The big picture: should you follow Crispin Odey and sell?

If you respect Crispin Odey then sell stocks. The British hedge fund manager who cut his teeth in the 1994 bond market debacle, reckons equities will get devastated.

Yield-chasing, also boosted by quantitative easing (QE), has over-priced markets relative to inexorable deflation; central banks won't be able to counter.

'I am amazed to see so many are fully invested given that equities are already fighting the downturn. Mid and small caps have moved into bear markets and much relies on large caps to keep the whole thing going and they are very exposed to international trade.'

This rings true with the many stocks I have profiled as drifting down in 2014 after a QE-inspired blow-off in late 2013.

Odey's newsletter to clients disputes that lower oil prices provide a net stimulus: 'My problem with such a hopeful outcome is that, in my experience, those that lose out from a fall in their income are quicker to adjust than those that benefit. In the inter-temporal space lurks a recession.'

He contends we are in an early phase of firms cutting spending, with a self-reinforcing effect for incomes and employment. European QE is nothing like the monetary stimulus for borrowers in 2009 when US/UK banks cut interest rates. If economies falter there will be a painful round of debt defaults.

Odey is an intelligent doomster; history does not support his view on oil

He differs from the likes of Albert Edwards and Marc Faber who have scorned central bank intervention all along as a distortion of capitalism. In playing markets' upside as a result of QE but turning sceptical now, Odey appears of similar mind to Mervyn King who was a proponent of QE as Bank of England governor, but now warns it cannot remedy weak demand.

Odey's view of low oil prices appears jaundiced however, according to economic history since 1970: each time the oil price has doubled it has led to global recession, and each time it has halved and stayed down for six months or more then it has given the global economy a major boost. When I recall falls in the early 1990s, oil prices went much lower and lasted far longer than the consensus imagined possible.

Might oil prices find a trading range of say $20-50 now competition among suppliers has changed the pricing regime away from OPEC's 2005-2014 monopoly? There was a similar shift to competitive pricing after North Sea and Alaskan oil broke OPEC's dominance from 1974 to 1985.

Mixed effects of the oil price plunge

Perhaps the biggest risk will be insolvencies in the US shale oil industry, causing trouble for the US high-yield bond market, hence a wider impact on business. Shale represents 15 per cent or so of this financial market which is significant if not immediately scary.

Caterpillar Inc has just warned, the oil price plunge is set to harm demand for energy equipment - and even after its stock has fallen in response it trades on a forward price/earnings (p/e) multiple in the mid-teens, which is still pricey for a cyclical at the early stage of an industry downturn.

Or at least that's how it looks from the UK, with many US stocks still buoyed by the Fed's expansive QE. Areas of heavy industry look exposed as US durable goods orders trend down, and there will be some unemployment from a slowdown in capital investment. Yet such cyclical stocks are due some retreat.

Last year's rally in Wal-Mart Stores to a p/e in the high teens was logical in the sense of US consumers benefiting from lower fuel prices. Beware reading this across directly to the UK where 60p in every pound spent on petrol goes on tax; although as lower energy prices filter through to gas/electricity bills it will all help disposable income.

Overall it looks premature to fear the oil price plunge and its real risk might be subtly political in disturbing international power balances.

UK company reporting remains supportive; cautions emanate from US

Somewhat ironically given the 'booming' US economy, 2015 has commenced with warnings e.g. from Proctor & Gamble, DuPont and Microsoft. However, they relate largely to dollar strength raising the hurdle for US multinationals with high foreign revenues. Not enough to cause a US slowdown, but it could contribute to one - e.g. if there are wider deflationary forces.

The tenor of UK companies reporting - pre-close statements for 2014 results, and Christmas period updates - remains strong. Its note is broadly 'trading in line with expectations' with disappointments being sector-specific: e.g. cut-throat retail, London property, oil services.

This month's reporting has broadly affirmed the case for equities in a low-interest rate environment, with useful yields still offered and no real alternatives for investors. If some combination of events - say another crisis in Europe or a Chinese stock market crash - were to trigger risk aversion hence a plunge, the big pension funds are likely to buy it.

There was a slightly negative straw in the wind, UK GDP growth reportedly slowing in the fourth quarter of 2014 (Q4), and May's general election will be disruptive to some extent. Yet consumer spending is buoyant, e.g. Greggs bakeries' reporting very strong trading and Mitchells & Butlers' pubs doing well.

Consumers represent about 60 per cent of the UK economy relative to 70 per cent in the US: obviously wage increases are becoming vital for demand growth, but it is hard to identify major risks that could erupt.

Odey contends it is precisely in the early stages of a downturn, that 'it is too early to see what will happen - a change of [this] magnitude means the darkness and mist is very great'. He is really referring to the international risks but certainly they are possible of jolting the UK.

Recruiters are currently bullish - a good sign?

Bulls can take heart from the recruitment industry citing considerable momentum. Gross profit being the benchmark indicator, Michael Page International saw its rise 12.9 per cent in Q4 2014 relative to 10 per cent annualised and Robert Walters was up 17 per cent in Q4, 14 per cent annualised.

This is encouraging in terms of recruiting being an expression of corporate confidence, if tricky to be sure how far its visibility extends. Recruiters like these also broadly reflect service industry professionals, likely enjoying a momentum effect after QE has boosted asset prices hence transactions - benefiting accountants, lawyers, bankers and IT people.

Given such employment agencies serve multinational clients it will be interesting to follow what the updates may imply for big-cap stocks and international trade.

Private investors face a plainer choice with stocks

The likes of Odey may imply 'sell' but they will keep skin in the equities game: partly from their scale of assets under management, but also hedged with short positions and derivatives. This can get complex and costly for most individuals who realistically face a plainer choice of what extent of exposure to equities.

Indeed there are reasons to lock in gains and avoid a focus say on higher-risk cyclicals. But more warnings are needed among UK companies reporting, to fear a major sell-off. Furthermore 'devastation' implies earnings damage to an extent that de-rates dividend yields.

With interest rates unlikely to rise significantly, long-term money will buy into an equities plunge. The bull market is in its seventh year and certainly more attention should be paid to risk; but don't be swayed by this high roller.

This article was written for our sister website Interactive Investor.

Subscribe to Money Observer Magazine

Be the first to receive expert investment news and analysis of shares, funds, regions and strategies we expect to deliver top returns, plus free access to the digital issues on your desktop or via the Money Observer App.

Subscribe now

Add new comment