Stocktake: Quindell collapse vindicates short sellers

AIM-listed insurer Quindell’s share price collapse marks another victory for short-selling outfit Gotham City Research – and a reminder how careless institutional investors can be with clients’ money.

Shares have fallen 95 per cent since April’s damning Gotham report, which branded the £2.7 billion company a “country club based on quicksand”.

The scandals have since piled up.

Quindell's joint broker gave notice it was to resign on October 21st, an event not disclosed at the time. Soon after, Quindell announced three directors, including founder Rob Terry, had bought almost 1.6 million shares in the company.

Within days, it emerged the complex “sale and repurchase agreement” had actually resulted in the directors selling millions of shares.

Terry, who last month said Quindell’s market valuation was “materially below its true value”, last week sold most of his remaining stake – 25 million shares – causing market pandemonium. PwC is now investigating the firm’s accounts.

Note that in April, M&G Investments “enthusiastically” defended the firm against Gotham’s “unpleasant anonymous bear raid”.

In June, Fidelity doubled its stake to 10 per cent of the company, while Prudential and UBS owned more than 5 per cent of the shares.

Gotham did its homework; Quindell shareholders blamed the messenger, and learnt an expensive lesson. Market mania driving China Trading in Chinese equities has gone bananas. Before last Tuesday's 5.4 per cent decline – the biggest one-day fall in five years – stocks had risen by a quarter in three weeks and by 45 per cent in 2014.

China recently elbowed out Japan as the second most valuable market in the world, and big gains have catalysed manic activity among ordinary investors, who account for up to 80 per cent of stock trades. China's financial sector has risen 50 per cent in a month, compared to a 3 per cent gain for the MSCI Emerging Markets Financial Index. The number of new trading accounts opened nearly tripled between May and September. Trading volumes recently quadrupled in a week, hitting record levels. Leverage is soaring, with the value of margin positions doubling since July.

China has been here before, stocks losing two-thirds of their value after the bubble burst in 2007.

Today’s market is much cheaper, but leverage was not permitted in 2007. Investors are much more exposed today, and will be badly burnt if the tide turns.

Bottom fishing in Tesco shares Tesco shares hit a 14-year low last week, plunging 17 per cent after it announced its fourth profits warning in five months.

Shares have looked cheap for months, but it's always dangerous to catch a falling knife. Last month, Sanford Bernstein bemoaned the "current doomsday scenarios" baked into share prices. In September, Schroders' Ian Kelly said "uncertainty and panic can create exceptional opportunities for long-term value investors like us".

Tesco’s continued decline doesn’t mean they’re wrong. Few catch the bottom, and Tesco may be much higher next year. It may also be a value trap, however; no one knows for sure.

Analysts are better off qualifying their opinions, as Schroders' Kevin Murphy did last September, when he said history "suggests buying a portfolio of 100 businesses with Tesco's characteristics will result in significant outperformance over the long term". He's right: value investing is a proven strategy, but it requires a systematic approach. The guessing game regarding individual stocks, whether Tesco or some other firm, is best left to Nostradamus wannabes. Parochial Bogle guilty of bias Indexing guru and Vanguard founder John Bogle is an investing legend, but his recent dismissal of international stocks is oddly parochial and historically ignorant.

"I wouldn't invest outside the US," he told Bloomberg last week. Emerging markets are fragile, while there's no "excitement" about developed markets such as the UK, France and Japan. Yes, US stocks look expensive, but you "have to invest at today's valuations. You can't not invest now."

What strange advice. Bogle is ignoring valuation; international indices are cheaper than the US, and that is the best determinant of long-term returns. Secondly, he is guilty of home bias and underdiversification; the US accounts for less than half of global market capitalisation.

Betting on one country is inherently risky. In 1989, Japan accounted for almost half of global market capitalisation, compared to less than 10 per cent today. Japan, Germany and France have all suffered 50-year periods where stocks lagged inflation; US stocks have suffered 20-year periods of flat returns.

Ironically, Bogle is betting on continued US outperformance, an active position for a ‘passive’ investor.

In numbers 22.6 Global central bank assets now total $22.6 trillion, more than the combined GDP of the US and Japan.

50 The percentage of all government bonds in the world yielding 1 per cent or less. 83 The percentage of the world’s equity market capitalisation supported by zero interest rates.

Source: Merrill Lynch Global Research