SE ED PT IT 14 IO N The e-magazine created especially for active spread bettors and CFD traders
Issue 32 - September 2014
An SBM Biotech Special How to profit from the healthcare revolution www.financial-spread-betting.com
THE UK’S ONLY FREE ONLINE FINANCIAL MAGAZINE! JIM MELLON ON THE MARKETS
A ZAK MIR INTERvIEW SPECIAL WITH SBM FOUNDER RICHARD JENNINGS
FUND MANAGER IN FOCUS – HEDGE FUND SUPREMO DAvID EINHORN
ZAK MIR’S MONTHLY PICK HIKMA
AND MUCH, MUCH MORE - PACKED FULL OF TRADING IDEAS FROM ALL OUR CONTRIBUTORS!
Feature Contributors Robbie Burns aka The Naked Trader Robbie Burns - The Naked Trader has been a full-time trader since 2001 and has made in excess of a million pounds trading the markets. He’s also written three editions of his book, “Naked Trader” and the “Naked Trader Guide to Spreadbetting” and runs day seminars using live markets to explain how he makes money. Robbie hates jargon and loves simplicity.
James Faulkner A true stockmarket anorak, James Faulkner began investing in the stock market in his early teens. James is a devotee of the PEG-based growth investing model pioneered by Jim Slater in his seminal book, The Zulu Principle, while also being t1ps.com’s resident economic ‘guru’. James is an Associate of the Chartered Institute for Securities & Investment and holds the CISI Certificate in Investment Management.
Richard Jennings Richard was the founder and original inspiration behind Spreadbet Magazine. A prolific trader for many years and former institutional fund manager, he holds the CFA designation and now runs the unique tax free investment house www.titanip.co.uk. A natural contrarian and true to his Yorkshire roots, his primary investment approach is of a value bias.
Samuel Rae Having completed his Economics BSc Degree in Manchester, Samuel Rae quickly discovered that the retail Forex industry was for him. His personal trading style combines classic candlestick analysis with a simple, logical and risk management driven approach to the financial markets - a strategy that is described and demonstrated in his best selling book, Diary of a Currency Trader.
Alpesh Patel Alpesh Patel is the author of 16 investment books, runs his own FSA regulated asset management firm from London, formerly presented his own show on Bloomberg TV for three years and has had over 200 columns published in the Financial Times. He provides free online trading education on www.alpeshpatel.com.
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Editorial List EDITORIAL DIRECTOR Richard Gill
Foreword Once again it would appear that, just as important as p/e ratios, cashflow, GDP and interest rates, geopolitical issues are at the forefront of investors’ minds. The situations in Iraq, Gaza and Ukraine remind us of the revelation that of the 162 countries covered by the Institute for Economics and Peace’s latest study, just 11 were not involved in any conflict.
EDITOR Zak Mir CREATIvE DESIGN Lee Akers www.cfdmedia.co.uk COPYWRITER Seb Greenfield EDITORIAL CONTRIBUTORS Alpesh Patel Richard Jennings Filipe R Costa Simon Carter James Faulkner Samuel Rae Dave Evans Patrick Callaghan Jim Mellon
Disclaimer Material contained within the Spreadbet Magazine and its website is for general information purposes only and is not intended to be relied upon by individual readers in making (or refraining from making) any specific investment decision. Spreadbet Magazine Ltd. does not accept any liability for any loss suffered by any user as a result of any such decision. Please note that the prices of shares, spreadbets and CFDs can rise and fall sharply and you may not get back the money you originally invested, particularly where these investments are leveraged. In comparing the investments described in this publication and website, you should bear in mind that the nature of such investments and of the returns, risks and charges, differ from one investment to another. Smaller companies with a short track record tend to be more risky than larger, well established companies. The investments and services mentioned in this publication will not be suitable for all readers. You should assess the suitability of the recommendations (implicit or otherwise), investments and services mentioned in this magazine, and the related website, to your own circumstances. If you have any doubts about the suitability of any investment or service, you should take appropriate professional advice. The views and recommendations in this publication are based on information from a variety of sources. Although these are believed to be reliable, we cannot guarantee the accuracy or completeness of the information herein. As a matter of policy, Spreadbet Magazine openly discloses that our contributors may have interests in investments and/or providers of services referred to in this publication.
The misery is added to by one-off events such as unrest in Ferguson, Missouri – a perfect piece of time travel back to 1964. Sprinkle in Ebola, which looks as though it will almost inevitably spread far from West Africa, and it looks as though it will be a difficult autumn for the world and for the markets. Ironically, to start August it did appear that the markets were ready to follow the obvious path to the downside, backed by the prospect of rising interest rates on both sides of the Atlantic. Unfortunately for the bears, so far the picture is not quite as cut and dried as might have been expected. It was never going to be given the way that Fed Chairs do not come more dovish than Janet Yellen. And if the accusations are correct, Mark Carney was parachuted into the Bank of England on the basis that he would be loathed to tighten fiscal policy ahead of the General Election. In the end, he may be let off by weakening inflation, but this kind of mud does tend to stick. As we head into September, and after a particularly quiet summer period in terms of company news, it will be interesting to see whether geopolitical torment will be the excuse for not raising interest rates. This is a pivotal issue, especially in Europe where the effects of retaliatory sanctions delivered by Russia after the Ukraine debacle threaten to make a stagnant growth/inflation picture turn into recession and deflation. On this basis one might argue that, rather than the Federal Reserve, this autumn we should be focusing on the ECB. This idea was first flagged in May by the stated wish of ECB President Mario Draghi to weaken the single currency in order to help Eurozone exporters. He is perhaps to be applauded in being ahead of the curve in this call in that the subsequent fall from just under $1.40 to $1.33 will have eased the pressure somewhat. Nevertheless, with France threatening to become a “PIIGS” nation in the wake of socialist tax hikes causing both a cash flight and economic contraction, it could be the weakening of the Euro gathers momentum. This is especially if, as it would appear, Germany is dragged down with France. The prospect of the “core” of Europe becoming unhealthy would be as unwelcome as it is novel in terms of the aftermath of the financial crisis to date. Away from such grisly matters and I am celebrating the biotech/pharma theme of this month’s edition of Spreadbet Magazine with Hikma Pharmaceuticals (HIK), where the trend should be my friend. I am also shining the spotlight close to home in terms of Spreadbet Magazine founder and Titan Investment Partners supremo Richard Jennings in this month’s interview. Given that this magazine likes to shoot from the hip and Mr. Jennings is a “no holds barred” individual, you may imagine correctly that this is an exchange of verbal gunfire at its most intense. There is also mention of fund management, and how to achieve consistent outperformance in the financial markets for those who prefer things to be a little more tranquil. Enjoy this month’s issue and happy trading. Zak
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3 blue-chip pharma stocks to buy James Faulkner of t1ps.com looks at three trading ideas within the large cap pharma arena.
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Zak Mir interviews Richard Jennings In an eye opening interview Zak Mir grills SBM founder and fund manager at Titan Investment Partners, Richard Jennings.
The Best of the Evil Diaries Highlights of what infamous short seller Simon Cawkwell (aka Evil Knievil) has been trading and gambling on during August.
Fund Manager in Focus David Einhorn of Greenlight Capital is in the spotlight this month.
Herding and the dangers of crowds Richard Jennings returns and with Filipe R Costa looks at how herding can present real danger to investors.
Alpesh Patel on the Markets Regular SBM contributor Alpesh Patel carries on the pharma theme and looks at his favourite picks from around the world.
Mellon on the Markets Multi millionaire investor and entrepreneur Jim Mellon predicts trouble ahead. Read how he thinks you can benefit from the global troubles.
The state of the global pharmaceuticals industry James Faulkner returns and runs the rule over the current state of the global pharmaceuticals and biotechnology market.
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Revisiting the Japanese reflation story
Zak Mir’s Monthly Pick SBM editor Zak Mir takes a technical and fundamental look at Hikma Pharmaceuticals.
Richard Jennings & Filipe R Costa examine the current economic situation playing out in the Land of the Rising Sun.
Three small caps pharma stocks to buy Continuing the pharma/biotech theme, Richard Gill, CFA, of t1ps.com looks at three promising growth companies within the sector.
Binary Corner: The Puzzle of The Pound
Sporting Index’s Champions League Preview
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Dave Evans of binary.com examines recent movements in sterling.
Patrick Callaghan examines the top clubs’ chances in this season’s trophy of champions.
Currency Corner New SBM contributor Samuel Rae, author of the best selling book “Diary of a Currency Trader”, explains why he is bearish on the Aussie dollar.
Technology Corner SBM’s resident technology specialist, Simon Carter, takes a look at some of the big technology stories currently in the news.
Markets In Focus A comprehensive markets round-up of under and out performers during the month of August.
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Zak Mir Interviews
ZAK MIR INTERvIEWS
RICHARD JENNINGS Richard Jennings is the founder and former editor of Spreadbet Magazine and now heads up the unique fund management company that is Titan Investment Partners. Richard sits on the other side of the fence this month as his replacement as editor of this magazine, Zak Mir, puts him under the spotlight. In this explosive interview Jennings reveals some serious insight into the industry and tells it, in his own inimitable style, as it is! Zak: At the end of June, Titan Investment Partners (TIP) published its inaugural one year performance data, with certain funds up in excess of 100% over that period. Has the response of the public been an avalanche of money heading your way to be managed as a result of this success? Richard: Hi Zak, it is interesting for the two of us for me to be on the receiving end of these questions for once! To answer your first question, we have had a very noticeable pick up in the volume of clients coming into our managed accounts since the end of June. We were always aware that to start a fund management company from scratch and build the trust of investors was not going to be an overnight affair. A one year record is a start, but we believe we need to continue delivering and, most likely, get to the three year stage before our funds are viewed as a real alternative to an ISA (albeit a higher risk one). I guess the early adopters (thus far) are reaping the benefits of being invested with us.
Zak: Can the big plus of managed spread betting accounts being tax free sometimes be a double edged sword in terms of perceived risk and lack of credibility (however incorrect this may be) of spread betting as an investing instrument? Richard: That is a very interesting question and one that I welcome the opportunity of answering. As we all know, the typical spread bet account has, anecdotally, a life of less than six months. You only have to look at the profits of IG Index to see who wins... There is a simple reason for this. The firms give you the rope to hang yourself. By that I mean that they supply you excessive leverage. Human nature being what it is, it will take that excessive leverage, and so unless you are (a) very lucky in getting the direction right or (b) a seasoned trader (of which there are very few), then you will lose over the long haul. Fact.
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“I have many contacts In the Industry and one of these relayed to me that In hIs near 25 years workIng at some of the largest of the spread bettIng fIrms, he can count on less than two hands the number of clIents who have been “net up” durIng theIr spread bettIng. thankfully I am one of those! that, however, Is an amazIng revelatIon.”
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Zak Mir Interviews
I have many contacts in the industry and one of these relayed to me that in his near 25 years working at some of the largest of the spread betting firms, he can count on less than two hands the number of clients who have been “net up” during their spread betting. Thankfully I am one of those! That, however, is an amazing revelation. To give you an idea of just how dangerous the leverage is that is offered to the retail public, let me regale you with a true story… It was revealed to me by an industry insider that one well-heeled overseas client was trading gold futures into the spring of 2012 and had made a couple of million pounds being on the long side. All well and hunky dory for said chap. However, out of the blue in April 2012, the gold price fell dramatically as some will recall. The poor client wound up, on the day alone, losing in excess of ten million pounds. Think about that. The life savings of a small village evaporating in a few short hours when the proverbial hit the fan. The sole reason was that the chap in question had way, way too big a position on his account and the reason he had the position was the spread bet firm allowed him to. Is there dual blame here? Notwithstanding all the T&C sign offs and such, I believe so. It is also an open “secret” within the industry that a larger than life sports retail billionaire lost anywhere between £40m and £200m trying to buy certain UK banks down in 2008. We all know how that ended… Moral of that story? No matter how deep your pockets, the market will, if over leveraged, find a way to empty them at some stage. At Titan, we have all made the same mistakes (thankfully not to the same degree). Indeed, I have had a couple of serious routings in the market. I am thankful for these, as at the heart of our approach is the mantra – “dial back the leverage, dial back the leverage, dial back the leverage!” When we set up Titan we put in place leverage maximums that are mere fractions of what is ordinarily allowed in a spread bet account. For example, on equities we have a leverage cap of 2.5 times. That is, for a £10,000 account, the maximum value of the underlying positions that we can take is £25,000. With minimum position diversification numbers and maximum individual stock values relative to the account overlaid too, the chances of us waking up in the poor gold chap’s shoes is somewhere between slim to non-existent.
So, to conclude your question, yes, the perception of a spread betting account has probably been a handicap and so we make clear here and to all clients that the spread betting element is simply the means to the end, the mechanism for booking the trades to deliver the returns tax free. What we are doing at Titan is no different to a typical hedge fund. In fact, we run less leverage than many hedge funds. We are using the tax legislation in the UK that allows gains from a spread betting account to be delivered tax free. This being the icing on the proverbial cake with absolute returns being the body of the cake.
“I have many contacts in the industry and one of these relayed to me that in his near 25 years working at some of the largest of the spread betting firms, he can count on less than two hands the number of clients who have been “net up” during their spread betting. Thankfully I am one of those! That however is an amazing revelation.”
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Zak: You are effectively giving ordinary retail investors the chance to be invested in hedge funds with a very low ball figure of £10,000, which is industry disruptive. Given the myths (and legends) associated with this industry, do you not think that many of the smaller investors in your fund might struggle to understand what they are getting themselves into? Richard: We take our authorisation by the FCA very seriously here Zak, and all clients must pass the “suitability” test. For example, if a client only had say £20,000 to their name and they were stretched on the mortgage side with, say, no pension provision too, and they asked to put £10,000 in our funds, we would not and could not accept this. We make it very clear that our funds are designed to be a complement to an existing balanced portfolio, perhaps no more than 5-10% of a client’s funds should be allocated to our suite of offerings. The Titan funds are not meant to be a replacement to a balanced portfolio, but a complementary supplement and with, hopefully, limited correlation. What our clients are basically doing is entering into a contract where the risk/reward dynamic is at the contract’s heart. I.e. they are taking on incremental risk for the potential of higher reward. We also stress that the funds should not be viewed as day trade funds (although clients can withdraw money at immediate notice, unlike almost all other hedge funds) but rather as medium term ones given the asset allocation value basis of our approach – this takes time to come to fruition and there can be periods of underperformance. Indeed, we had one chap come in last year just before we experienced an inevitable drawdown. Said chap withdrew his capital quickly only to see the value of the primary fund – our Global Macro one – increase by near 100% over the subsequent period… Zak: To paraphrase Shakespeare, reputation in fund management is something which can be gained and lost in the most unfair way. Particularly irksome is the way that it apparently takes a long time for a rising star to get noticed. But then individuals who have faded keep their “A” List status well beyond their sell by date. Do you acknowledge such a phenomenon? Richard: There is indeed such a phenomenon at play. Take for example Anthony Bolton. He made an asset allocation call on China and got it wrong. Ditto with “The Sub-prime King” John Paulson regarding his gold play in 2011.
However, to quote back to you, “one should not measure a man or fund manager by a small fraction of their career, it should be viewed in its entirety”. So, does Bolton still deserve his elevated status given the disaster that has been China? In my book, given his record over the preceding thirty years, categorically yes.
“So, to conclude your question, yes, the perception of a spread betting account has probably been a handicap and so we make clear here and to all clients that the spread betting element is simply the means to the end, the mechanism for booking the trades to deliver the returns tax free.” I guess I can only hope that in ten years’ time the name of Titan and Richard Jennings will be held with a mere fraction of reverence than the likes of Anthony Bolton are. That would be an achievement. Zak: What are you doing to ensure that Titan is getting the kind of fair publicity its performance deserves? Richard: We have just taken on a firm of City PR specialists and so this will hopefully ramp up the market’s awareness of what we are doing. Zak: I have found it interesting that, especially at the time of your one year performance statistics being issued, you were able to highlight the difference between the benchmark and say the Global Macro fund. The benchmark being up 20.7% and your fund being up 158.94%. Other funds also appear to show a massive (positive) difference between Titan’s performance and the respective benchmark. Is it fair to assume that Titan could apparently make money whatever the underlying was doing?
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Zak Mir Interviews
Richard: It is most definitely not the case that Titan can make money irrespective of market conditions. If that were the case, with due respect, I would not be carrying out this interview, but would now be running a big cat and animal sanctuary in millions of acres in South Africa with billions in the bank as I would have found the proverbial “Holy Grail” of investing! As I have a small cat, just under an acre and merely a plot of land in South Africa, then patently I have not found this Holy Grail! We have not reinvented the investment landscape here at Titan. What we have done in our first year is alight upon two asset classes with our Natural Resources and Precious Metals funds and where we believe that they are materially undervalued. We have applied appropriate leverage and traded the moves more right than we have wrong. In fact, when we analysed our average leverage level in these funds over the last year it was less than two times. Given our average leverage of two times, whatever the benchmark did, then we should have produced twice the returns. This is the true test of a fund manager that is presently hidden under the covers in the hedge fund arena. That is, that a measure relative to a base benchmark is meaningless without the leverage level taken being disclosed. Many hedge funds will say for example, “we generated 10% over a year and our benchmark was 5%”. If they ran leverage of five times, for example, then they have massively underperformed and their Sharpe ratio should be shocking. I know of one other managed spread betting service whose focus is playing the “momentum” game through the entire cycle and that is folly in my book too as the market moves through cycles in which particular styles are in focus. If you are pigeon-holed by style then, by its very nature, at some point in the cycle you are destined to underperform.
Over the period since they started in early summer 2012 the FTSE has risen around 20% and they have been leveraged around four times. Their returns, I understand, are less than 40%. If they had paced benchmark, then they should be up 80%. That is major underperformance that the market is not really aware of. To come back to your question, our Global Macro fund in particular allows us to go wherever we want globally in the pursuit of absolute returns. If any fund was to continue to produce positive returns in a market decline, then it is likely to be this as we fundamentally believe in the Precious Metals and Natural Resources funds and in the inherent value there, and do not have the mandate flexibility of the Global Macro account to go outright short the global markets or long bonds for example.
“Over the period since they started in early summer 2012 the FTSE has risen around 20% and they have been leveraged around four times. Their returns, I understand, are less than 40%. If they had paced benchmark, then they should be up 80%. That is major underperformance that the market is not really aware of.”
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Zak: Why make any correlation at all with respect to the benchmarks given that you are clearly trading in a highly leveraged way and returns both positive and negative are likely to vary wildly? Richard: To answer in reverse, hopefully it has become clear to you that we are not in fact trading in a “highly leveraged” way. We are in fact trading in a very, very modestly leveraged way. With regards to why apply a benchmark? Well, we need to be measured against something, and the benchmarks we chose are the most appropriate ones given the portfolio compositions. Zak: One of the best ways of trading is to scale in and out of positions, hence maximising the gain when your call is correct, and minimising the hit when you are wrong. Is there anything more to know about trading a leveraged instrument than this – apart from doing one’s homework beforehand? Richard: There is a great deal more Zak, rather more than this forum will allow us to go into. However, your base points are indeed valid. That is, scaling into a position instead of “going all in” will give you the wriggle room to buy (or sell on the short side) more of a position if it gets even cheaper. This business about arbitrary stops, at say 10% away from one’s entry level, is one of the biggest myths in trading, certainly in relation to good solid asset backed stocks. If, for example, there is an unrelated market shock in Russia that makes an oil stock in Africa fall with the wider market by 20%, then, assuming nothing has changed with the African stock’s fundamentals, more should be bought, not sold!
“This business about arbitrary stops, at say 10% away from one’s entry level, is one of the biggest myths in trading, certainly in relation to good solid asset backed stocks.” The stop story does become much more important with higher leveraged instruments. For example, if you are trading FX then (a) you shouldn’t be in the first place as nobody, repeat nobody ever makes sustainable money trading FX (!) and (b) the leverage of 50, 100, 200:1 will require you, depending on the capital you deploy in your account, to have active stops.
As for the homework, anyone who doesn’t do their homework on an investment is, quite simply, a fool and is destined to lose. Zak: You and your fellow Titan traders are clearly one of the 10% or less of people who are able to trade successfully. Given all the regulatory headaches, the pressure to perform and the way that very often those who invest in funds can never be “up” enough, would it not be easier to sit at home and trade for yourself? Richard: Good question. After quite a few years trading and investing for myself that allowed me to live a good life, be mortgage and debt clear and travel the world, many have asked why do this. The answer is more complex than I can relay here, but the core of it is that, sadly, I turned the big 4-0 last year and despite developing property successfully, my base knowledge has always been “the markets”. I believed that there was a massive gap in the market place with what Titan is pioneering – using a spread betting account and applying professional fund management techniques to generate positive returns. Given the landmark birthday, if I was ever going to start this business, then now was the time. That, and near 20 years’ experience in the markets which I feel gives me a good understanding of what can happen (basically everything!). Don’t forget also that the directors’ own capital IS invested in the funds, and so in essence what we are doing is simply replicating our investment capability for our clients’ accounts and so benefiting from scale of capital. Zak: One of the big “hooks” as far as investing with Titan is concerned is that the directors have their own skin in the game. But doesn’t this lead to the phenomenon of “talking one’s own book” and becoming emotionally attached to a position? Is this not just as bad in its own way as the armchair fund managers or the bloggers with no track record in that you do not have objectivity when you have money on the line? Richard: I personally believe that every fund manager should have their own “skin in the game” with regards to their funds. If I do not have the faith to back myself, then how dare I ask Joe Public to come along and join me?
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Zak Mir Interviews
Next time you receive a CFD “advisory” call or seminar invite, ask those guys (who are generally in their early twenties and have the collective knowledge of a gnat) what personally they have invested in their ideas and supposed “insight”. If this means I am “talking my own book” as you describe it, then very happy to plead “Guilty your Honour”!
“You are the founder of Spreadbet Magazine and have had a “shooting from the hip” style on the blog and in the magazine ever since. How much of this crosses over into your fund management style?” Zak: You correctly called the stock market down at the start of the year prior to one of the worst January’s in recent times. Is successful fund management anything more than just being a contrarian or, as I have read recently, having psychotic characteristics to avoid getting sucked in and out of the market with the herd? Richard: What all the master investors and traders that I have observed seem to have in common is that they are of strong mind, being individual characters that revel in going “against the crowd”. By its very nature I believe that the real outsized investment returns can only come from positioning against the masses as once “the story” has become known, the real returns are gone. Think of Facebook or Twitter for example. The real money was made backing the new idea then of social media (before this became an accepted description of their business models). The early stage investors were ahead of the curve and were buying into something that had not been proven. You could say they were going against the crowd and had the conviction of their beliefs.
In fund management, as we are restricted to the public markets rather than the private markets, unless you are lucky with a resource or technology stock, the chances of making tens of thousands of percent on your money is largely non-existent. So, to generate real alpha then you must position yourself against the herd as you have all the buying (or selling on the short side) to come and carry you forward if you are right in your view. A bit like a lone surfer waiting for the big wave if you like – he sits out in the ocean waiting patiently and when it comes he gets carried ashore with style. Place enough of these dislocated value trades, position size appropriately, do your homework and wait for the unarguable event of mean reversion to take place and you have half a chance. Zak: Master investor and Sunday Times Rich List regular Jim Mellon has taken a stake in Titan. Do you consider this a game changing affirmation? As you are still something of a “start-up”, if only in terms of a one year track record, could his presence “take you to the next level” in terms of Titan gaining critical mass? Richard: We are exceptionally pleased to have Jim on board as a shareholder in Titan. I have been an admirer of Jim for many years and only wish I had taken up his job offer back in early 2000 at Charlemagne Capital instead of, ironically given what we have created here at this very publication, an online equity research offering. I would likely have been materially more wealthy! Jim is, of course, known for spotting early stage trends and I hope that we can live up to his confidence in Titan in the years ahead.
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Zak: You do not have to be a cynic to observe that the fund management industry in general and hedge funds in particular have been particularly good at hoodwinking their clients over costs, fees and even performance. How much needs to be done to get this industry into shape, and in what ways is Titan a breath of fresh air? Richard: We don’t even begin to pretend here at Titan that we can have any material effect on entrenched industry practices. However, we have applied what we believe are best practices with regards to execution, in recent weeks partnering with a specialist trading house – Peregrine and Black – to execute our trades. Additionally, most funds have initial fees of up to 5% when clients enter. Ours is 1.75% but has been waived for the foreseeable future for all new clients. Our annual fee of 1.25% is less than the typical hedge funds’ 2%, and of course our performance fee of 20% is less than the current capital gains tax rate of 28% and is also subject to a high watermark. We think our cost positioning is a compelling one. Zak: You are the founder of Spreadbet Magazine and have had a “shooting from the hip” style on the blog and in the magazine ever since. How much of this crosses over into your fund management style? Should would-be traders and fund managers emulate you (via the calls made on the blog and in the magazine) on the basis that there is only one way to call the market correctly/ make money, but an infinite number of ways to get it wrong? Richard: They should, subject to the suitability test of course, look at our funds Zak. I am also winding down my contributions to the website now due to the time requirements of Titan. Many of our trades require one to be nimble.
For example, as I write this, we moved from a net short position in the markets to a net long one. This may change in 24 hours again if circumstances dictate and if someone was following a blog from a week ago they may then in fact be positioned in the opposite manner to how we are at Titan. Basically, if they want access to our fund management capability, then only via the funds will this be possible. Zak: Is there scope for Titan to be a new Jupiter (JUP), Aberdeen (ADN) or Man Group (EMG)? Is this even desirable in terms of you being able to continue the maverick philosophy of Titan? Richard: We can but hope Zak! Given that the vast majority of our positions are in deep and liquid markets, our current funds are, in my opinion, scaleable materially from here before we hit performance drag due to size. Zak: Who are your fund management heroes? Richard: Paolo Pellegrini – the real brains behind the sub-prime trade (I recommend reading “The Greatest Trade Ever” that tells the story of John Paulson’s multi-billion dollar haul from the US housing market implosion). The late Tony Dye was another chap I admired immensely – a true contrarian fund manager and one of the all-time greats in my book. I know that he has had a difficult time in recent years too, but I also take my hat off to Hugh Hendry of Eclectica. From humble origins in Scotland (I believe his father was a lorry driver?) to make it to the top of the UK hedge fund pile is some feat. I am sure he will deliver strong returns again soon.
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INVESTMENT PARTNERS Specialist Tax Free Fund Managers
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Risk Disclaimer - Titan’s funds use a spread betting or CFD account and are leveraged produ you fully understand the risks and seek independent advice if necessary. *Spread betting in regulated by the FCA. Registration No - 590782
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The Best of the Evil Diaries
THE BEST OF THE
The man the Daily Mail dubbed “The King of the Short Sellers”, Evil Knievil (aka Simon Cawkwell) is Britain’s most feared bear-raider. He mostly famously exposed the fiction that were the accounts of Robert Maxwell’s Communication Corporation, an event which helped to earn his pen name.
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The Best of the Evil Diaries
A big man with a bigger reputation, Evil Knievil famously made £1 million by short selling shares in Northern Rock during its collapse. He also uses his knowledge and experience to buy shares, often resulting in the same devastating effect. Three times a week Evil provides his thoughts and musings on the markets only at theevildiaries.com. He doesn’t just deliberate about the financial markets on The Evil Diaries but also comments on politics, current affairs, which horses/sports bets are his latest favourites, with the occasional film and book review thrown in for good measure. Here we take a look back on the highlights of Evil’s diaries in the month of August.
1st August 2014 Carillion (CLLN) is not now to merge with Balfour Beatty (BBY). It is very surprising that two large concerns with aged professional managers can declare eternal love and then split on such obviously foreseeable grounds. This suggests to me that there is some Blairism going on and, just speculating, that nobody would sanely seek to hold either company. At the races, Goodwood has been simply awful in that, save for trousering £25,000 on the opening of day one, it has been downhill all the way. Seconds galore. That is the trouble when one always helps oneself to seconds. I must be careful as to what I wish for...
4th August 2014 I was told about improper payments at Afren (AFR) about three years ago. However, since there was no evidence to support such allegations I eventually paid no attention. And then last week the two top executives were suspended. Anyway, I am told that there is nothing wrong with the oil assets and that the shares are a stonking buy. So that is why I bought them.
“I am told that there Is nothIng wrong wIth the oIl assets and that the shares are a stonkIng buy.” 6th August 2014 Globo (GBO) is taking its time to slip. But at last it is obliging. It is now 45p. There is therefore still time to clamber aboard the good ship Collapso. It is surprising that Alistair Darling should be proving such a star in rebutting Alex Salmond’s trip down fantasy lane. But he clearly is.
8th August 2014 ISIS has probably hit its limits in Kurdistan or at least the Americans will shortly bomb sufficiently to persuade most that that is the case. I therefore went long Genel (GENL) at 778p. I can’t do the same with Gulf Keystone (GKP) since there is the problem of its debt. Bombing cannot blast this away. I have now shorted Naibu (NBU). I did this very reluctantly. But the price action is undoubtedly strongly indicative of further falls to come. Or so it seems to me. Elsewhere in financials, Hargreaves Lansdown (HL.), now 1,070p, looks a short to me. I never understood how it got up to 1,500p or so. As some will recall I was short at 550p.
11th August 2014 Sirius Minerals (SXX) is getting nowhere with its Yorkshire potash mine and, further, there are severe local reservations about the safety of this putative mine since, I am told, there has been a disaster in Canada in a similar mine. This has not so far been reported in this country. I sold at 10p. Although there is plenty of cash, my informant thinks a target price of 0.5p is appropriate. Elsewhere on the minerals front, a Chinese operation intends to mine on the surface of the moon. I doubt if this is even remotely economic and therefore reckon it is an exercise in establishing territory. The precedents are of visitors establishing mining rights by simply nicking territory.
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The Best of the Evil Diaries
I need hardly list the consequences of such an approach. So I offer the following from The Times’s comments section: Though compared with our Earth night and day, The moon’s not exceedingly large, But will certainly please, All lovers of cheese, For it’s a helluva lot of fromage.
15th August 2014 A voice contacted me yesterday evening and reminded me of my reckoning expressed here some years ago that all is not well with Carillion (CLLN). If the voice is correct, Carillion needs to get something, possibly at any price, to keep the gravy train rolling. Quite why Balfour Beatty (BBY)’s Parsons Brinckerhoff should be crucial to Carillion’s plans is far from obvious to me or indeed anybody else – at least as far as I can see. Anyway, Balfour has today rejected Carillion’s approach, which I suppose means that Carillion will go hostile. If I am correctly informed on Carillion, it is a short at 337p. And Balfour, itself in trouble, is a sell as well at 240p. I think maybe Flybe (FLYB) has a wobblee chart. Steer well clear. Now 110p.
18th August 2014
13th August 2014 Plus500 (PLUS) has reported this morning. I may be wrong on timing of the demise, but there are promising signs of topping out. For instance, the number of new customers in a quarter has not increased which suggests that all this marketing spend has hit its limits of effectiveness. The ARPU (average revenue per user) is declining whilst the cost of marketing per new customer acquired is up from $600 to $900. I grant the fans that the figures are pretty impressive in terms of return on capital. But are they sustainable? I think not. Anyway, I still have severe reservations as to the integrity of the operation.
“I grant the fans that the figures are pretty impressive in terms of return on capital. But are they sustainable? I think not.”
South American success: Orosur (OMI) this morning report the year to 31st May’s figures. They really are good. Cash net of debt is a useful £3.5m and, of course, rising. The debt is well under control. The business is profitable and, surely, will so continue. Orosur is capitalised at c. £16m. All we need now is a dividend. And finally, yesterday’s SunTel requested that readers telephone Scots they know and urge them to vote NO. In recent years I have only spoken to one Scot. So, with a light work schedule, I telephoned. He wasn’t in. I left a suitable message on his voicemail. This could yet swing it.
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Donâ€™t miss out!
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Fund Manager in Focus
FUND MANAGER IN FOCUS
WUNDERKID DAvID EINHORN OF GREENLIGHT CAPITAL BY RICHARD JENNINGS, CFA OF TITAN INv PARTNERS, & FILIPE R COSTA
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Wunderkid David Einhorn
â€œfoolIng some of the people all of the tImeâ€?
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Fund Manager in Focus
When it comes to bluffing in poker, it probably isn’t a good idea to push it too hard if the player sitting in front of you is David Einhorn! Having finished 18th in the World Series of Poker main event in 2006 winning $650,000 (£383,000) and 3rd in the World Series of Poker Big One for One Drop in 2012 and scooping more than $4.3m (£2.5m), David Einhorn is the kind of player that is patient enough to wait for his moment to call your bluff. When that happens you may be in serious trouble… While his fellow poker players are certainly aware of Einhorn’s abilities, it is in the asset management business, however, that he really excels. For a manager of a firm with only 25 employees, and occupying just a single floor in Central New York, Einhorn makes a lot of noise through his “activist” approach to fund management, and he has certainly intimidated many in both investment and political circles. Motivated not only by the profits, but also by a strong sense of morality, he has gained a reputation for ballsy short positions and then shouting the story from the rooftops without being intimidated by the potential fallout that can come from such a stance. Einhorn is famously quoted that the system is “fooling some of the people all of the time” and he believes he has a duty to uncover any wrongdoing he finds. Allied Capital and Lehman Brothers are just two examples of companies that have been targeted by him and, in Lehman’s case, to devastating effect.
Just like at the poker table, Einhorn plays for big stakes, and in being proved right on the issues he raised with these companies he hit the jackpot on his payouts. Of course, he has his detractors, levelling accusations that he uses “short and distort” tactics. The truth is that we shouldn’t blame him for having the courage to publicly oppose flimsy companies and wrongdoings. The plain facts are that the companies targeted were hiding their wrongdoings from shareholders while management were being paid millions in bonuses. While their subsequent bankruptcies cost many employees their jobs, Einhorn arguably merely helped bring their inevitable demise to a speedier end than would otherwise have been the case. At the relatively young age of 45, David Einhorn is in fact the 6th youngest billionaire in the investment industry, as reported by Forbes. With $6bn (£3.5bn) of assets under management at his firm Greenlight Capital that he founded in 1996, his hedge fund operation is certainly one of the most prominent and profitable in the industry.
“out of a small wIndowless sIngle room offIce and wIth neglIgIble employees, eInhorn knew that It would requIre a lot of concentratIon and effort to buIld thIs busIness and that the margIn for error was almost non-exIstent.”
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Wunderkid David Einhorn
The Rise of a Contrarian David Einhorn was born to a Jewish family in New Jersey in 1968 before they moved to Wisconsin when he was seven. He went to the College of Arts and Sciences at Cornell University to pursue studies in Government where his remarkable performance resulted in his graduation summa cum laude and provided a hint of the promising career that was to come. Investment and business in general ran in the family blood with Einhorn’s father and brother running Einhorn & Associates, a Wauwatosa mergers-and-acquisitions consulting firm, and Capital Midwest Fund, a venture capital fund. Following in their footsteps, David Einhorn founded his own business in 1996 with just $900,000 (£530,000) in assets, with help from his parents. Unlike most hedge funds, Einhorn started out very modestly. Out of a small windowless single room office and with negligible employees, Einhorn knew that it would require a lot of concentration and effort to build this business and that the margin for error was almost non-existent. Einhorn’s comments in his first newsletter to his investors expressed his commitment to his trading activities and depicts appositely his behaviour over the following 18 years of investment management: “I don’t consider myself a home-run hitter. but when I’m seeing the ball and hitting it hard, it will go out of the park”.
That statement ultimately proved to have a ring to it as a few select short sales were hit out of the park and made him immensely rich, and gave Greenlight Capital its huge prominence in the industry. To grow from just $900,000 in 1996 to the $6bn (£3.5bn) mark today is no mean feat. Of course, it has not been all plain sailing, with Greenlight posting a 23% annual loss in 2008. Although, it must be said, this was the first and only loss ever recorded by his firm and one that was completely reversed in 2009. Overall, Greenlight has delivered to its investors a 25% annualised gain. Had you invested £1m in Greenlight in 1996, you would now have a remarkable £55 million; a record shared by precious few hedge funds out there. What is also intriguing is that the culture of Greenlight is somewhat different to your typical hedge fund: office doors are open, people tend not to work crazy hours, there is no complicated hierarchical structure, there’s only one trader, and Einhorn always goes home in time to have dinner with his family.
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Fund Manager in Focus
PERFORMANCE CHART COMPARING EINHORN AND S&P 500
Betting Against the Crowd Einhorn is known for being a contrarian. Although limited in terms of human resources, Greenlight usually spends weeks or even months doing research to find companies they believe are trading at a material disconnect to the underlying fundamentals. The company carefully chooses its plays and is prepared to hold positions for years if needed. It makes very few trades such that trading volume and turnover are very slim – in contrast to the very vast majority of hedge funds. At the same time, and against the norm in the industry, Greenlight doesn’t borrow any money, so there’s no leverage involved. But, while zero leverage means lower “risk”, Greenlight’s performance is therefore highly dependent on the performance of a small number of single trades, which means there is much more unsystematic, or company specific, risk involved in their fund.
Einhorn has in fact been a long term critic of investment banking practices, believing they “outmanoeuvred the watchdogs” and that they maximise employee compensation at the expense of the real owners of the business who supply the actual capital – the shareholders, for example paying up to 50% of revenues as compensation bonuses! Since its very early years, Greenlight prospered by identifying a succession of weak financial firms and aggressively shorting them. Such shorts include Conseco, CompuCredit, Sirrom Capital and Resource America during the late nineties and early 2000s, each returning more than 80% in profits to Greenlight. Around the turn of the millennium, the firm also placed some bets against what was a dot-com frenzy. Unfortunately, and as Keynes recognises, “the market can stay irrational more than you can stay solvent” and Greenlight was forced to cover a short position on Chemdex as the stock soared ever higher.
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Wunderkid David Einhorn
This erased 4% of Greenlight capital at the time. You know what’s coming next of course… Yes, Chemdex’s share price was crushed just a few months later, and so proving that even hedge fund titans are not immune to the “timing” problem in the markets! The first notable short revealed by Greenlight and publicly expounded by Einhorn was on Allied Capital, a mid-cap financial company that until 2002 was doing very well. Einhorn publicly eviscerated Allied claiming the company was involved in lending practices that defrauded the Small Business Administration. The next day Allied’s shares plunged 20% and Einhorn became embroiled in a bitter public spat with the company that ultimately culminated with the recognition he deserved as he was proved right about the stock. Still, it is speculated that the spat cost his wife her job at Barron’s and led to a prolonged investigation from the SEC casting doubt on Einhorn’s real intentions. Allied accused him of conspiring with others to bring the stock price down and so Einhorn decided to write a book in which he explained his case against Allied, systematically disassembling the company’s financials and in the process proving the fraud.
“But, while zero leverage means lower “risk”, Greenlight’s performance is therefore highly dependent on the performance of a small number of single trades, which means there is much more unsystematic, or company specific, risk involved in their fund.”
Lehman Brothers Even though he was right on Allied, the public exposure had a severe cost on Einhorn’s life. While shorting shares is a common practice by hedge funds, no one talks much about the specific trades they carry. That is not because they want to keep it secret but rather because they fear public opinion and retaliation from fellow corporate insiders. Company managements are largely scared to death of short sellers though and they don’t take it lightly when targeted.
It was in 2007 that Einhorn got the “bit between the teeth” on Lehman Brothers. He believed the investment bank was too exposed to illiquid real estate investments and, further, that they were being improperly accounted for. Lehman was at the time taking advantage of an accounting mechanism that actually allowed companies to book revenue based on the declining value of their own debts. As the “risk” increased on the money borrowed by Lehman, the actual lenders experienced a decline in the value of these bonds where Lehman was the counterpart. The accounting rules, amazingly, allowed Lehman to record this difference as a gain! The practice was plain insane in Einhorn’s view. If the value of the loans went to zero, then the bankrupt borrower would record a huge gain, as a consequence of the decline in value. It’s like getting immensely rich right before going bankrupt! While many financial companies used the above trick, it was only Lehman that tried to hide it from investors in order to make their accounts appear better than they were. Going into the GFC, Lehman was just one of many on Greenlight’s short list of financial stocks. In April 2007, the company shorted Lehman’s shares and Einhorn again appeared in public exposing this case. Dismissing the trouble Allied created on his own life, he was again determined to point his finger, this time at Lehman, as being emblematic of the arrogance and greed that caused the credit crunch. Erin Callan, Lehman’s CFO at the time, tried to convince Einhorn he was wrong, insisting that he was actually missing the complexity behind the bank’s business in a desperate attempt to explain the discrepancies Einhorn highlighted in Lehman’s accounts. As history would come to show, Callan failed in her pitch and just weeks later Lehman ended up reporting a $2.8bn loss for the quarter. In September 2008 the company would finally declare bankruptcy, once again proving Einhorn was right.
“If the value of the loans went to zero, then the bankrupt borrower would record a huge gain, as a consequence of the decline in value. It’s like getting immensely rich right before going bankrupt!”
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Fund Manager in Focus
Einhorn and Greenlight Fined for Market Abuse Einhorn has not been squeaky clean throughout his career however. In January 2012, the UK Financial Services Authority (FSA) fined both Greenlight and Einhorn £7.2m pounds for alleged trading abuses. The FSA claimed that Einhorn obtained information on Punch Tavern’s Plc equity fundraising from a broker prior to public knowledge of the event. This information led him to sell more than 11 million shares on the company and avoid the subsequent 29.9% loss experienced in the share price of Punch, representing a £5.8m loss avoidance. The FSA acknowledged that Einhorn’s trading on Punch was not deliberate because he didn’t believe that it was inside information. However, taking into consideration Einhorn’s prominent profile and knowledge about the market, the FSA considered that such belief was not “reasonable” and that he should have taken the necessary measures to avoid trading on such information. Even though Einhorn considered the fine unjust and inconsistent with the law, he did not appeal and coughed up. Most likely paying heed to the immortal words of Kenny Rogers in “The Gambler” song: “know when to walk away”!
Final Comments The main distinction between David Einhorn and other good fund managers is that he is also a free speech advocate, with a sense of duty to expose any fraud, while of course attempting to profit from the exposure. He believes that people should say what they think and sees no conflict between his public moralism and the fact that he stands to profit from it. While Einhorn is relatively young for his position, he is, it seems, endowed with old wisdom. Traditional valuation metrics are his key to identifying value dislocations. If you wish to merely go with the crowd, you are better simply investing passively in an index tracker. To outperform the market over a long cycle, however, history shows that dedication and many hours of deep digging into financial statements and market data is required, just as the profiles of the various hedge fund managers at the top of their game that we have run here illustrates. As in most other endeavours in life, courage, conviction and hard work are the real dividend payers.
“hIstory shows that dedIcatIon and many hours of deep dIggIng Into fInancIal statements and market data Is requIred, just as the profIles of the varIous hedge fund managers at the top of theIr game that we have run here Illustrates. as In most other endeavours In lIfe, courage, convIctIon and hard work are the real dIvIdend payers.”
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The “Herd Instinct”
The “herd instinct” and its very real dangers BY RICHARD JENNINGS, CFA OF TITAN INVESTMENT PARTNERS, & FILIPE R COSTA
“One million people cannot be wrong” There are many decisions in our daily lives that we take socially. In many of these instances, we often look at what other people do before taking action. For example, ever noticed how if two or three people in the passport queue at the airport go one way then the crowd tends to follow? The supermarkets we patronise, the number of children we decide to have, the food we eat, the brand of beer we drink: these are just some examples of decisions that are influenced by what surrounds us, by the preferences of the people that are near us, and not always by a rational evaluation of all alternative options we have available. A very common real world example, often given by textbooks and academics, is that of a choice between two restaurants. Imagine that a tourist comes downtown to a street where there are two restaurants. Let’s call them for our purposes restaurants A and B. The time being a little early for dinner, said tourist has to decide between two empty restaurants, and very little else in the way of information to help him decide. In the end, he just chooses one randomly. Let’s suppose it is restaurant A. Then, after a while, another tourist shows up, looks through the restaurant’s windows and opts for restaurant A, because it already has one customer.
This situation repeats and all newcomers opt for restaurant A because it is the more popular of the two. They do so irrespective of their own information about the two restaurants. What they are doing is taking solace in the fact that because there are many more people in restaurant A relative to restaurant B, and so surmising automatically, the food must be better in A. They are trend following at heart. The first client picked up restaurant A, however, completely randomly. Not rationally or with considered judgement, it was pure chance. Taken to its logical extreme then we could have a full restaurant that is made up of “irrational” clients. The restaurant may or may not be the better of the two, but by virtue of the embedded acceptance in human nature that “the crowd cannot be wrong”, everybody is dinning at restaurant A. At Titan, by the way, we would have checked the menu at restaurant B, and if it appeared to be better, we would have eaten there! While the above example gives us a very simple situation where rational people may inadvertently make irrational decisions, it is just a textbook case, not a real case. So, let’s consider now a real case that was studied by Hanson and Putler in 1996.
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The “Herd Instinct”
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The “Herd Instinct”
“When we apply the above behaviour to financial markets, what results is investors copying other investors’ actions. That is, buying the same group of equities that the others are buying.” These researchers decided to use a real world situation under laboratory controls, and without people knowing about it. They essentially manipulated a service provided by AOL regarding the download of games. Customers were able to download free games from AOL’s website. The aim was to choose the games that could bring them amusement. Each game was made available for download with some basic information which included the number of times it was downloaded by others, being interpreted as a popularity index. The researchers took pairs of games and manipulated the number of downloads for one of them in order to see if that influenced the decision. What they found, the more astute readers amongst you will no doubt find unsurprising, is that when they pushed the popularity number higher the guinea pig customers selected these in preference to the others. In other words, they were influenced a great deal by looking at what other customers did. Customers rely on other customers’ choices without any rational reason other than “one million people cannot be wrong”. The above examples exemplify a behaviour that is known as “herding”. By herding we mean the act of following others’ actions, even if it means giving up our own beliefs.
We follow the common trend just because it is the “done thing”. This means that there is no fundamental reason for this behaviour; it is mostly guided by emotion. When we apply the above behaviour to financial markets, what results is investors copying other investors’ actions. That is, buying the same group of equities that the others are buying. At times like the 1990s, when shares in dot-com companies were rising so rapidly, people were attracted by the popularity of such stocks, even with the knowledge that traditional valuation metrics didn’t support the price rise. In effect, the thought process was “I buy because you buy”. Everybody else buys because we all buy. Herding is often led by a positive feedback effect pushing investors to buy what is already rising. When prices are pushed too far from fundamentals, as was the case during the late 1990s, a bubble forms. At some point, a catalyst occurs in which a few people realise that fundamentals don’t sustain such high prices. They start selling and the trend change causes all the others to start selling at the same time. That happened in March 2000 and in October 2007, when liquidity freezes resulted as a consequence of massive sell orders (see chart below).
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The “Herd Instinct”
15 YEAR S&P 500 MONTHLY CHART In the example given above, if restaurant A doesn’t live up to expectations, people won’t come back, and, eventually, at some point, it will lose customers. But in the stock market, things are not quite as clear cut. At the point that the “crowd” realises they’re wrong, they instantly start getting rid of those equities they do not want to own. The bursting of such a bubble represents a return to rationality which ultimately turns out to be a good thing after all, despite the severe consequences it carries, as appropriate valuations are reapplied to stocks. Going back to our open gambit, “emotions”, completely naturally, often lead our decisions in life. This of course includes investment decisions. Under certain conditions, we become overconfident and lose some degree of rationality, taking on additional risk without really being aware of it. When investor sentiment indicators are high, volatility is low; when the number of IPOs reaches giddy heights, it often is a consequence of irrationality leading decisions.
At such times, we are more willing to be influenced by positive feedback and to herd. Stocks then start rising above fundamentals. No one wants to be left behind... The problem with this is that, according to several academic studies and from our own experiences, when sentiment is too positive, contemporaneous returns over the medium term are poor. So, if you’re already in when sentiment rises to lofty levels, this is precisely the time you should be looking to get out. If you aren’t in, it is probably too late for you to enter too. The bolder investors in markets can start looking over the hill to go against the crowd and actively short it. The smart investor is that one guy who follows fundamentals that become out of kilter with sentiment. For example, if you have a situation where an asset class is cheap but sentiment is poor, then herding is at play in reverse here.
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The â€œHerd Instinctâ€?
Prime example being Global Oil E&P stocks at present, selected European banks, Russian equities (and bonds), and, of course, our favourite: gold and silver stocks.
Below is a table of sentiment measures that private investors can keep an eye on in assessing prevailing sentiment.
The points contained in here are also a big warning sign for buying index tracker funds towards the end of bull markets. That being that as equities rise and herding self feeds, the case for buying blindly diminishes and active fund management, ideally by contrarian fund managers, is probably most appropriate.
SENTIMENT MEASURES TABLE
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Titan Investment Partners - Natural Resources Fund
Returns from inception (01 July 2013) to 22nd August 2014 Titan Natural Resources Fund +96.11% v FTSE 350 Mining Index Benchmark +19.39% Outperformance relative to benchmark +76.72% These figures are gross returns and have not been adjusted for Titan’s fees. Past performance is not necessarily a guide to the future. • A diversified selection of natural resources related stocks and positions
• All returns completely free of CGT* • Leverage capped at 2.5 times on stock positions
• Long/short flexibility
• Directors OWN capital invested within the fund
• Minimum investment of only £10,000
• 90% of gross dividend credit on stock positions
CLICK HERE FOR MORE INFORMATION 0203 021 9100 www.titanip.co.uk Risk Disclaimer Titan’s funds use a spread betting or CFD account and are leveraged products that involve a higher level of risk than conventional non-leveraged funds. Ensure that you fully understand the risks and seek independent advice if necessary. *Spread betting in the UK is currently tax free but this may change in the future. Authorised and regulated by the FCA. Registration No - 590782 September 2014
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Alpesh on the markets
ALPESH ON THE MARKETS
PHARMA ON MY MIND I write to you having returned from Singapore and Thailand. I will be in Bangalore by the time you read this - the bio pharma hub of India â€“ so pharma is very much on my mind. Generic profits Playing on the theme that some $86 billion worth of branded drugs will lose patent protection between 2013 and 2017, there must be a lot of money to be made for the generic drug maker - especially as such drugs are typically 30-80% cheaper than their branded rivals. So which companies do I have my eyes on? Well many of these are billion dollar companies, so are safe given their size. In this area we are not talking about risky plays along the lines of some oil exploration company in the Pacific or gold miner in Angola. Names I love for their performance and size include: Perrigo, Actavis, Mylan, Hospira, Taro, Akorn and Lannett. These are all US listed firms so easy to access from anywhere in the world. Whatâ€™s more, given their size they provide a certain amount of safety, although I see no signs that their growth will slow down.
Some of these firms provide over the counter drugs, while others provide drug ingredients. Overall, P/E ratios are quite high at around 40 times, but this reflects the markets pricing in the future increase in profit potential.
Opening up new markets Minimally invasive surgery companies are related to this sector too and they are much loved because they help insurance companies to pay less. Of course, the patients and doctors love such companies too given the faster recovery times their products offer and, as the name suggests, less invasive surgical methods. I note a number of attractive companies in this area, but within microsurgery in particular. These include Conmed, AngioDynamics, NuVasive and Cardiovascular Systems, all of which have been performing very well lately and only show signs of continuing to rise.
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Pharma on my mind
Alpesh B Patel Alpesh is a hedge fund manager who set up his asset management company in 2004. His Sharescope Special Edition has outperformed every UK companyâ€™s fund manager over the past decade, as well as Warren Buffett. He has written over 200 columns for the Financial Times and presented his own investment show on Bloomberg TV for three years. He is a former Visiting Fellow in Business & Industry at Oxford University and the author of 18 books on investing. Find out more at http://www.investingbetter.com and http://www.inter.tradermind.com
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Alpesh on the markets
Robotic surgery companies in this sector also catch my eye. Intuitive Surgical, the NASDAQ listed player which makes robotic surgical systems, including the da Vinci Surgical System (below), is the stand out performance leader. This high tech product allows surgeons to make small incisions into the patient to insert miniaturised instruments and a high-definition 3D camera.
“Biotech giants increasing their merger and acquisition activities, as they fight to own the next big technology, means this sector is buoyant.” In the arena of imaging and detection I would go with Hologic, a NASDAQ listed firm specialising in women’s health. The company is a market leader in mammography and breast biopsy, breast magnetic resonance imaging, radiation treatment for early-stage breast cancer and cervical cancer screening. In the laser category the stand out leader based on performance is Spectranetics, whose products treat arterial blockages in the heart and legs, as well as remove pacemaker and defibrillator leads. The shares are up by 74% over the past 12 months.
Play on M&A? Biotech giants increasing their merger and acquisition activities, as they fight to own the next big technology, means this sector is buoyant. My own particular favourites to potentially benefit from this are:
For other general diseases, companies on an upward trajectory include Alexion and Regeneron. And in case it’s not enough for you to profit from the misery (or the happiness in cure) of others, then an ageing global population should make you pleased with these stand out players: In diabetes care, Novo. In dialysis the players to look out for are DaVita and Rockwell. For assisted living companies go for Chemed and Gentiva. If cardiovascular care interests you then it’s Vascular Solutions and Spectranetics. And finally, for orthopaedic care the performers are Wright Medical and NuVasive. Happy health. I’m off for a run after I take my beetroot juice and broccoli. Alpesh
In cancer: Amgen and Celgene for their performance. In infection diseases: Gilead Sciences, which works in everything from AIDS to liver diseases. Autoimmune disorder specialists are also doing well, including Biogen and Incyte.
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Mellon on the markets
MELLON ON THE MARKETS
Bad Omens are Building up Entrepreneur and financier Jim Mellon is a regular in the Sunday Times Rich List, with an estimated fortune of £850 million in 2014. With a substantial international property portfolio and interests in a variety of companies, particularly in the alternative energy and biotech sectors, Jim is a highly experienced and successful investor. Markets continue to waft upwards on the wave of easy and abundant money that seems to characterise the post QE phase. And yet, I can’t help but think that this is a party that’s going to end soon. It’s hard to say why exactly. But when I hear that institutions supposedly still have a lot of cash, and are deploying in in some scarily overvalued technology company IPOs, I get worried.
“crazy valuations and rising interest rates are combined with anaemic growth and high insider selling. Does that make you comfortable? I hope not.” In 1987, and 2000, the assumption that there was more to go because institutions still had a fair amount of liquidity (notwithstanding that such analyses are always late), coupled with clearly stretched valuations, was rewarded with disaster.
Are we headed that way now? Possibly. All sorts of bad omens are building up, blithely ignored by the bullish hordes. - margin debt in the US is at record levels. - IPOs are finding it harder to power ahead as they did earlier in the year. - corporate earnings growth in the US is largely the result of share buybacks, so that once pristine balance sheets are now more leveraged than they were, at a time when interest rates are likely to rise. - We might point to the raft of geopolitical tensions with which we are all familiar, as well as the continued lemming like run to the cliffs by the Eurozone, and the problems that are fast accumulating in China. So crazy valuations and rising interest rates are combined with anaemic growth and high insider selling. Does that make you comfortable? I hope not.
By Jim Mellon
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Bad Omens are building up
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Mellon on the markets
Opportunities But of course, there are always opportunities. Let’s look at a few of the ones I highlighted in my last two epistles. One, the euro. I said I disagreed with economist Steen Jacobson on little except the direction of the euro. It has fallen from 1.38 since my last letter to 1.31 and looks set for further declines. Why wouldn’t it? There isn’t a squidgin of evidence that the Eurozone is improving in any sense. In fact, large parts of it are in a secondary depression. When I see that lump of Gallic lard Hollande getting drenched in the Brittany rain, it is surely a metaphor for the sense of entitlement – little work, early retirement, cradle to grave care – that characterises so many of the Mediterranean countries. And now, Germany, so stupid about not encouraging domestic consumption and instead focussing on exports, is also slowing to the pace of a funeral march.
3. Bonds. I can’t believe that they won’t start backing up in yield again, and I like the short of the JGBs (the widow maker). I would short US 10 year Treasuries and French OATS, as well as a have a small position in short Bunds. 4. Gold and silver. I am a buyer. Gold recovered above its 50 moving day average and to my mind is set fair for $1,350. 5. Gilead was my big call at the Master Investor show. Signup for next year’s show below – it’s going to be spectacular!) It has doubled, or nearly, since then and I would sell it now. 6. I am a fan of Arrowhead, as you might know, and it’s close to a readout on its Hep B drug. I also like Summit plc where I am a director and large shareholder. 7. I shorted Twitter some time ago and covered. It’s time to short again. 8. In Japan I still like Astellas, which is still undervalued relative to its peers and to its partner in the drug for prostate cancer Xtandi, which is made by Medivation. 9. The Nikkei still looks like a better investment than the S&P for the rest of the year. And finally...
This is not good. And while we in the UK, especially our focus group led leaders, enjoy fast growth, slow growth internationally certainly won’t help us to maintain it. Everyone in the financial world is looking for a Black Swan event so it may not happen. Or might it? My guess is that we are in the last balmy days of complacency, and it’s time to batten down the hatches.
Please check out Amazon in a couple of weeks for the pre-orders of our new book, Fast Forward, which we are really proud of and which has taken about a million decaf coffees to write. My co-author Al Chalabi and I would really appreciate your support on this one. All the best in your investing Jim Mellon
So what to batten down as a hedge? 1. I think for those of strong stomach, the euro remains a short against the dollar. It is way overvalued and even Mario Draghi will be Draghied to his senses and start insisting on re-flation. 2. The Japanese yen, one of our best trades, now looks to be too WEAK, and is a buy. Look for 104 to 102. Every little bit helps.
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The state of the global pharma industry By James Faulkner of t1ps.com
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The state of the global pharma industry
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The global pharmaceuticals industry is undergoing a period of fundamental change. A dearth of major drug discovery in recent decades has combined with the expiry of patents on many blockbuster drugs developed in the 1990s, in a phenomenon known as the â€œpatent cliffâ€?. This opens up the door to generic competition (i.e. other companies copying patented drugs and selling them for cheaper prices), which is a major headache for the large pharma companies. It is also putting a serious dent in the sales of big pharma, and the industry has struggled to adapt in recent years.
Sources: Company Filings, IMS Health Data, Fisher Investments Research. Dollar figures of drug sales as of 2009.
So why havenâ€™t the pharma companies simply brought out a raft of new products to replace the old ones? The short answer is that the pharma industry is stuck between a rock and a hard place. On the one hand, the cost of developing a new drug is spiralling upwards due to increased regulations and more advanced (and expensive) technology.
However, as Bernard Munos of the InnoThink Center for Research In Biomedical Innovation has noted, that estimate could be a misrepresentation of the true costs of bringing a drug to market. Just adjusting that estimate for current failure rates results in an estimate of $4bn in research dollars spent for every drug that is approved.
According to numbers often posited by industry figures, it now costs on average c.$1-1.5bn over a period of roughly ten years to develop a new drug.
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The state of the global pharma industry
“According to numbers often posited by industry figures, it now costs on average c.$1-1.5bn over a period of roughly ten years to develop a new drug.” Meanwhile, drug companies are being pushed in the opposite direction by governments, who want to see lower drug prices in order to ameliorate their own budgetary pressures. Thanks to Obamacare, gone are the ‘good old days’ where pharma companies could charge what they wanted in the US; European healthcare budgets are under pressure due to austerity, while the EU Mutual Recognition System has imposed uniform pricing across states; and the Japanese government simply imposes price cuts every two years to keep drug costs down. Entry into emerging markets has helped many a pharma company take up the slack somewhat, although not on the kind of scale originally anticipated.
In many ways this is a good match. Large pharma, despite its difficulties, still has great cashflow, as well as the sales and distribution infrastructure that smaller players lack. In addition, there are many (our chairman, Jim Mellon, included) who believe that we are on the cusp of a new golden age of medical advances, as the focus moves away from the “one size fits all” compound drugs we are all familiar with and towards more personalised biotechnology, which is more interested in the interplay of biological systems, living organisms and their derivatives.
In order to cope with these headwinds, pharma companies have been busily streamlining their operations in recent years, which in some cases has meant scaling back research operations.
PHARMA INDUSTRY ACQUISITION VALUES
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With many a big pharma having downsized its early-stage research operations in order to reduce costs and placate shareholders, biotech companies have a major role to play in early-stage drug discovery. Through multiple small-scale trials, biotech can explore a broader range of the early clinical development space more quickly at a lower cost than large pharma, thereby freeing-up the latter’s resources for more late-stage studies. Clearly, the owners of big pharma stock are more risk-averse than the owners of biotech stock, so a separation of roles along these lines makes sense. More recently, however, big pharma has become more willing to in-licence potential treatments in the earlier stages as the battle to replenish pipelines heats up. For the relatively small-scale biotech outfit, a deal with big pharma can be transformational. For example, PanGenetics, a small biotech based in the Netherlands, received $170m from Abbott Laboratories in 2010 for the rights to an experimental pain treatment in Phase I trials, an almost unheard-of sum for such an early-stage asset. Deals of this nature help share risk between the pharma company and the biotech firm, as they usually include an up-front fee that provides the biotech with a useful cash injection, while potential milestone payments offer further upside to the biotech firm and limit downside for the pharma company.
For investors looking to play the pharmaceuticals and biotech sector, we believe that a basket approach is necessary in order to minimise the often significant stock-specific risks. Large pharma offers income attractions as well as some potential for modest single-digit growth in the coming years, whereas specialty pharma and biotech offer potentially very significant upside but carry greater risk. We believe that a handful of carefully selected assets in the sector could provide investors with a decent return on a medium-term view.
“Through multiple small-scale trials, biotech can explore a broader range of the early clinical development space more quickly at a lower cost than large pharma, thereby freeing-up the latter’s resources for more late-stage studies.”
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Three blue chip/mid cap pharma trading ideas By James Faulkner of t1ps.com
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Three blue chip/mid cap pharma trading ideas
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Switch idea: AstraZeneca (AZN) into GlaxoSmithKline (GSK) AstraZeneca has been the clear winner of the two UK mega-cap pharmaceutical stocks in 2014. While GSK has been mired in bribery scandals, Astra was the subject of a takeover approach from Pfizer, which sent its stock soaring to an all-time high. Marked out as a takeover target, AstraZeneca shares still trade at a premium to the prevailing price prior to the takeover approach from Pfizer, despite the fact that the UK political establishment made clear its opposition to a deal. The truth is, however, that in the absence of a takeover deal, the immediate future looks highly uncertain for AstraZeneca, as the company faces numerous challenges. separates the plastic coating from the fibre.
On broker Panmure Gordon’s estimates, Astra trades on a rating of 14.6 times rising to 17.2 times, “with no real visibility to trough year earnings”, although it currently assumes this to be 2016.
“sorIot seems to have resurrected several drugs that had prevIously been consIdered a lost cause, whIle also shoutIng a bIt louder about astra’s pIpelIne, whIch Is, admIttedly, rather attractIve from a long-term perspectIve.” Buy Glaxo
Astra’s CEO, Pascal Soriot, took the helm in 2012, since then the shares have outperformed the rest of the European pharmaceuticals sector. However, this hasn’t been down to any major acquisitions or restructuring. Instead, Soriot seems to have resurrected several drugs that had previously been considered a lost cause, while also shouting a bit louder about Astra’s pipeline, which is, admittedly, rather attractive from a long-term perspective. But therein lies the problem for Astra – it is essentially a long-term play on a promising, albeit uncertain pipeline, with very little medium-term visibility. In the near-term, its portfolio will undergo significant disruption as the Nexium, Crestor and Seoquel drugs all decline as they come under pressure from patent expiries and generic competition.
Meanwhile, GSK has been going through a tough time of late, but looks set to emerge from its patent cliff sooner than its UK rival. In addition to allegations of corruption in its sales operations in China, Iraq and Syria, GSK recently disappointed the market with second-quarter results that were below market forecasts, also prompting the company to cut its outlook to flat from +4-8% EPS growth previously. As if this wasn’t enough, it also implicitly suspended its 2014 share buy-back for the remainder of the year, with only £238m repurchased compared to forecasts of around £2bn. That said, Glaxo’s problems are largely of a short-term nature. The majority of the Q2 earnings miss was down to negative forex movements, slower than expected launches in the respiratory franchise, and the China problem, which looks likely to blow over in due course.
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Three blue chip/mid cap pharma trading ideas
“GSK has overcome the larger part of its patent cliff, its balance sheet is strong, and there is little need to carry out acquisitions in order to shore-up its pipeline.” Elsewhere, however, the picture is a brighter one. GSK has overcome the larger part of its patent cliff, its balance sheet is strong, and there is little need to carry out acquisitions in order to shore-up its pipeline.
In addition to this, the firm has a well balanced and diversified portfolio of businesses that stretches across North America, Europe and Emerging Markets, and straddles consumer healthcare, branded pharmaceuticals and vaccines.
In fact, the pipeline is looking pretty strong in comparison to many of its peers, with six new molecular entities expected to exit Phase III trials in 2014 and 2015, while a planned ten new key area molecular entities will enter Phase III of development.
Trading on a P/E of 14 for FY14 and 14.4 for FY15, GSK is now the clear value option of the two UK pharmaceutical mega caps. Moreover, there is now also some very hefty yield support at around 6% versus Astra’s 4.1%. What’s more, Panmure describes GSK’s dividend as “very secure”. Once the market begins to look past the short-term negatives at GSK, we believe there is scope for a modest recovery in the stock price.
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Takeover target: BTG (BTG) A specialist healthcare company with a direct commercial presence in US acute care medicine and interventional oncology, BTG is one of the great UK pharmaceutical success stories of recent years. It operates three main business divisions: Interventional Medicine, Speciality Pharmaceuticals and Licensing, and a number of internal and partnered R&D projects. BTG has a rather interesting business model whereby its highly cash generative Speciality Pharmaceuticals and Licensing divisions provide the funding for investment in Interventional Medicine, the main growth driver of the business. This part of the business is focused on high-value, innovative and differentiated products/procedures, supported by clinical data, which address unmet medical needs and can therefore be quite lucrative.
The first commercial patient treatments have been pre-authorised by insurance companies and are expected to be conducted during Q3 2014. In the longer term, there could be additional upside should Varithena extend its reach into the cosmetic market in the US, as well as other markets outside the US.
“we belIeve that Its market-leadIng posItIon In several rapIdly growIng markets wIll make It hard for larger players to Ignore.”
Management has a pretty ambitious plan to grow Interventional Medicine revenue to in excess of $1bn by 2021, which, to put things into context, compares with current-year anticipated revenue of £330-£345m for the whole group. To do so would be a major achievement, especially given that the current financial contribution from Interventional Medicine is relatively modest. Following the 2013 acquisitions and subsequent FDA approval of varicose vein treatment Varithena, BTG now has four commercial-stage products targeting the fast-growing interventional oncology and interventional vascular markets.
What’s it worth? Numbers BTG recently reiterated full-year guidance despite the recent strength of Sterling, which is impacting dollar-denominated revenues. Furthermore, a good start was made with Varithena. More than 85% of vein clinic physicians have been contacted and the first 96 physicians are currently being qualified to use the product.
Having made a profit of £33.3m in 2014 and boasting a market capitalisation of more than £2.2bn, BTG is not cheap by any conventional standards. However, investors should bear in mind that the business is not currently focused on driving the bottom line – rather it is concerned with reinvesting income for growth. With this in mind, we note that the firm invested £47.2m in R&D in 2014 (up from £41.2m the previous year).
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Three blue chip/mid cap pharma trading ideas
It also invested ÂŁ260.3m on acquisitions during the period, but still managed to register a net cash position of ÂŁ38.2m at the end of March. With the contribution from Varithena set to rise rapidly in the coming years, BTG is entering an exciting period in its history.
We believe that its market-leading position in several rapidly growing markets will make it hard for larger players to ignore.
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Speculative Play: vectura (vEC) Vectura is a UK-based speciality pharmaceuticals company focused on the development of inhaled drugs mainly for respiratory diseases – a market which is estimated to be worth $32.4bn in 2013 and is expected to grow to $43.9bn in 2018, with a compound annual growth rate (CAGR) of 6.2% (source: BCC Research). The group currently has eight products marketed by its partners including GSK, Novartis and Baxter International and a portfolio of drugs in clinical and pre-clinical development, some of which have been licensed to major pharmaceutical companies.
In addition to these drugs, Vectura possesses a host of other compounds – for the treatment of Parkinson’s disease, cystic fibrosis and erectile dysfunction to name but a few – that have yet to find licensing partners. Vectura has been busy gaining the necessary European marketing authorisations for AirFluSal Forspiro (formerly known as VR315). VR315 is a generic copy of GlaxoSmithKline’s $8bn-a-year inhaled lung drug Advair, a real blockbuster. With other European approvals likely to follow suit, the shares could really take off from here. For example, analysts at Berenberg had been assuming a 40% chance of approval in Europe and 2017 sales of around $250m, or roughly 10% of Advair’s current European sales. This could prove conservative. What’s more, Novartis has been very open about its ambitions in the inhaled medicines arena, and has not ruled out the prospect of acquisitions. Vectura would be the obvious target.
Valuation Product pipeline The main driver for Vectura’s business is its relatively diverse R&D pipeline, centred on inhaled drug therapeutics. In terms of revenue generating potential, the main focus for investors are four compounds: NVA237, QVA149, VR315 and VR632.
In any case, Vectura is poised to make the transition from loss-making R&D outfit to profitable pharmaceuticals business. There is also cash of £81.7m on the balance sheet, and the company has no debt. With this in mind, we could be nearing an inflexion point, both in terms of the firm’s financial performance and its share price.
The first two are licensed to Novartis and in development for chronic obstructive pulmonary disease (COPD), while the latter two (excluding the US rights to VR315, which have been acquired by another “leading international pharmaceuticals company”) are both licensed with Novartis’ generics division, Sandoz, and in development for both COPD and asthma.
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Three blue chip/mid cap pharma trading ideas
Vectura is now generating royalty revenues from its three lead products, Seebri (NVA 237), Ultibro (QVA 149) and AirFluSal Forspiro. Elsewhere, the recent acquisition of German pharmaceutical company Activaero packs out the companyâ€™s development pipeline into the foreseeable future and represents a focus for the reinvestment of the royalty income from the aforementioned products.
With the caveat that Vectura carries risks traditionally associated with the pharmaceutical sector (e.g. product development failure, regulatory risk etc.) it appears to be building what could ultimately become a valuable franchise, and we believe the shares are worth a look for the more adventurous investor.
VENTURA CHART * Disclosure: James Faulkner, a contributing analyst at SpreadBet Magazine, owns shares in Vectura.
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THREE SMALL CAP PHARMA STOCKS TO BUY BY RICHARD GILL, CFA OF T1PS.COM
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Three small cap pharma stocks to buy
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The London based Pharmaceuticals and Biotechnology industry has a number of quirks about it. Firstly, there are a relatively small number of companies to invest in compared to other sectors. Unlike mining, financials or oil & gas, which have hundreds of companies to choose from, there are only slightly fewer than 60 pharma & biotech companies listed in the UK. Secondly, three heavyweights dominate the industry. The combined market capitalisation of FTSE 100 giants GlaxoSmithKline, AstraZeneca and Shire is currently almost 11 times more than the rest of the sector put together. Thirdly, the London markets have seen their fair share of small cap pharma disaster stories. Some which come to mind include inhalation drug delivery company Skypharma, which has spent over half a billion pounds of investors’ money over the years without any considerable success; and scar reduction firm Renovo, which effectively shut down after its flagship drug Juvista failed to get through Phase III trials. Of course, given the risks involved in the industry major losses with some individual shares are to be expected. But there is also the potential for major gains. Here are three small cap pharma/biotech companies which I believe are worthy of a closer look, all having plenty of potential newsflow in the coming months.
We begin by returning to Skyepharma (SKYE), which, despite having fallen in value by more than 98% since the year 2000, has been making some good progress recently. The return to good form has already seen the share price triple over the past year or so, but we believe it may have further to go.
Skyepharma is a drug delivery specialist, with a particular expertise in oral and inhaled therapies. Despite the disappointing long-term history on the markets, with many products now across the portfolio, we believe that the company looks to have many interesting investment opportunities. The medium-term outlook is underpinned by recent product launches: asthma treatment flutiform in multiple territories including in Europe and Japan, Exparel and GlaxoSmithKline’s next generation of asthma/COPD products (for which royalties are capped at £9 million per annum). In addition to this, the company generates revenues from royalties, contract development fees, product supply and milestones from a portfolio of oral, inhaled and topical products using its technologies, plus a share of sales from Exparel, a product from its former injectable business. The company had until recently been suffering from some debt overhang. However, at the end of March it announced a £112 million placing at 191p a share, the proceeds of which were used mainly for the early re-payment of bonds at a cost of £95.6 million, representing a discount of £25.2 million compared with the total amount which would have been payable at the earliest normal redemption date of November 2017. It is hard to exaggerate the impact on the balance sheet, which saw net debt fall from £84.2 million to just £2.9 million as at 30th June. Furthermore, this will save the company a significant amount in interest costs, with the greater net cash flows paving the way for further investment in product and technology development. Results for 2013 were significantly ahead of market expectations, with positive development on several fronts. The continued roll-out and market traction of flutiform remains the key value driver, but the firm’s strong track record, growing proportion of recurring revenue (up from 66% in 2012 to 72% in 2013), blue-chip partners (including Mundipharma, Kyorin, Sanofi and GSK) and expansion potential suggest there could be much more to go for here. Main risks include the fact that Skyepharma draws over half its royalty income from one product (flutiform), regulatory issues and competitors developing rival drugs.
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Three small cap pharma stocks to buy
â€œThe return to good form has already seen the share price triple over the past year or so, but we believe it may have further to go.â€? Despite the strong performance of late we believe the valuation still looks reasonable, with the shares trading on 21 times consensus forecasts for 2014, falling to 11.2 times for 2015.
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TyraTech (TYR) While not strictly being a pharma or biotech company (it operates within “life sciences”) Tyratech has a number of products which benefit human health. The firm is a specialist in insect and parasite control products, with its unique selling point being that it uses natural plant essential oils in order to kill parasites and pests. The technology works by targeting and disabling specific receptors which are active in insects and parasites but not in humans or other mammals. The benefit here is that, unlike competitive products, Tyratech’s products are non-toxic and thus safer to use. Also, the company’s products have been shown to have superior efficacy compared to pesticides (which insects can be resistant to) and other natural products. While Tyratech has a number of products across its portfolio, all of which I won’t cover here, the one that has received the most attention in recent times is Vamousse, a treatment for head lice and nits. Sold as Vamousse Treatment Mousse and the Vamousse Prevention Shampoo, when used as directed Vamousse has been scientifically proven to kill 100% of lice and eggs within 15 minutes of application. This superior efficacy is becoming ever more crucial in a world where lice resistance to the chemical found in common over-the-counter treatments has been estimated to be up to 99.6%.
Tyratech scored its first major commercial coup in January this year when it announced that US retailing giant Walmart would be stocking Vamousse from the end of March, thus opening up a huge market. According to the Centers for Disease Control and Prevention, up to 12 million US children each year are infested with head lice. This drives a market for head lice control products which is estimated by TyraTech to be worth $150 million per annum in the US, with an estimated global market worth of $700 million. Over 4,000 Walmart stores across the US now stock the product range, as do independent stockists including Rochester Drug, Lewis Drug and Bartell Dru, along with online stockists at Walmart.com, Amazon. com, drugstore.com and Walgreens.com.
A few months into the second half of the year and Tyratech has already made a number of significant developments. July saw the firm raise £3.5 million in an over-subscribed placing to fund the further expansion of the Vamousse head lice product range.
“with the growth trajectory being firmly upwards I believe the shares look worthy of a speculative investment.” This was done in conjunction with the company gaining listings for the range in Superdrug and Boots stores in the UK. Around £1.5 million of the placing proceeds are being used to support the Boots/Superdrug deal via a marketing campaign and to build up inventory. A further £1.2 million is being spent on further anticipated listings in additional US and UK retailers, as well as on expansion into further countries.
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Three small cap pharma stocks to buy
On that note, at the end of August Tyratech secured further product listings for Vamousse in supermarket giants Sainsbury’s and Tesco in the UK, with the first products expected on the shelves in September. The timing here is significant, tying in with the new school year and “lice season”, a time when infection between children starts to ramp up. An advertising campaign will be tied in to support the expansion.
What’s it worth? Tyratech is now showing excellent progress in commercialising its intellectual property, with the listings in some of the world’s largest retailers being testament to the quality of its products. It is still relatively early days in the investment case however, with the company making a net loss of $4.9 million in the year to December 2013 as it continued to invest in the development of its products.
The shares are down from March highs of 14.375p, and at the current 8.5p the company is capitalised at just £13.7 million. Early indications of Vamousse sales at Walmart are said to be promising, although a hurdle remains for Tyratech in the sense that it needs to prove to the market that it can successfully sell enough products to move into profitability. On that front the firm’s joint-house broker is looking for a net profit of $2.68 million (£1.6 million) in 2016, which puts the shares on a rating of just 8.5 times. While this rating looks cheap there are considerable uncertainties over these forecasts for obvious reasons. However, with the growth trajectory being firmly upwards I believe the shares look worthy of a speculative investment.
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Plethora Solutions (PLE) A common theme amongst all the companies covered here is that their shares have fallen significantly from all time highs, a fundraising has recently been completed and that good commercial progress now looks imminent. Adding to that list, my final company is Plethora Solutions, a firm which specialises in the development and marketing of products for the treatment and management of urological disorders. The firm’s flagship product is the rather unimaginatively titled PSD502, a spray treatment for male premature ejaculation. This is a distressing condition, estimated to affect anywhere between 18-30% of sexually active men worldwide, with an estimated 30-45 million and 50 million men suffering from the condition in the EU and US respectively. The product works by decreasing the sensitivity of the head of the penis to increase time before ejaculation. Three sprays are simply sprayed on five minutes before intercourse.
There is the potential for a share price catalyst here, with Plethora currently expecting to enter into a licencing agreement by 18th September, when we can obviously expect a further announcement to be made to the market. While the EU itself is a huge potential market, the real blockbuster for Plethora could come from the US, where regulatory consultants were appointed in September last year. While timelines can be nothing more than an educated guess (just ask Skyepharma!) Plethora currently estimates that it will submit a New Drug Application to the US Food & Drug Administration (FDA) by the end of 2015, with approval forecast around Q4 2016. Plethora goes into the rest of the year having conditionally raised a total of £18.2 million at the end of August – the main condition being that the firm signs its European licencing agreement mentioned above. Of the funds, £15.2 million is being spent on effectively buying back the previously sold exclusive rights to all future global royalties generated from “out licencing” PSD502. The rest of the money will be used to finance the FDA application, to finance the ongoing costs of manufacturing and developing a new six dose can of PSD502 and for working capital.
What’s it worth? In June 2009 results from a Phase III study of PSD502 met all of its co-primary endpoints, crucially showing a statistically significant increase in time to ejaculation amongst users. Other benefits reported include reduced stress, increased control, higher satisfaction and interpersonal relationship improvements. Plethora has been listed in London for almost a decade, joining AIM in March 2005. However, its sole focus is now on the commercialisation of PSD502. On this front a key milestone came in November last year, when the European Commission granted marketing authorisation for PSD502, enabling Plethora to start discussions with potential partners for the product’s commercial exploitation. The firm is currently in advanced talks with a licencing partner to cover Europe as well as Russia, the CIS, Turkey and North Africa. While the final terms have not yet been agreed Plethora expects to receive a number of milestone payments of varying sizes over the life of the deal.
Shares in Plethora saw recent highs of 18.25p in November last year following the EC approval but have fallen back to 10.375p as I write. This capitalises the firm at £61.45 million (although this will rise to c.£80 million once the recent placing shares are admitted to the market). The significance of the investment opportunity is shown in internal models from the company which have suggested that PSD502 has the potential to make $1 billion in annual peak sales in the US and EU alone. If sales are only half of this forecast at the peak then there will still be significant upside to be had here, especially with gross margins of PSD502 expected to come in at around 80%.
“Internal models from the company have suggested that psd502 has the potentIal to make $1 bIllIon In annual peak sales In the us and eu alone.”
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Three small cap pharma stocks to buy
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Zak Mir’s Monthly Pick
ZAK MIR’S MONTHLY PICK Buy Hikma Pharmaceuticals (HIK): Above 1,650p Targets As High As 2,150p Recommendation Summary
In what has been a rather dull year for the FTSE 100 and leading stocks to date, one of the highlights was the way that a couple of its key drugs constituents, Astrazeneca (AZN) and Shire Pharmaceuticals (SHP) became bid targets. While cynics could dismiss these events as merely triggered by the so called “tax inversion” ruse employed by US companies, there is little doubt that in the wake of this newsflow drugs companies as a whole have been positively re-rated.
While it may not be quite a parabolic or even an exponential rise for Hikma shares over the past couple of years, the fact that the price action has remained wholly above the 200 day moving average (now at 1,485p) for over two years speaks volumes regarding the momentum behind the longevity of the bull run.
“the ultra strong uptrend In place for the shares over the past two years adds to the ImpressIon of a solId company, wIth the potentIal for the shares to go hIgher stIll.” This is particularly the case at Hikma Pharmaceuticals where the specialist player has taken advantage of drugs shortages in the US over the past year, and looks set to outperform for the rest of 2014. The ultra strong uptrend in place for the shares over the past two years adds to the impression of a solid company, with the potential for the shares to go higher still.
Indeed, it would appear to be not too bold to suggest that if there is any near-term dip for the stock, one would be almost obliged to go long in the first instance. This is on the assumption that we are enjoying such a profound rally that, rather as in the case of an oil tanker, it would be very difficult for a quick turnaround to be delivered. As far as the detail of the daily chart is concerned, perhaps the best way to analyse it would be to look at the way a rising trend channel can be drawn over the price action, with the floor of the channel currently running level with the 50 day moving average at 1,729p. This trend channel is backed in the near term by a line of support in the RSI window from May running towards the 35 level. The suggestion now is that at least while there is no end of day close back below the 50 day line, one should give the benefit of the doubt to the buy argument and new highs for 2014.
66 | www.financial-spread-betting.com | September 2014
Buy Hikma Pharmaceuticals
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Zak Mir’s Monthly Pick
The favoured destination at this point is seen as being as high as the 2014 resistance line projection which is pointing as high as 2,150p – a valid target over the next 2-3 months. The notional stop loss is a weekly close back below the July 1,666p floor, effectively suggesting that we have a decent risk/reward trade.
“The favoured destination at this point is seen as being as high as the 2014 resistance line projection which is pointing as high as 2,150p – a valid target over the next 2-3 months.”
68 | www.financial-spread-betting.com | September 2014
Buy Hikma Pharmaceuticals
The company also raised its full-year generics revenue forecast to $270m as sales of the antibiotic continued to rise.
Recent Significant News 20th August (Reuters) Hikma Pharmaceuticals reported a 44 percent rise in first-half adjusted profit, helped by strong demand for its high-margin injectibles particularly in the United States. Adjusted profit attributable to shareholders rose to $176m in the six months ended June 30 from $122m a year earlier. Revenue at the Jordanian company, which makes and markets branded and non-branded generics and injectibles, rose 16 percent to $738m. Revenue rose 41 percent to $346m at Hikma’s injectibles business, accounting for 47 percent of total sales. 2nd April (Reuters)
The drug maker has raised its full-year revenue forecast four times this year and said in November that it expected revenue from its generics unit to be about $260m. However, Hikma said that it expects revenue from its generics business to be lower in 2014 due to increased competition in the US doxycycline market. Hikma said its global injectables business performed well, with revenue growth of about 14 percent. “We are confident that our Injectables business will continue to deliver strong revenue growth and an adjusted operating margin above 30 percent in 2014,” the company said in a statement.
Hikma Pharmaceuticals Plc’s full-year profit more than doubled helped by strong demand and higher prices for the antibiotic doxycycline. The company reported an adjusted profit attributable to shareholders of $274m compared with $120m a year earlier. Revenue for the year ended Dec. 31 rose 23 percent to $1.37bn , in line with the company’s estimate last month. Hikma, which has grown over the past year due to a shortage of doxycycline in the United States, said generics revenue rose 158 percent to $268m for the year. 12th March (Reuters) Hikma Pharmaceuticals Plc’s full-year profit more than doubled helped by strong demand and higher prices for the antibiotic doxycycline. The company reported an adjusted profit attributable to shareholders of $274m compared with $120m a year earlier. Revenue for the year ended Dec. 31 rose 23 percent to $1.37bn , in line with the company’s estimate last month. Hikma, which has grown over the past year due to a shortage of doxycycline in the United States, said generics revenue rose 158 percent to $268m for the year. 14th Feb (Reuters) Hikma Pharmaceuticals said it expects a 23 percent growth in full-year revenue, up from its prior forecast of about 20 percent, benefiting from strong performance in its injectables and generics businesses towards the end of 2013.
2nd Jan (Reuters) UBS upgrades the Hikma Pharmaceuticals stock to “buy” from “neutral”, as it expects the drugmaker to benefit from a weaker Japanese yen and to continue to profit from sales of doxycycline. The brokerage said that, even factoring in a dip in doxycycline sales and a 40 percent fall in the drug’s price in 2014, it expects Hikma to report earnings before interest and tax (EBIT) from sales of the drug in excess of $50m. This year, Hikma’s doxycycline sales could be hit by the entry of another generic drugs player, but UBS analyst reckons that any new entrant would likely have the incentive to keep prices relatively high.
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Zak Mir’s Monthly Pick
“small is beautiful on a fundamental basis, with few companies illustrating this point in the recent past better than Hikma Pharmaceuticals.” Fundamentals M&A activity associated with drugs giants AstraZeneca and Shire Pharma has brought the whole sector into positive focus, even if the offers for the companies concerned were not exactly welcomed with open arms initially. Indeed, the Astra episode effectively provided an illustration of how a US company should not go about trying to take over a UK counterpart. But what can be said, especially in the wake of GlaxoSmithkline’s issues in China, is that we are looking at a period of rapid change here with many of the old bankable assumptions going out the window. With Hikma Pharmaceuticals the message is that being a specialist player can deliver outperformance over and above the giants of the sector. This is in addition to the historic status of drugs companies as being highly cash generative, presumably after the not insignificant matter of research and development, and of course product approval. The counterintuitive message is that small is beautiful on a fundamental basis, with few companies illustrating this point in the recent past better than Hikma Pharmaceuticals. Its chosen battlefield is that of bacterial infections, with the antibiotic doxycycline being its flagship product. Doxycycline treats a wide range of bacterial infections including urinary tract infections, acne, gonorrhea, chlamydia and Lyme disease. In addition, it acts to prevent malaria.
The hook here is that even with the threat of greater generic competition this year in the US, a shortage of doxycycline over the past year has meant that generics revenues are expected to hit $170m for 2014, a rise of 5%. It helps that Hikma has been cautious regarding future performance, a habit which is well appreciated by the market. This cautious approach meant that in 2013 Hikma raised its US generics estimates four times . It is widely expected that the company can repeat this type of action for the rest of 2014, despite pricing pressure. On this basis it is difficult to resist going with the fundamental flow at Hikma, as we take a ride on the general bullishness coming from recent events at AstraZeneca and Shire. While projecting such M&A hopes here could be excessive, it does appear that the positive momentum which has dominated the newsflow over the past couple of years and more seems set to continue. This is especially so in the wake of the 2014 injectibles forecast rise of 20%. Indeed, any signal that this forecast is a cautious one could see Hikma being one of the second line pharmaceutical outperformers of the latter part of the year.
70 | www.financial-spread-betting.com | September 2014
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By Dave Evans of binary.com
The Puzzle of The Pound Since taking over the stewardship of the Bank of England, Governor Mark Carney has not had a smooth ride. Forward guidance has been wide of the mark, with interest rate projections slipping quickly between bullish and dovish from month to month. In defence of Carney, he has continually stated that policy decisions will be data driven. The problem is that the data keeps on springing surprises. We have seen a further example of this as UK CPI unexpectedly dropped to 1.6% for July, with RPI slipping to 2.5%.
72 | www.financial-spread-betting.com | September 2014
The Puzzle of The Pound
Inflation ain’t what it used to be...
It seems the Bank of England may not know either.
The latest Bank of England voting figures also showed that the Monetary Policy Committee’s unanimity is at an end, with two members voting for a rate hike at the last meeting. These votes were cast without full sight of the latest inflation figures, but still, the change is telling.
The puzzle for the MPC is that while the economy is improving and unemployment dropping, wage growth is stubbornly dripping lower.
Still, this is just two votes in favour of a rate hike and if recent British pound volatility is anything to go by, market traders still don’t have a firm idea of when UK interest rates will increase.
UK GDP 2nd estimate Q/Q UK GDP has been on a strong run for over a year with one of the strongest growth rates in the Western world (see chart below).
UK Unemployment Claims M/M At the same time, UK unemployment claims have dropped steadily month on month.
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UK wage growth
The final piece of the puzzle is the steady drop in average UK earnings. How can there be such a strong recovery while wages are dropping in real terms? One explanation is that loss of relative earnings from creeping inflation has less of a psychological impact than a general feeling of an economy that is growing. We are buying more items and providing more services to each other, but this is not translating into higher take home pay. Perhaps after soaring growth in the 90s, living standards have generally reached a point where the majority of people can get by without rapid pay increases provided there is work around.
Whatever the answer, the lack of wage growth is a major consideration in the Bank of Englandâ€™s interest rate policies. The latest guidance appeared to kick a rate hike even further into the long grass, but that was this month â€“ next month who knows. Over the last six weeks, the interest rate balance has certainly tipped back towards the dovish end of the spectrum, sending the GBP/USD and EUR/GBP shooting lower. This is especially the case as asking prices in the London property market start to drop lower.
74 | www.financial-spread-betting.com | September 2014
The Puzzle of The Pound
GBP/USD weekly chart The GBP/USD chart shows how the last few weeks have rapidly reversed the poundâ€™s advance.
EUR/GBP Weekly Chart
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While the EUR/GBP has also switched course, the move has not been as dramatic due to the weakening German economy. It is this consideration that brings up a potential trading angle. There is no doubting that UK interest rate speculation became too overheated, with recent weeks providing a much needed reality check. The question now is whether the pound has found parity or if it has further to fall.
Against the dollar, there may indeed be further to go until the dollar index weakens for the first time in weeks. Against the euro, however, there could be room for the pound to regain some ground. While UK interest rate speculation has reversed course, so too has the German economy at the centre of the eurozone.
German ZEW Economic Sentiment
76 | www.financial-spread-betting.com | September 2014
The Puzzle of The Pound
Economic sentiment in Germany has hit reverse gear with eight consecutive months of below expectation reports. Europe managed to paper over the 2010 crisis cracks, but the fault lines still remain. In addition, it seems that the Russian sanctions may be having an impact on Germany which itself is not feeling the effects of austerity politics.
A good way to play this is a LOWER trade predicting that the EUR/GBP will close below 0.7950 in 62 days time. At the time of writing, this offers a potential return of 136%. Or put another way, betting that the EUR/GBP will be below 0.7950 in 62 days could return £23.54 from a £10 stake.
Even if the British pound were to stand still from here, there’s a strong likelihood of further weakness in the euro, which makes a downside trade attractive here.
CLICK THE IMAGE BELOW TO GO STRAIGHT TO THIS TRADE.
“The question now is whether the pound has found parity or if it has further to fall. Against the dollar, there may indeed be further to go until the dollar index weakens for the first time in weeks.” Disclaimer: This financial market report is intended for educational and information purposes only. It should not be construed as investment or financial advice and you should not rely on any of its content to make or refrain from making any investment decisions. Binary.com accepts no liability whatsoever for any losses incurred by users in their trading. Fixed odds trading may incur losses as well as gains.
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78 | www.financial-spread-betting.com | September 2014
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CHAMPIONS LEAGUE PREvIEW BY PATRICK CALLAGHAN
There’s no finer club competition in the world than the Champions League – and this season’s edition is already shaping up to be a fantastic spectacle.
80 | www.financial-spread-betting.com | September 2014
Champions League Preview
Since the new format replaced the old European Cup in 1992, no side has ever retained the trophy, but you’d be a brave bettor to oppose last year’s winners Real Madrid as they go on the hunt for an incredible 11th continental crown. Here’s Sporting Index’s take on the leading countries’ contenders.
SPAIN Real Madrid finally achieved the legend of La Decima – a tenth European Cup – last year with a dramatic extra-time victory over city rivals Atletico Madrid. The club’s philosophy is to bring in a Galactico every summer and the signing of Colombia’s World Cup star James Rodriguez fits the bill. At £63m, he might even represent value in a world of bloated transfer fees. The starting XI in the Super Cup against Sevilla a few weeks ago was worth a record £364m. As a result, Carlo Ancelotti’s biggest challenge may be keeping all his stars happy. Cristiano Ronaldo contributed a record 17 of his team’s 46 goals in the 2013/14 competition. That total haul was 15 more than any other side managed. Madrid had seven of UEFA’s 18-man Squad of the Season and four of the top-five assist makers in the tournament. Matching those stats, let alone beating them, this time around would make them irresistible once more.
“madrId had seven of uefa’s 18-man squad of the season and four of the top-fIve assIst makers In the tournament.” You’d think with all the plaudits Barcelona have received over the last decade that they have dominated Europe. The truth is, three wins in six glorious years has been followed by a failure to even make the final. Lionel Messi wasn’t at his best last year and Neymar endured a frustrating debut season. But the addition of goal-machine Luis Suarez makes their front-line the strongest in the world assuming they can all be accommodated.
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“the blues dId reach the semI-fInals last year and, granted Improvement and a bIt of luck wIth the draw, a last four spot should be the mInImum target.” They’ve also made changes at the back. But Thomas Vermaelen couldn’t keep his place in the Arsenal team and has plenty to prove before he can be classed as a replacement for Carlos Puyol. Teams know how Barca play now and are happy to let them keep the ball all day. They’ll need to adapt their game under new manager and former Nou Camp hero Luis Enrique if they are to regain the trophy.
GERMANY Riding the crest of a treble-winning year, Bayern Munich, with Pep Guardiola at the helm, were expected to sweep all before them last term, but were taught a lesson in counter-attacking football by Real Madrid. The Spanish team thrashed them 5-0 on aggregate in the semi-final, as Guardiola’s attempts to recreate the tiki-taka style he employed to great effect at Barca back-fired. The signing of Robert Lewandowski adds goals. But from Samuel Eto’o to Thierry Henry, and Zlatan Ibrahimovic to Mario Mandzukic, Guardiola has proven consistently that he struggles to get the most out of traditional strikers. Lewandowski’s old club Borussia Dortmund beat Munich 2-0 to lift the German Super Cup earlier this month. Consequently, there’s a feeling Bayern are regressing from the team that dominated 2012-13.
ENGLAND Jose Mourinho’s failure to deliver a Champions League trophy in his first spell at Chelsea contributed to his exit. He’ll doubtless be under pressure again this season to recreate the successes he enjoyed with FC Porto and Inter Milan. Despite an outstanding league record as a coach – seven titles in three countries in 11 years – a return of two Champions Leagues may be considered disappointing, especially looking at the riches he had at his disposal at Real Madrid. If injury strikes Diego Costa, it’s hard to see the ageing Didier Drogba causing the top teams too many problems up front. The Blues did reach the semi-finals last year and, granted improvement and a bit of luck with the draw, a last four spot should be the minimum target. Back at the top tier of European football for the first time since the 2009-10 season, Liverpool fans will be dreaming of a sixth European Cup. It’s easy to forget after that glorious triumph in Istanbul in 2005 that the side made it back to the final two years later. Raheem Sterling and Daniel Sturridge will be a handful for any side, but they are likely to be found out by a more streetwise outfit. The Reds scored for fun last year. This time they’ll have to do without Luis Suarez, and their defence was leaky too. Throw in the fact they exited in the third round from both cups in 2013-14 and the club will be opposable if they get through to the knock-out stages.
82 | www.financial-spread-betting.com | September 2014
Champions League Preview
Capable of brilliance on their day, the nagging belief endures that Arsenal are not mentally strong enough for the really big occasions. They failed to win half of their eight games in this competition last season. Arsene Wenger has spent wisely in the summer, though, and Alexis Sanchez has always looked like a player to excel in this competition. Complemented by Olivier Giroud and the promising Yaya Sanago, their attack is backed up by a good midfield. Whether they are decent enough at the back remains to be seen, and Wenger’s overall record in the Champions League as Arsenal boss is average: one runner-up and one semi-final spot in 16 seasons. The Gunners have exited in the last-16 for the last four years. Bettering that will be deemed a success. This showpiece will surely be the main focus for Manchester City. They improved on their debut showing in the competition last year by progressing from the group stages, before losing home and away to Barcelona in the next round. However, they’ve added to an already enviable squad. If Sergio Aguero and Stevan Jovetic can stay fit, and Yaya Toure can get over his birthday snub, then this could be the year they make the breakthrough at the elite level.
ITALY Italy has been represented in just one of the last seven Champions League finals, making the country’s demise one of football’s big talking points. Juventus, two-time winners and five-time runners-up, have won the last three Serie As. But it’s interesting to note that the last three Italian Golden Boot winners all moved on to pastures new the following season, reflecting how the league struggles to keep hold of its best players. The Old Lady’s Arturo Vidal is their big name linked with a move this time, and the loss of the Chilean would be a massive blow.
Surprisingly, the team couldn’t even advance from a group containing Galatasaray, FC Copenhagen and Real Madrid last season, winning just one game. Another disappointing effort looks likely.
FRANCE Paris St-Germain have lost just one knock-out game in the last two editions of the Champions League – last year to Chelsea. Their only other defeats were meaningless group stage losses when they had already qualified. They were undone on away goals in 2012/13 and only a late Demba Ba goal knocked them out last season. In Zlatan Ibrahimovic they have arguably the most mesmeric player in world football. His goals, backed up by a glittering supporting cast, could help the Parisians to the final. They can beat any team on their day and should be supported on Sporting Index’s Champions League Index.
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.COM 84 | www.financial-spread-betting.com | September 2014
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CHAMPIONS LEAGUE? FOR EXCITEMENT, SPORTS SPREAD BETTING IS IN A DIFFERENT LEAGUE There’s no more exciting way to follow Europe’s top club competition than with a sports spread bet. Open a Sporting Index account, place three bets each risking at least £20 and claim a free £200 Total Goals bet.* The real markets spring to life when the big players are out in force, when the heart of the trading action switches from the Square Mile to the Champions League. And we’ve got every skirmish covered. Open a long term position on a team - where your winnings (or losses) are on a sliding scale directly linked to how far they progress in the tournament - or take a short-term view on every match with up to 200 markets to choose from including Supremacy (winning margin in goals) and Bookings. Volatility is optional, excitement guaranteed. Losses may exceed your initial deposit or credit limit. September 2014
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Revisiting Japanese reflation
Revisiting the Japanese reflation story By Richard Jennings, CFA of Titan Investment Partners, & Filipe R Costa
86 | www.financial-spread-betting.com | September 2014
Revisiting Japanese reflation
Ever since Shinzo Abe was re-installed as Prime Minister of Japan at the end of 2012, a series of important economic policy changes have been implemented. After more than a decade of deflation and economic stagnation, the newly elected Abe set about implementing his new and aggressive ideas of which the express aim was the arresting of deflation while simultaneously encouraging consumption and investment. The new millennium brought further stagnation for the embattled Japanese with the country continuing to be held captive in a liquidity trap brought about through the zero interest rate policies for many years (and a lesson for the US & Europe given their mirroring of the Japanese experience since the GFC).
Economic policy had failed to deliver results over the last 20+ years with a complete failure by successive policymakers to instil a rise in long-term inflation expectations by Japanese households as the chart below depicts.
CPI CHART In a country where pension funds invest just 8% in equities, it has proved extremely difficult to manage the expectations of a highly risk-averse population. Even the low yields offered by Japanese Government Bonds (JGB) didn’t prevent investment in them, and faced with the expectation that prices decrease over time, investors logically have been willing to accept the lousy returns offered by this, supposedly the safest of all asset classes. Capital preservation is the order of the day.
“In a country where pension funds invest just 8% in equities, it has proved extremely difficult to manage the expectations of a highly risk-averse population.”
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Revisiting Japanese reflation
Such is the global economic backdrop confronting Prime Minister Abe as he attempts to wake up the dormant tiger that, faced with an unfavourable environment, the task is even more Herculean for. Whether he will be successful or not remains to be seen, but here at Titan we believe that Japanese equities continue to offer some of the best value globally amongst developed equities. We expect The Bank of Japan (BoJ) to continue to explicitly attempt to weaken the yen and to create negative real interest rates to drive asset price inflation, and consequently push consumption and business investment higher. While the world remains largely in an accommodative monetary policy environment, it is Japan that has the “loosest” monetary policy of all with a huge quantitative easing programme aimed at expanding the monetary base at an annual pace of some 60-70 tn yen.
Further fiscal measures are going to be taken in late 2014/15, in particular on corporate taxation. Japan’s equity valuations are still very attractive in both absolute and relative terms, with the whole market trading at a modest premium to book compared to the US that is nearly 2.5 times, and probing valuation peaks. Finally, after a bad start to the year which has much to do with the start of the Fed’s unwinding of their current quantitative easing programme and the hot money flows it generated to other markets including Japan, the momentum effect shows early indications of returning to the Nikkei.
NIKKEI 5 YEAR CHART
88 | www.financial-spread-betting.com | September 2014
Revisiting Japanese reflation
Strong yen acted as a brake on equity returns During the first half of the year, the most popular trade in relation to Japanese equities was the Hedged Japanese Equity trade, which is basically a strategy of investing in Japanese equities but hedging for the currency risk. Since the BoJ has an open strategy of weakening the yen, investors could see any yen-denominated profits from investing in equities turned into a loss when converted back to US dollars. During the first half, however, this fell apart as the Nikkei declined AND the yen increased in value. An investor in the Hedged Japan Equity strategy would have felt a 2% currency loss plus more than an 8% loss in MSCI Japan index during just the first quarter â€“ un-useful for any macro manager. An unhedged investor would of course have had his equity losses mitigated by the currency gain.
For the weaker emerging economies, this has necessitated the raising of their domestic interest rates, and in some cases, such as South Africa and Turkey, even mini currency crises setting in. The drop in Japanese equities relative to other global markets has been exacerbated by this rising risk-aversion and the consequent rise of the yen. As we write, although geo-political tensions have once again risen, the difficult days of late spring and the currency tensions at that time have abated and the markets appear to be absorbing the Fedâ€™s unwinding of the bond buying programs. With a 6% year to date decline (at time of writing) in the Nikkei, we believe now is a good medium-term entry opportunity for the Japanese equity market. In fact, there could be a good pairs trade between the US and Japanese markets given that the Nikkei lost 12% versus the S&P 500 during 2014 as the chart below illustrates.
The hedged strategy worked a treat during 2013, but this year, so far, seems to be a period of mean-reversion with the US bond tapering proving to be the catalyst for this. A less accommodative policy has resulted in hot money flows out of various emerging markets with the consequent weakening effect on their currencies.
NIKKEI CHART 2
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Revisiting Japanese reflation
Just how radical is Abenomics? The mild monetary policy applied in Japan for over a decade patently yielded very little in the way of concrete economic traction. Aware of this, and on a platform of a bold, emergency plan aimed at creating shock and awe in the economy, Abe was re-elected at the end of 2012. His plan of action could be divided into three main areas of intervention: (1) weaken the yen and in the process create negative real interest rates to drive consumption and investment higher; (2) put in place an expansionary fiscal policy aimed at cutting corporate taxes and in turn push investment higher; and (3) conduct necessary structural reforms, something sorely needed in a country where the ageing population is a major concern. Unlike the situation in Europe and the US, where monetary and fiscal intervention is conducted by different entities and sometimes in an uncoordinated manner, Abe is able to join all three plans of intervention, orchestrating a cohesive effort of intervention with the intent of magnifying its effects.
We can be certain that the Japanese government will do whatever it can to reduce the burden of this huge debt pile. With monetary policy now at its “easiest” in recent memory, while in contrast becoming progressively less accommodative in the US, the interest rate differential between the two countries should drive the dollar higher relative to the yen, which should benefit Japanese exporters. In terms of fiscal policy, Abe implemented a 3% sales tax increase in April, a measure that was opposed by many as it acts in the opposite direction of stimulating growth. With this now behind us, however, we should look forward to what is going to happen in the near future. Abe wants to reduce the corporate tax level from the current 35.6% level to something between 20% and 29% in order to encourage businesses to invest in more capacity and new hiring. Such a measure, if implemented, will have a direct impact on companies’ ROE and very likely on their share prices.
“In a country where pension funds invest just 8% in equities, it has proved extremely difficult to manage the expectations of a highly risk-averse population.” In terms of monetary policy, the latest data revealed the first significant rise in the CPI. Abe will continue to do like Draghi, “whatever it takes”, to maintain this pace and generate the targeted effect in long-term inflation expectations. If prices continue to rise at 2% or more, as they are now, investors will be pushed out of the government bonds which currently deliver negative real interest rates and consumption of capital will thus become more attractive. The incentive to save will decrease, and growth may, finally, be stimulated. At the same time, Japan carries a debt-to-GDP that is north of 200%, having surpassed the quadrillion-yen level. Inflation is now effectively the only way of managing this debt load.
Structural reform is clearly the toughest form of action as it takes years to drive changes in society. In this area, the government will concentrate efforts on overcoming the ageing population and shrinking workforce problem, potentially including the announcement of immigration reforms and the adoption of measures to attract more women into the workforce. These measures will potentially also generate investor enthusiasm.
90 | www.financial-spread-betting.com | September 2014
Revisiting Japanese reflation
“Unlike the situation in Europe and the US, where monetary and fiscal intervention is conducted by different entities and sometimes in an uncoordinated manner, Abe is able to join all three plans of intervention, orchestrating a cohesive effort of intervention with the intent of magnifying its effects.” Conclusion If we take the pre-Abenomics date of 13th November 2012 and compute the returns up to 18th April of this year, we find that the Nikkei is up by 67.6%. But what seems to be a great absolute performance is not as great through the relative lens. In the same period, the DAX rose 84.6% and the CAC 81.7%. Even the Dow rose the same as the Nikkei.
Given the very low valuation base of Japanese equities, shouldn’t Abenomics have generated more in the way of equity returns? Shouldn’t Japanese equities be expected to deliver returns in excess to other markets?
After a lousy first half experienced by the Nikkei, and with the return of loose fiscal and monetary policy in the second half, Japanese equities, we believe, will regain their momentum relative to other major global markets, particularly as Europe looks to heading back into a continent wide recession. We remain resolutely long here at Titan, having re-entered this market in our Global Macro account in recent weeks.
You should not take this piece as an advocation to trade in any of the instruments mentioned, and should always take professional advice in relation to your own personal circumstances.
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Titan Investment Partners - Global Macro Fund
Returns from inception (01 July 2013) to 22nd August 2014 Titan Global Macro Fund +166.24% v MSCI World Index Benchmark +20.19% (in constant $‘s) Outperformance relative to benchmark (before fees) +146.05% These figures are gross returns and have not been adjusted for Titan’s fees. Past performance is not necessarily a guide to the future. • A diversified portfolio of Global Macro themes
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CLICK HERE FOR MORE INFORMATION 0203 021 9100 www.titanip.co.uk Risk Disclaimer Titan’s spread betting funds are leveraged products that involve a higher level of risk to your security and can result in losses of some or all of the capital invested. Ensure you fully understand the risks and seek independent advice if necessary. *Spread betting in the UK is currently tax free but this may change in the future. Authorised and regulated by the FCA. Registration No - 590782 92 | www.financial-spread-betting.com | September 2014
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Why I am Long Term Bearish on the Aussie dollar By Samuel Rae
Between January 2012 and January 2014, the Australian dollar lost close to 20% of its value versus its US counterpart. During the first half of this year a steady correction has brought this figure closer to 12%, but it still represents a significant decline. As we head into the latter half of the year, I have been trying to form a reasonable directional bias to plug into my discretionary price action strategy – one that will give me some idea of the proportional levels of risk I am comfortable taking on when entering long or short. After careful consideration, I have concluded that this reasonable bias is to the downside, and, interestingly, that the fundamentals on which I am basing this bias don’t really have anything to do with Australia. Well, that’s not entirely true, but you will see what I mean in a minute.
“There is one indication, however, that Australia could hit some serious trouble over the next six months to a year, and that indication comes from China.”
CHINA WORRIES It is all too easy to be a harbinger of doom and pick out small and relatively meaningless indications that an economy – or economies – are in trouble. There is one indication, however, that Australia could hit some serious trouble over the next six months to a year, and that indication comes from China. It is no secret that the Chinese property market is slowing. It used to be said in China that an individual’s goal in life should be to save money, buy a home, save some more money then buy another. With double-digit price growth a staple feature of Chinese fundamental releases, this seems logical. Now, however, the Chinese attitude towards the property market is changing. I’ve read reports of parents telling their children not to bother buying houses as it is “no longer worth it”.
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Why I am Long Term Bearish on the Aussie dollar
New SBM contributor, Samuel Rae, is the author of the best-selling book “Diary of a Currency Trader”. Sam’s personal trading style combines classic candlestick analysis with a simple, logical and risk management driven approach to the financial markets – a strategy that is described and demonstrated in his “Diary of a Currency Trader”.
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Further, and perhaps more dangerous in the short to medium term, is the expectations of potential buyers. Chinese first-time buyers are delaying purchases in anticipation of a further decline in price. Common economic theory outlines the potential dangers of such attitudes towards deflation. If home-owners (or potential home-owners) are delaying spend in the property market in the hope that they will be able to get more for their money in three to six months or even a year, it is only a matter of time before this reluctance to spend filters through to other potential purchases. Obviously there will always be a necessity to purchase staples, but the non-essentials – would you refurbish your home now if you thought you might be able to do the job 10% cheaper in six months? Maybe, but probably not. It is worth mentioning that the Chinese economy is far from deflating, but perceptions that the property market is in decline could become a self-fulfilling prophecy.
AUSSIE WOES And this is where Australia comes in. Another snippet of common market knowledge in the financial space is that the Australian property market is experiencing something of an unprecedented boom at present. National house prices have risen more than 10% during the first half of this year, and house prices in Sydney specifically have risen more than 15% during the same period. One way of looking at this is that it is testament to the efficacy of the Reserve Bank of Australia’s (RBA) attempts to rebalance the Australian economy as a response to the reduction in Chinese demand for its natural resources. The RBA has deliberately held interest rates at a (relative) low level in order to encourage consumer spending and shift its economic reliance away from its mining sector. This is all well and good, but the question for me is whether or not it is sustainable. One statistic suggests to me that it is not. The statistic? That China represents the single largest source of foreign direct investment in the Australian property market. From what I’ve read, the majority of analysts do not see this as a problem.
The fact that China is effectively driving the Australian property market – to them at least – is simply representative of the disparity between the returns on property available in China and the returns on property available in Australia. A report I read recently suggested that policymakers in Australia expect huge levels of Chinese foreign direct investment to continue for at least the next three years. When looked at in combination with what’s happening in China, however, to me this seems unlikely.
“The fact that China is effectively driving the Australian property market – to them at least – is simply representative of the disparity between the returns on property available in China and the returns on property available in Australia.” If the deflationary attitudes of potential home-owners filter through to other areas of the Chinese economy – something that is far from unlikely – Chinese investment could quickly dry up. This would be something akin to taking the stool out from underneath the Australian property market – and you do not need me to tell you what happens when a property market collapses. It is for these reasons that I have a long-term bearish outlook on the Aussie dollar. This does not mean that I will not enter long if price action suggests there may be some upside gains to be had, but it does mean that I may think twice about taking on too much risk before entering a long position, and, concurrently, that I may be willing to take on a little bit more risk when entering short.
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Why I am Long Term Bearish on the Aussie dollar
To learn more about Samâ€™s travails in the world of currency trading, click the advert after this piece to receive your FREE book.
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TECH SHORTS By Simon Carter
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SBM’s resident technology specialist, Simon Carter, takes a look at some of the big technology stories currently in the news. AOL Being the type of discerning, switched on, modern person who reads SBM, there’s a high chance you downloaded this month’s edition over WiFi. Some of you may have superfast, fibre optic broadband; some of you may be on good ol’ regular broadband. Hell, some of you may even have figured out the password to connect to next door’s broadband (I mean, come on, ‘p4ssword’? You’re positively inviting invaders!) But it’s very unlikely that any of you used a dial-up connection to get hold of your favourite mag this month.
No doubt we all have ‘fond’ memories of that period between 1995-1999 when you couldn’t move without finding yourself face-to-face with an AOL CD-ROM promising an open door to the new and exciting World Wide Web But the recent news that AOL takes homes $144m a year from their dial-up customers will likely come as a surprise to most. With subscribers shrinking at a rate of only a quarter of a million a year, AOL seems set to milk that cash cow for some time yet.
Unless you’re one of AOL’s 2.3 million customers who still routinely enjoy the “will you get off the internet, I want to use the phone” conversation.
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Football vs The Modern World With its ‘vanishing’ spray and goal line cameras, big football would like us all to think that it has taken up permanent residence on the very cutting edge of modern technology. But all the 3D matches, official club smartphone apps and in-stadia WiFi can’t mask the stark truth that the Premier League hates the tech world. Well, any tech that it can’t make money from.
Meanwhile, over at Old Trafford, Manchester United chiefs have written to fans to tell them that any electronic device larger than a smartphone is now banned from the ground and will be confiscated at the turnstiles. The move is apparently to prevent fans from recording the action on high-end devices. Although, who would want to record recent events at Old Trafford is anyone’s guess.
Why else would the stuffed suits at Premier League HQ have chosen the eve of the new season to open a can of buzzkill and announce that they were “developing technologies like gif crawlers and Vine crawlers” to ensure that fans weren’t able to post videos of Premier League action to social media. Conveniently ignoring the fact that a Vine is a six second video, the League has said that such postings harm their intellectual property.
“all the 3D matches, official club smartphone apps and in-stadia WiFi can’t mask the stark truth that the Premier League hates the tech world. Well, any tech that it can’t make money from.”
Internet 1 Bullying 0 If there’s one problem with the internet, it’s that one problem that exists with everything: people. Honestly, give us humans a little bit of freedom, or even worse, anonymity, and it won’t be long before a good proportion of us have ruined it for everyone else. Just take a quick look in the comments section of pretty much any YouTube video, Daily Mail news article…well, any comments section really, to understand that Tim Berners-Lee should probably have kept the internet to himself.
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But the good news is the internet is fighting back. Following the sad but inevitable news that some people had used Robin Williams’s sad death as an excuse to ‘troll’ his daughter, Zelda Williams, to the point where she quit all social media, Twitter have stepped in to pledge to review their policies and procedures relating to abuse and user interaction. In the wake of the Williams tragedy, two people have already been banned from the site.
Elsewhere, a Chicago teen, Trisha Pabhu, has been making headlines with her entry to the Google Science Fair, “Rethink”. The software is able to detect when somebody has written something hurtful or offensive towards another person and alerts the originator to this fact, explaining some of the possible consequences of their comment. Although in its very early stages, trials have indicated that 93% of posters reconsidered and
iPhone 6 So what news of the iPhone 6? In a summer period devoid of big releases, news, or much of anything happening in the tech world (really, you’d think that some of the many struggling companies would use the summer lull to grab some column inches!), one of the most shared stories in the last month has been the news that the iPhone 6 is likely to land with us on 9th September.
Now, you may be reading this after 9th September (you may or may not be reading this on an iPhone 6), and this story might already have turned out to be wholly inaccurate, but the good news is that after two consecutive months of iPhone 6 stories in this column, one way or another, the story will be over before next month’s issue.
“one of the most shared storIes In the last month has been the news that the Iphone 6 Is lIkely to land wIth us on 9th september.”
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Markets In Focus
MARKETS IN FOCUS AUGUST 2014
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Markets In Focus
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Thank you for reading. We wish you a profitable September!
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