Edward Chancellor part 1: ‘intelligent contrarians’ should follow the capital cycle


Published on Mar 23, 2016

Merryn Somerset Webb talks to financial historian and strategist Edward Chancellor about how following the capital cycle can make you a better investor.

Edward Chancellor part 1: ‘intelligent contrarians’ should follow the capital cycle0:08welcome to another one of our video interviews with me today as ever
0:11chancellor who is a very experienced and well-known financial strategist and
0:16investment expert also the author of this week’s cover story or last week’s
0:20cover story by the time you see this which is very intrigued about gold
0:23miners and the editor editor really of this most recent book capitol detergents
0:28a series of essays written by very successful money managers at marathon
0:32and editors introduced them beautifully and then edit them into a great
0:36collection well worth reading it will be on our Christmas book list when we get
0:38to that now that’s what we feel that the premise of the book of the Weimar best
0:43should I say they invested capital cycle basis yes the capital cycle one american
0:51asset management schools capital cycle is free to look at companies not on the
0:57perspective of their valuation whether they’re cheap or expensive on a p/e
1:03basis for price book basis that really to look at whether capital is entering
1:09into or exiting an industry and if you look at things that way sometimes you
1:14find businesses that look expensive but are actually quite cheap because they
1:21can sustain returns for a long time but more to the point
1:25investors often failed pay attention to the amount of capital that is being
1:31spent in an industry now take for the global mining industry or all the energy
1:37oil stocks recently over the last 10 years have been enormous searches in
1:43capital spending in both sectors and that surging capital spending three
1:49figured they’ve the collapse in prices in commodity prices but also the clouds
1:56and stock so if you look at things from a capital cycle respective capital
2:01flowing into or out of an industry you’re likely to be a better in
2:05the basic idea is that as capital flows into an industry supply of whatever that
2:11industry produces is going to go up very fast then the price of that thing is
2:15going to for a new one to be in winter pliers low and outweighs supply of high
2:21yeah I mean the principal is very simple as you expressed it entails a simple one
2:28shouldn’t really need to write a book on the definite time to simple in that case
2:33let’s discuss a few of these instances it will last twenty years that your your
2:42readers viewers might remember go back to the dot-com bubble in the nineteen
2:49there was a surge of spending in technology in particular laying out
2:54fibre optic cables both in Europe and in the states and actually cross the
3:01crossing continents to that in the UK the world number of so-called
3:07alternative carriers will let listed at least businesses with huge capital
3:13funding needs now the same time we had the telecoms companies spending vast
3:18amounts of money on 3G mobile networks and so forth that surge in spending
3:25anticipated the collapse of the dot-com collapse in fact in determined the
3:31dot-com collapse in 2008 in 2000 2002
3:36you got to a situation then that of all the fiber optic cable that benlate
3:42something like 95% of it was excess capacity now move into the next decade
3:48you for surgery of a housing boom is sourced surge of spending on on on
3:55construction spending residential real estate not so much in the UK but
4:00certainly in in Spain and Ireland and in
4:03in dus what’s quite interesting about the USS example is that some very
4:08well-known investors in 2005 2006 started saying hey housing stocks us’
4:16housing stocks achieve their trading roughly book value this is the low range
4:23at which they had ever traded and you want to make you want to hold your nose
4:27and there may be problems in the housing market but you want to buy these now
4:32those talks on average fell roughly 75% from that point to their trough say for
4:40five years later so you could aboard housings dog of a perfectly respectable
4:45company that actually survived the real estate path you could have bought it at
4:50a very cheap value and still loss of $0.05 your money and the capital cycle
4:55argument is that what you should be looking for is not the valuation as a
5:00how much money had been sucked into these businesses in the run-up in the
5:05truth is that those businesses had been expanding their capital base by about 25
5:10percent per year for the previous five years writing and we see this time and
5:16time again the market’s encouraged and fund capital spending investors chariot
5:23on then things start turning turning down a bit and the value investors come
5:29in and say these stocks are cheap and then the value investors get completely
5:33wiped out so if you understand the capital cycle you you stand back from
5:38the from the sort of the madness of the crowds as things are being bid up but
5:43you also avoid that the great value traps which which which constantly
5:50hitting so-called contrarian or value investment and you also stand back from
5:54the demand story on the way out of this is the way that these these events as
5:59children Vestas that the supply side is rarely mentioned is mentioned is the
6:04ongoing demand
6:05yes you’re quite right extrapolation extrapolate that demand never add up how
6:12much supplies coming up
6:13the same time and this interesting point is that people I don’t quite know why
6:21they love to think that project demand future they loved I suppose because they
6:29like rejecting demands because demand is unknowable because it’s a noble then you
6:34can have any events you want about it at all optimistic or pessimistic but you
6:39know given the nature of mankind those would tend to be optimistic now people
6:44are huge amount of work goes into forecasting demand as our mutual friend
6:53russell Napier says analyst spent ninety percent of their time thinking in bed
6:58and forecasting tomorrow and 10 percent of their time thinking about supply but
7:04the interesting thing about supply it’s supply actually can be forecast it
7:08because it takes in most industries it takes quite a while for the supply to
7:14come on stream you can see how much assets have grown inside an industry or
7:18in inside any particular business are you can see it through any number of
7:23measures through IPO issuance through secondary shares winds through companies
7:28taking on more debt relief companies going through a boom such as the mining
7:33companies all the help us’ home builders who had a sort of surging profitability
7:37and have reinvested those profits you can measure it technically through
7:41things like looking at current capital spending to depreciation reaches or or
7:48you can look at it for instance again technically you can look at the rate of
7:53profitability reported profitability of the company to its up to its cash flow
7:59the so-called cash convert cash conversion rate and if the company is
8:03generating large profits but not generating any cash for it it’s probably
8:08in a negative things of the capital cycle to the point to get back to what
8:12you were saying is that investors if they knew the right way to approach
8:18would be thinking 90% bad

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