Is the UK a screaming buy now that the Brexit fog has cleared? Will inflation make a comeback as politicians wrestle the printing presses back from central bankers? John Stepek grills the experts at our roundtable.
Our roundtable panel
John Stepek: How do we feel about UK stocks now that the election is over?
Lucy Macdonald: There were two reasons why nobody wanted to go near the UK in recent years. One was Jeremy Corbyn, the other was Brexit. Corbyn is now off the table – and on Brexit, we still don’t know what the trade deal’s going to look like, but it’s clearer. So the UK is now more investable than it was.
John: Might we get a big influx of capital now?
Lucy: I think we’ve actually had that. A lot of “underweight” positions have closed up over the last few months. So I don’t think there’s going to be an enormous wave – but for global investors, the UK is certainly back on the table.
Max King: I’m not so sure. The Labour party had the worst leader imaginable and the most reckless economic policies – and it still got a third of the vote. No political party has ever won five elections in a row. So you have to assume that in five years’ time the Conservatives are out on their ear – it’s not a given, but that’s the precedent. Also, a notable thing about this election is that the idea of fiscal responsibility went out of the window. So I think there’s every chance that in five years’ time you will get a Labour government who will trash the pound and the economy.
Lucy: Markets don’t mind a Labour government as such. They just don’t really like Marxists.
Max: Yes, but they’re not going to change. The grassroots are hardcore. I’d just be cautious.
Alastair Mundy: Yes, but in the meantime, we get a mini boom!
Jim Mellon: Exactly. There’s not going to be another election for five years.
Max: Yes – you may have five years to get your money out of the country.
Jim: That is a cheery Christmas message!
Steve Russell: You’re almost certainly right, Max, about fiscal looseness leading to massive spending. But I don’t think the UK’s going to be remotely alone in that – it’ll be the same everywhere you look.
Lucy: Except possibly Germany.
Steve: We recently had Stephanie Kelton – the US economist who’s an expert on MMT – into our office.
John: MMT – Modern Monetary Theory – this is the idea that governments can spend what they want, provided that inflation doesn’t take off?
Steve: Basically, yes. Anyway, she’s brilliant. The academic rigour behind MMT is absolutely there. And I think that whichever side wins the US election in 2020, they will use it as an excuse to spend money, be it on healthcare or infrastructure. I think it will gain traction everywhere. The magic of MMT is that it’s totally rational – as rational as monetarist approaches. The problem is that, while the academics are right, the politicians, when they use it, will be wrong.
The example Kelton gave was the Green New Deal. Effectively, it’s a long-term investment in productivity – spending on creating green infrastructure and jobs to combat climate change and reinvigorate the economy. You then stave off any inflationary effects of there being too much demand, in a full employment environment, by raising taxes. That’s all great. You can equal it out. The theory works.
The trouble is, politicians won’t raise tax. So you do the Green New Deal, funded by cheap bonds, say, but then the mechanism to offset the inflationary impact just won’t happen. So it’s massively attractive, and will, I think, get fantastic traction because of its academic rigour – and it will be disastrous. It might start in the US – but it might start with Boris Johnson. If he goes out and spends money and the UK economy is seen to pick up, then everybody else is going to think: well, why don’t we do that?
An irresistible temptation for politicians
Dylan Grice: I think you’re right. You say you find MMT academically rigorous – I find it laughable. But that doesn’t matter – I agree, it’s going to happen.
Max: This is the risk. That governments will seize control of the printing presses from central banks, because they realise that’s where the money is made now, rather than via commercial banks making loans. What this election and visiting Argentina and writing about it recently has convinced me is that allowing any government – particularly democratic ones – control over their currency is madness. Nearly all countries trash their currency.
Tim Price: The Financial Times recently reported that the Federal Reserve was considering relaxing its inflation 2% target. And Paul Volcker’s just died. The universe is definitely trying to tell us something.
Jim: So which currency would you regard as a reference currency of high repute?
Max: The Swiss franc.
Tim: The Singapore dollar.
Max: Then the US dollar. And maybe the euro? It might well blow up, but by the time it does, we’ll have knocked a couple more zeros off the pound. That was always the argument for joining the euro – that Britain was not capable of running its own economy.
John: So, in that case Max, how long is it before inflation takes off in the UK?
Max: Well, once the currency starts spiralling downwards, inflation goes up.
Jim: But why is the currency going to slide? Conservative fiscal policy, as far as I can see, is to borrow another £28bn a year, which is nothing.
Max: It’s not going to be under the current government. It’s going to be the fear of what will happen next. I’m just saying that you’ve got to have a long-term perspective on this.
Jim: We’ll remind you of this prognostication in six years’ time! I’m actually very bullish on the UK. I’m loaded up on UK assets, as I mentioned at the MoneyWeek Wealth Summit last month, and I think the pound will go to $1.50-ish quite quickly. UK domestic stocks in particular are very cheap. Look at the dividend yields – why wouldn’t you buy Lloyds Bank (LSE: LLOY), on a 7% prospective yield? It’s among the best of all the banks in the UK.
Lucy: Yes, and when you look around the world, dividend yields are higher than bond yields in nearly every country, which is quite unusual. It is nearly always the other way around.
Alastair: That could correct in two ways, of course!
John: Alastair, you tipped a lot of banks this time last year, and they’ve done pretty well. RBS (LSE: RBS) is up about 20%, Lloyds about 15%. And that’s before dividends. Are you still hanging onto them?
Alastair: Yes, I still think too many investors are looking in the rear-view mirror. They still think of these things as “nasty banks with toxic assets run by lunatics and with no regulation”. All of those things have changed substantially. As I said last year, all I want is for the banks to be dull and boring and I think they’ve done a good job of that. They’ve sold all their rubbish to the investment or life insurance industries. And they look pretty solid. What does that mean? It means it gets you a solid yield, it gets you a bit of a re-rating and makes you a bit of money.
Lucy: Can they make any money though? With rates where they are?
Alastair: I think the odds are we’re going to get an upwards sloping yield curve [where long-term interest rates are significantly higher than short-term ones, making it easier for banks to make profits] in the end.
Steve: In any case, Lloyds does make money. Yes, most of it’s on the back book [older loans made at higher interest rates], but Lloyds has shown it can make money on a flat yield curve for the last couple of years. Of course, that money’s been spent on PPI compensation. But now it’s not. It’s not going to suddenly grow its profits unless the yield curve steepens, but it can pay that dividend.
A contrarian opportunity in oil
John: What about oil? Saudi Aramco’s public listing flopped and Apple is now worth more than the entire S&P 500 energy sector – surely those are signals to any contrarians in the room?
Dylan: Yes, the Saudis are selling oil and buying venture capital. I like a lot of what’s going on in oil.
Max: The correct strategy now for energy firms is to stop exploring. Just pump the oil and generate cash.
Jim: And pay dividends.
Alastair: That’s becoming quite common across commodities in general, not just oil.
Dylan: Yes, you’re seeing a recalibration to lower prices. It’s not so much the supply of these commodity markets – whether it’s oil or coal, or even the equipment suppliers. It’s the balance sheets. The capital structures are not sustainable at these price levels. So, balance sheets are in the process of being reset. There are now some clean, pretty much full-equity balance sheets in the sector. And so now you’re seeing depressed multiples [ie, low valuations] on depressed earnings [ie, lower-than-average earnings] with clean balance sheets [ie, little or no debt]. And some of the old-timers are returning to the sector to invest – so you’ve got smart money moving into a completely bombed-out area that clearly has a future. You could do worse.
Lucy: There will be more forced divestment though.
Jim: The “Greta Thunberg” effect.
Lucy: Yes. It’s just starting and that will keep valuations lower than you maybe think.
Dylan: Yes, but that all argues for a higher expected return ultimately. I wouldn’t compare oil companies too closely to the tobacco industry – tobacco businesses are fundamentally far better than oil businesses – but there is a parallel.
Steve: Also what we know for certain, thanks to environmental, social and governance investing (ESG), is that they will be capital constrained. That’s great if it’s forced on you, because then you have to start making your returns better. So I’m still positive on the oil majors. I’m a bit nervous on the services sector because that capital constraint means they won’t spend money. But there’s been such a fall in the price of the services companies that they could double, and they’d still be down 70%.
Dylan: The offshore pipeline is actually pretty healthy. There’s enough for the survivors to make very, very good returns. And it’s as symmetrical on the way up as it was on the way down. You had the melt-down – my guess is, the next move’s a melt-up.
Lucy: But this is not a normal cycle, is it? There’s something structural going on. The transition to electric cars and more renewables is real.
Dylan: But what is a normal cycle? They always feel quite early at the bottom. Although I do agree that the batteries and electric vehicles are a different factor.
Max: But far too much money is going into alternative energy. It’s becoming riskier because the subsidies are no longer there and also, as we’re saying, when money floods in, returns tend to go down. The renewable energy investment companies all trade at unprecedented premiums to asset value. So I’m not saying it’s bad long term, but you’ve got to be careful.
Dylan: It probably is bad long term. It’s also riskier as you raise the portion of the grid that these guys are responsible for, because of intermittency.
Jim: That’s why energy storage will be big business. The problem is, it’s not public. Well, Tesla is one example. I don’t like Tesla, but battery storage is a very big, growing business; it’s going to be huge. Everyone’s house will effectively be their own grid provider.
Living long and eating clean
John: Jim, what else are you investing in at the moment – how’s the longevity sector?
Jim: Longevity is interesting, but it’s not really investable yet – we know that something’s going to work, but we don’t know exactly what. But if we’re right, and people live to 110 or 120 as a matter of course, then everything changes: consumption patterns, the financial industry – everything.
However, a much nearer prospect I like is “clean meat”. If you have young children, you know that a lot of them want to be vegan or vegetarian, or pescatarian because they understand the impact of this stuff on the world. In supermarkets in the US, when the plant-based burgers, Beyond Meat or Impossible Burgers, are on sale, they outsell minced beef, even though they’re much more expensive. The thing is, plant-based burger substitutes are no better for you than McDonald’s. But they’re much better for the environment. Around 80% of antibiotics go into farmed animals. That could lead to a pandemic that could kill us all very quickly. Or land usage – just 1% of the land required to raise farm animals would be required for lab-grown meat. Or water usage: a kilo of beef uses 15,000 litres of water. So imagine the benefits if you could grow meat in a lab without all the hormones, antibiotics and other bad stuff. I think this will replace normal agriculture over the next 20 years. So I’m making quite sizeable investments in these areas. Last week, for example, there was an unveiling of a tuna steak grown from cells by a cellular aquaculture company called BlueNalu.
John: Is there anything to invest in?
Jim: Well we set up a company – it’s not very big, about £15m – called Agronomics (LSE: ANIC). I’m the biggest shareholder, so I’m talking my own book there. But I’d also look at biotech – there is amazing stuff going on there. Maybe five years ago we talked about immunotherapy here. That is now a $180bn industry. For many people who get cancer, especially blood cancers, or, increasingly, solid tumours, it’s now the gold standard of care and it’s only getting better. Gene therapy is another area that’s really taking off. Years ago I recommended a company here called Arrowhead Resources. It was one or two dollars then. It’s $78 today. That’s in RNAi interference. All of this stuff will be huge and all of these companies are made to be acquired by the big pharma companies, who are marketing machines, but don’t do any research – the Glaxos, the Astras, the Pfizers and so forth.
John: Which stocks do you like in that sector?
Jim: I always like Gilead Sciences (Nasdaq: GILD), one of the world’s great biotechs. It’s trading on just 11 times earnings. It’s got $25bn cash – net cash, a market cap of $83bn and a yield of 4%. It’s the leader in CAR-T technology, which is a form of immunotherapy that’s going to take over the world. It is the absolute leader in HIV therapy, including this new prep drug that people at risk take to prevent themselves getting HIV. It is also the company that cured Hepatitis C.
What’s better – gold or bitcoin?
Jim: The other thing that’s interesting to me right now is gold. We are on the cusp of rising inflation and you can see it in gold. Gold is an established bellwether. If you’ve got rising inflation, you get rising gold – 19% in the last year, which is pretty impressive, but I reckon it will be at least $2,000 by the end of next year because there will be a buying frenzy.
Steve: Much as I like what you’re saying, Jim, I don’t think it’s true yet. I don’t think gold is indicating the return of inflation at all. All it’s doing so far is reflecting negative interest rates.
Jim: So, the carrying cost of gold has vanished?
Steve: Exactly. If you’re in Switzerland and you’re having to pay – what is it? 1%, 2% on cash savings? – then why wouldn’t you have gold? The beauty of it for us is that it does very well when you have negative yields, but it’s also a safe haven against inflation.
Jim: So it doesn’t really matter what the reasons are, it’s going to go up!
Steve: What you want for gold is for bond yields to get more and more negative. And then for that eventually to work and cause inflation.
Dylan: Or for governments to start listening to Stephanie Kelton and implementing MMT.
Alastair: In which case, you want gold because you’re outside the fiat currency system.
Jim: And bitcoin is now discredited, right?
Max: Well, it may have been a false start, but the idea of blockchain currency might work. It is a phenomenally attractive idea for people in troubled countries, such as Argentina.
Dylan: Yes this is where you see the most activity – Argentina, Venezuela, Iran. So bitcoin is actually doing what the original libertarian dream was, which is providing a refuge for people against oppressive government, financial repression and hyperinflation. But the problem with cryptocurrencies is that bitcoin has been around since 2009 and so far that’s the one demonstrable use case. Other than that, there’s not one application that everyone needs to use. The thing is, ironically, I think blockchain can have a future, but if it does get off the ground, I think it will be a very dark future, because blockchain is the ultimate surveillance mechanism. You can search every single transaction. This is how you enter into Stasi land – Stasi on steroids, which is completely against the whole ideal, but that’s where it would end up.
Tim: If only there was some kind of item like physical gold…
Dylan: Yes, but even in Switzerland – where if you have less than 25% gold in your portfolio, you’re seen as a complete idiot – gold is becoming less liquid. The last time I tried to sell gold they wanted my passport. And just try to buy and sell gold bars in London – it’s like facing the inquisition.
Max: If you buy gold and carry it in a briefcase to Switzerland, can you cash it in? That would be useful to know in five years’ time.
Dylan: If you can get it through customs!
The corporate debt timebomb
Alastair: John, just going back to alternative assets, because I think this is important for your readers – alternatives have really benefited from the fact that a lot of investors are scared to invest in bonds because there’s no income and they’re scared to invest in equities because of the volatility. So they’ve piled in to this new thing, where we’ve seen huge amount of issuance in the last ten years. And they just let their guard down, because they’re so desperate for a 5% yield. I’m really concerned about that.
Tim: What’s that saying? More money’s been lost chasing yield than at the point of a gun.
Max: Yes and there have been an increasing number of funds blowing up in that sector.
Steve: And they’re often mislabelled. They come under the title “alternatives”, but what are they? They’re just corporate debt. But now it’s called private debt. What’s private debt? It’s just illiquid debt. We think this is going to make Neil Woodford’s problems look like a picnic. US corporate credit, in mutual funds and exchange traded funds (ETFs) – all stuff sold to the man and woman in the street – has gone from $500bn in 2009 to $2.5trn today. This is unit trusts, ETFs, mutual funds, all offering daily dealing, or minute-by-minute dealing and all of it is effectively illiquid – and it’s all chasing that yield.
John: Also, the quality of investment-grade bonds has collapsed – there is more BBB-rated debt out there than ever before. Is that a concern?
Steve: Absolutely. If you look at US companies, since 2014 they’ve been paying out more in buybacks and dividends than they’ve been making in cash. So, they have net negative cash flow. And then you’ve got the deterioration of investment-grade credit quality. Yet 30% of all investment-grade bonds in the world are on a negative yield, including corporations, because of this hunt for yield. That is an absolute disaster waiting to happen. We’re positioned by being long credit default swaps [CDS – a form of financial insurance that pays out if a company defaults on its debt].
John: Do you have a time scale?
Steve: Two or three years, I think. It’s exactly the same pattern as you got in 1999, and in 2007/2008. The only bit we don’t know yet – and the same with inflation – is how much zero- and negative-interest rates lengthen the cycle – something we didn’t know back in 2008/2009. But we think this corporate debt problem is more likely to break markets and then hit the equity market, than any other single area. And then you get back to Alastair’s point – this has all been driven by people who want to buy yield, but think equities are too risky.
Buy Vietnam and UK housebuilders
John: Let’s go to specific tips now. Tim?
Tim: We were already starting to nibble at UK stocks and we’re buying more now that the political clouds have dissipated. But our favourite market is still Vietnam. Of all the listed markets worldwide, this is the one that doesn’t appear to be much affected by what Donald Trump’s doing on trade. It’s probably the single largest foreign direct investment (FDI) magnet in South-East Asia. Vietnamese wage rates are a third those of China. Vietnam is one of the most well-educated populaces in the world. They work hard. They enjoy life. They all want the same benefits we’ve got: more cars, more property, more cholesterol.
It’s a really cheap market and they’re probably the equivalent of the early 1980s in the UK. So the Vietnamese government is powering ahead with privatisations and relinquishing state control of businesses. The investment trusts to look at are Vietnam Opportunity Fund (LSE: VOF) and Vietnam Enterprise Investments (LSE: VEIL). The other “secret sauce” aspect is that Vietnam is not even an emerging market. It’s a frontier market. So if you’re a fund manager who tracks the MSCI World index, or the MSCI emerging markets index, you can’t invest. But retail investors can do what they like. So as a country, that’s our single favourite market.
John: How are you feeling about Japan?
Tim: It’s our second favourite. Japan now yields more than the US. That’s unheard of.
Steve: I’ve been banging on about Japan forever, but I think it’s fascinating. It’s effectively the anti-US asset. Japanese corporate debt peaked at 70% of GDP in the early 1990s. It’s now down to less than 5%, compared with 40% in the US. Could the US be nearing its 1990 Japan moment? And even if not, which do you want to own? The one with the high yield and no debt, or the one with a lower yield and loads of debt?
And the activism thing is really kicking off. The number of activist funds running in Japan has trebled in the last five years. If you want to find the outrageously cheap, negative enterprise value stuff in Japan, you have to go down to about $300m-$500m market cap and for that you really need to be running a £100m or £200m investment trust. One option is the AVI Japan Opportunity Trust (LSE: AJOT).
Alastair: We were talking about a mini-boom in the UK. Every politician sees the housing market as key to the economy, so the government will focus on that. Housing transactions are incredibly low in the UK, particularly in London, so we just need to get the market going and we can all think of 100 ways to do that. You could make it a much more liquid market by getting rid of stamp duty, for a start. So we’re investing in builders’ merchants, DIY, the brick companies – any firm that benefits from increased housing transactions. We’ve got Travis Perkins (LSE: TPK), Grafton (LSE: GFTU), SIG (LSE: SHI) and Kingfisher (LSE: KGF) among others.
Steve: I’d add Countryside Properties (LSE: CSP). It’s a housebuilder, but roughly half of its business involves partnering with local authorities to build social housing. It is the leader in this area. It’s trading on ten times earnings – so just like an ordinary house builder – but it may well split it out next year. I absolutely agree that a mini boom in the UK, which ends badly – a Barber-boom-type thing – is quite likely. That’s why we’re also quite nervous about the interest-rate sensitive assets we own, because bond yields could rise a bit. But yes, housebuilders look good and Countryside is outstandingly cheap.
A globally competitive Brexit
John: Where do you think UK house prices are heading right now? They’ve been flat for a while.
Jim: Well, I have to say I’m buying a new flat in London because I think the UK will become a magnet for foreign capital again.
Max: I’d agree, which is why I think Capital & Counties (LSE: CAPC), with its huge development in Earl’s Court, is a buy.
Tim: Do you think Boris is going to go for a kind of Singapore-on-Thames deregulated Brexit?
Jim: Why wouldn’t he?
Lucy: Well, not while he’s trying to negotiate with the EU.
Jim: No, it will all be carefully done. But ultimately, that’s the way the country’s going to develop.
Tim: Otherwise there’s no point in having Brexit.
Max: Singapore is a highly regulated country.
Dylan: Well, maybe not Singapore, but if Ireland can collapse its corporate tax rate, why can’t the UK?
John: Any other tips, Max?
Max: We’ve had a year where there’s been no earnings growth and the US has already discounted next year’s earnings growth. So this might be the year where the rest of the world plays catch up. The best way to access that is just to go for a straightforward international investment trust. I’ll go for Mid-Wynd International (LSE: MWY) and Monks (LSE: MNKS). Japan, small cap, healthcare, they’re all good ideas. But I think you’ll do fine by just buying a vanilla fund.
John: Steve – we were talking about oil earlier.
Steve: Yes, I’m happy with BP (LSE: BP) and Shell (LSE: RDSB). I’d also stick with Lloyds, given the clouds clearing over the UK temporarily. The other one I’d suggest, which I’ve recommended twice before, is FDM Group (LSE: FDM), an IT outsourcing group. It’s currently on 28 times earnings, so it’s not cheap. But if you can wait for the UK or mid-caps to be out of favour, you can often get this brilliant company at cheap prices. Even now you get paid a 3%-4% yield, because all the cash they generate comes back to shareholders. I think it can just grow and grow.
Lucy: How fast does it grow?
Steve: About 20% a year. It’s going into the US and growing quickly there. FDM trains up IT people from universities, places them in companies for two years, and then the firm takes them on. It’s an arbitrage between the fact that university degrees do not provide the IT training companies want, and businesses are not willing to do that training themselves. So companies can’t train people to do coding, but need loads of coders. So FDM steps in. I’m still really keen on that.
Cheap global stocks and local pubs
John: Jim, anything to add?
Jim: I mentioned Gilead. There’s also pub chain Marston’s (LSE: MARS). Li Ka-shing, one of the smartest men in the world, bought Greene King for a huge amount of money. Marston’s is quite similar, but smaller. It’s got a yield of 5.8%. It’s the same sort of thing, why have you not buy it, basically?
I also like Prudential (LSE: PRU), now it’s been demerged from M&G. It’s a very good company for Asian exposure. It has a 3.6% yield and it’s on about 20 times earnings, but growing very quickly. I think Prudential’s an excellent buy. Then there’s VEON (Nasdaq: VEON), a Russian telecoms group with an 8.6% yield, it trades on six times earnings and it’s the biggest mobile operator in its area. I also think Russia will be rehabilitated, at some point. So, why not?
Lucy: I do quality growth investing. One stock I like at the moment is Schneider Electric (Paris: SU). Energy management is its biggest business – all of its customers need to reduce their carbon emissions and improve their energy efficiency, so that’s a good growth area for them. It’s bought Larsen & Toubro in India, which is now its third-biggest business. It’s pretty cheap – it yields 3% and it’s on 15 times earnings for next year – because everyone’s been worried about recessions, but those don’t look like they’re going to happen. So to me that’s a company that’s invested in all the right places.
Health and health tech is really interesting too. Biopharma group Agilent Technologies (Nasdaq: A) seems to be well positioned in that area. It has a big Chinese business, which is in food, pharma and environmental testing – all good structural growth areas that the Chinese government is pushing. Also an activist investor, Pershing Square’s Bill Ackman, has popped up, which might get things going. The other area I like is emerging consumers – there’s still plenty of long-term upside. So Yum China (NYSE: YUMC).
Jim: The KFC brand?
Lucy: Yes, but its menus are much healthier – my Chinese team checked that out as part of their research. The last one is stockbroker Charles Schwab (NYSE: SCHW) – what it’s done is really interesting. It came out with zero broker commissions in October, which crashed all of its competitors. And then the next month it merged with its big rival TD Ameritrade. I think that’s really smart.
Jim: How does it make money?
Lucy: Well, discount broking is a very small part of Charles Schwab’s business, but a big part of everyone else’s, which is why it could do it. And then it did the deal. So I thought that was very, very smart.
John: Thank you all for coming.