ he explained.

‘The combination of the normal cycle of investors’ expectations and central bank intervention has just made lots of financial assets very expensive,' he said.

The strong performance of economically-sensitive stocks, known as cyclicals, in comparison to companies with more defensive characteristics over the last 15 months is the biggest warning sign for Rice.

'That for us is flashing business cycle alarms,’ he added. 

Cash drag

Rice admits he has sacrificed some potential gains by sticking to his beliefs. Over the 12 months to the end of May, the Sanditon European fund returned 32.3%. This was slightly ahead of an average gain of 32% by the Equity Europe ex-UK sector sector.

‘Cash has been a drag this year, but you would anticipate that because of the way we tend to trade. Momentum has been high in markets and we have been gently selling into that.

'We’re business cycle investors and the primary means by which we would express caution is by going overweight defensives and underweight cyclicals,' he explained.

During a period of negative or lower equity returns when equity valuations look overvalued, Rice said cash can be used as an additional tool with defensives.

Alongside US interest rate rises, he said a combination of pressures could come together to trigger a sustained sell-off. These include rising wages and output prices, as well as a fall in productivity.

With this in mind, the fund has a very low allocation towards industrial cyclicals, with just 4% of his fund committed versus 19% of the benchmark. In contrast, the fund is heavily overweight 'defensive value' stocks, with a 31% exposure versus an 11% index weighting. 

Investment opportunities

In Rice's opinion, telecoms offer good value in today's markets. French companies Iliad and Bouygues, alongside Sweden’s Telia and Orange Belgium feature among recent buys.

‘We find price-to-earnings ratios in the 13-16 x range, dividend yields of 3-5% and free cash flow yields of 5-8% in telecoms. We’re basically finding good value characteristics in the sector and because they are exposed to domestic European growth, firms are seeing upgrades as economic growth is catching up a little bit,’ he said.

The fund manager is also starting to see value in food retailers once again, with the Netherland’s Ahold and France’s Carrefour on his shopping list.

He also added to the fund's pharmaceutical allocation, which now stands above 20%. Here, positions include Swiss giants Novartis and Roche and France’s Sanofi.

These have been part-funded by selling down financials, where exposure has fallen from 20% at the end of 2016 to around 12%. Credit Suisse remains a core holding.

‘We were bullish on financials because we felt they got very cheap after Brexit, which presented a buying opportunity,’ Rice said.

‘We have been running down that position slowly since February.’

He also exploited Brexit by buying three UK stocks – Dixons Carphone (DC), ITV (ITV) and Marks & Spencer (MKS) – which he has since sold down after their share prices rebounded.

‘This fund is almost always a Europe ex-UK fund, but there comes a time in life where something very extreme happens and I view it as part of my fiduciary duty to expose my clients to a bit of that,’ Rice said.

‘We felt the collapse after Brexit was the wrong response and the decline in sterling made everything cheaper. We will continue to sell out of these stocks as sterling recovers.’   

1 comment so far. Why not have your say?

Micawber

Jun 27, 2017 at 16:38

You know, when I try to look for "the cycle" since 2008, I don't find any normal one.....

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