Double or nothing: investments to swim against the tide

For once the Sage of Omaha looked a little out on his timing – his stock included warrants with a strike price of $115 per share, whereas Goldman actually plummeted to less than half that before moving back up into the 70s on Tuesday. (That said, when Buffett invests, he gets deals that you and I don’t, with a 10% dividend yield on his shares.) As for Prince Alwaleed, for a while he looked like being the latest major sovereign figure to be burned by investments in Western banks (others include Temasek, Singapore’s sovereign wealth fund; the Kuwait Investment Agency; and other institutions from Abu Dhabi to China), but the Treasury’s bailout of Citi last week seems to have kept the wolf from the door.

The problem is that banks are still exposed to the mountainous continued misery of economic data, and there’s still the pesky problem of these toxic assets, both on and off the books. One of the difficult things for investors to pin down this year has been whether banks will be allowed to fail: many believed Lehman would be pushed into a Fed-sponsored rescue deal, only to see it go under. Citi, on the other hand, was clearly too big to fail and that provides a buffer for investors. Which other banks are too big to fail, and which dispensable, is a moot point.

In Australia, banks are in much better shape because they didn’t have such high exposure to risky assets, but a recession would lead to bad debts. The bigger ones are probably good value over the long term but you don’t yet hear of fund managers piling into the sector.

• SMALL CAPS

ASX/S&P Small Ordinaries Index was down 57.55% year to date by Tuesday, compared to 42.85% for the S&P/ASX 200. It’s now back where it was in 2003.

The median long-only Australian equities fund is down 35.2% in the 12 months to October 31, according to Mercer. That’s clearly bad. But compare that to some of the country’s most celebrated small cap funds: Michael Triguboff’s MIR Emerging Opportunities Share Fund, down 55.79%; Erik Metanomski’s MMC Small Companies Fund, down 52.67%; and Peter Hall’s Hunter Hall Australian Value, down 44.29% if accessed on the Skandia platform (all these numbers are from Morningstar Research).

“In this environment, you get indiscriminate selling of small caps regardless of their valuation or quality,” says Steve Black, who runs the Pengana Emerging Companies Fund. “They all get smashed. But when trawling through the ruins, stock pickers can generally find stocks that are well and truly oversold.” An example: he holds a stock called CSG, an IT services company trading on a P/E of 3.5 times despite having contracts locked in for the next four years that underwrite their profits for most of that time.

“If 12 months ago you’d given someone who’s investing for 20 or 30 years an opportunity to buy shares at 50 cents in the dollar they’d have jumped to get it. That’s the opportunity we’ve got now.”

• OIL

Crude oil was trading on the Nymex exchange at $53.45 a barrel on Tuesday, from a high of $148.35 in July – down 63.9% in four months. Although oil briefly fell this low in early 2007 it has not been consistently at this level since 2005.

Nothing quite symbolises capitalism like oil: when things are going well we consume it voraciously, and when things start going less well, oil is a barometer. It’s not long ago that Goldman Sachs was outlining the case for oil at $200 a barrel but the world is a very different place since then: the collapse in the price is a reflection of how the market sees the outlook for the world economy and consumption in the year or so ahead.

“In the short run,” says Merrill Lynch commodity strategist Francisco Blanch, “global oil demand growth will likely take a further beating as banks continue to cut credit to customers. Global oil intake has started to contract relative to last year. This trend should continue well into next year.”

Still, a decline like this seems overdone, and despite Blanch’s bearish tone the Merrill Lynch house view for West Texas Intermediate crude (which is what most people are referring to when they talk about the oil price) is $91 for the first quarter of next year. For those who want to try their hand at investing in oil futures, the easiest way to do it is probably to open a contracts for difference (CFD) account: these allow trading in various commodities and currencies as well as shares.