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Woodford: It is dangerous to play the China story

Neil Woodford
Neil Woodford: ’These companies are generating supernormal returns on the back of supernormal commodity prices and i do not believe those supernormal commodity prices are sustainable’

Invesco Perpetual income manager Neil Woodford believes investors in Chinese commodity and mining markets are due “a dose of realism”.

In an interview with Money Marketing at the Fund Strategy Investment Summit in Kitzbühel, Woodford said he has concerns over overheating and a bubble forming in the Chinese economy.

He said: “We are already seeing some stresses resulting in policy tightening, which has had a negative impact on the Chinese stockmarket for some time but I do not know when it will have an impact on the trade in commodities. However, I do believe China’s growth will slow on the back of tightening and inflation.”

Woodford believes there is a bubble in construction in China. He said: “You have 26 million homes lying empty in China and sooner or later that will have an impact on the banking system, economic management and on China’s appetite for commodities.

“The biggest negative contributor to my performance has been holding pharmaceuticals and the biggest attributor has been not holding mining shares. I am not going to compound that error by throwing my hand up in the air and moving into mining shares. I still say it is dangerous to play the China story.”

Woodford said you have to have a macro perspective to be long, short or neutral on the mining sector. “These companies are generating supernormal returns on the back of supernormal commodity prices and I do not believe those super- normal commodity prices are sustainable.”

Woodford remains negative on the banking sector as it has still to fully recognise the extent of the bad news on its balance sheets. He says banks will not only have to raise capital to provide against those losses but they also have to be better capitalised in the future on the back of the likes of Basel III.

He said: “All legislators are moving in the same direction in a bid to avoid a repeat of what happened before in 2007-08 to ensure banks are much better capitalised. Instead of having capital-to-asset ratios of 2 per cent there has been talk of capital to asset ratios of 20 per cent. There will also be more competition in the sector.”

Woodford does not feel banks will be an attractive investment prospect for the next three years.

He said: “There are lots of bumps in the road ahead. We have seen problems in Europe with the banking system and sovereign debt, which have not been addressed.

“There will be writedowns and the solution will not be lending indebted countries and banks more money. There will be defaults across Europe and that will have knock-on effects for UK banks.

“There will be headwinds that are both domestic and international and I see banks becoming a lower return, capital-intensive industry and it is already priced for that in my view.

“To get to that position, there will need to be more capital injections. They would have to shed some of the toxic parts of their portfolios but there are simply no buyers.”

Woodford said tobacco will continue to be a strong sector to invest in despite having returned more than 9,000 per cent over the past 25 years and the amount of legislation and regulation now being attached to it.

He said: “These companies are still undervalued by the market because people do not like them. Investors continue to fret about the challenges facing them and the declining rates of smoking all over the world.

“It is a legal product and all bets are only off if there is prohibition, as there was with alcohol in the US in 1920s – but even then the US realised all it did was create a gigantic black economy. The fact is that people like to smoke and will continue to smoke.”

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