Banks and mining shares - a mug's game.

I continue to be amazed at the number of work hours spent (wasted!?) trying to call the bottom (top) of bank (mining) shares. Every morning meeting seems to be taken up with discussion and yet nothing ever seems to be decided on or resolved.

What is my view? To put it bluntly, I do not have one. If I were a fund manager I would neutralise both sectors and with my own money I would own neither. Here's why.

For the banks, the argument is pretty simple. There are far too many unknown variables involved when trying to value bank shares - how much further US housing has to fall, how much crap they have on the balance sheets, how bad is the current "crisis" really going to be, when will managements be changed etc. On some valuation metrics, such as dividend yields, banks, especially those in the UK, look exceptionally cheap. But against this, the future earning power of the banks is clearly far off what it has been in past years, where earnings were driven (inflated?) by new products and trading gains that are now history. I wouldn't be surprised if banks don't recover their 2007 level of profitability for another 2-3 years. In this case dividends will be cut and returns will be mediocre. It is possible that the economy will rebound, but this is not something I would want to bet on - there are other cyclical companies also on depressed valuations with the same or more upside and much less downside.

I continue to be astounded by the extent to which people manage to delude themselves with the mining and commodity boom. In our last morning meeting, the European CIO, who is a fervent "Chindia" commodity and mining bull, was banging on about how he thinks the FTSE index is heading for another 30% fall (i.e. 20% below the trough in January). What I find so odd about this argumentation is how one could believe we are about to enter a protracted bear market, while also being bullish on mining and commodities. It seems blindingly obvious to me that there is almost no possible way the index could fall 30% without this being led primarily by the sectors that are back up at their all time highs (i.e. mining). Let's remember that the recovery in the index from its January trough to where it is today was mainly driven by these "secular growth" industries. The cyclical media stocks that I look at are still on trough valuations. Now I haven't actually done the maths on this yet, but for the index to fall 30% and for mining to significantly outperform would entail cyclical names falling right through their trough valuations, while the mining and commodity related sectors accounting for an even larger share of the overall pie. How likely is that?

The reality is that the correction in cyclical names has already happened, such that they are now effectively pricing a recession. The downside is therefore limited to probably 10-20% in a really dire scenario - i.e. the actual realised fall in earnings, offset somewhat by multiple expansion. The real risk to the index comes from a slowdown in Asia and the collapse of the "decoupling" myth. This would lead to huge downgrades in everything related to the Chindia thesis. And nor would it take much for this to happen - a couple of weak data points out of China and that could be the end of it.

However it should also be appreciated that in a recovery scenario the mining and commodity sectors could easily become the next tech bubble. If the FED succeeds in turning around the macro situation then the next asset bubble is likely to be driven by a falling dollar, which would favour anything priced in dollars.

Therefore, the best course of action is to just ignore banks and mining shares. No need to take a view. Let the big boys waste their time debating it. I continue to focus my attention on value stocks with good franchises and sustainable business models, usually within the beaten up cyclical sectors (TNS, Prosieben, Wolseley to name a few).