Every month, we invite the best investors we know for dinner and ask what they would – and would not – put their money in now. This month we look at the UK housing market, the US stock market, and the big investment story of the day – commodities.
Merryn Somerset Webb: There has been a lot of talk about Greenspan’s legacy, but I think the weight of opinion at this Roundtable would probably suggest he is leaving the US in a pretty dismal state. What does this mean for the stockmarket?
Jim Mellon: That we should stay out.
James Ferguson: I’m not so sure about that. I think we all agree that the economy is not in the best of shape, but that doesn’t mean stocks will fall. New Fed chairman Ben Bernanke has got scope to cut rates, so he probably will when things start to wobble – I think the first signs of slowdown are going to come this year and we’ll see rates cut fast then. I wouldn’t go out of my way to buy US equities – there’s better value elsewhere – but if rates fall, I wouldn’t be anticipating a crash in US equities quite yet either.
MSW: Will disaster be delayed here, too?
JF: Not economic disaster, I don’t think. The economy here is a mess, but in the UK the Bank of England’s Monetary Policy Committee (MPC) would never cut rates as far as they are prepared to in the US. Imagine what would happen to our housing market if you cut rates to 1%! Now that would be a bubble.
John Walter: You only need to see what happened in the summer when rates were cut. It was a tiny cut, but within a month the buy-to-let junkies were back buying another 200 flats in Leeds off-plan.
JF: Exactly. Anyway, as Mervyn King points out, his job is to watch inflation, not economies. So given that inflation is right at the top of the 2% limit, rates aren’t likely to fall. Not with a rising oil price. They might even have to raise them. On the plus side, the authorities have done a good job in containing inflation, to the extent that they’ve kept inflation expectations low (albeit by fiddling with the data), and have thus stopped the unions demanding big rises.
JW: I’d worry about inflationary expectations now. They’ve been low for so long, but with utility bills going up 30%, petrol prices so high and council tax certainly going up too, people will notice, and come pay review time they’re going to ask for enough to cover it all.
MSW: Is anyone expecting rate cuts?
Francis Brooke: I think that probably the best thing the MPC could do is nothing. If they cut again, they would run the risk of reinflating the housing and consumer bubble.
David Stevenson: There may be one thing that would stop that happening: unemployment. Last year, companies sat on existing staffing levels, but now unemployment has been creeping up and if growth keeps coming off, I don’t doubt it will keep doing so. That’s going to deflate consumer confidence and rates could go down to compensate.
JF: It’s hard not to conclude that recession is on the way in the UK. Growth has never before been as low as it is now (1.7%) without continuing on into recession. I’m amazed more people aren’t more worried. We know, for example, that there is a close relationship between house prices and retail spending because of mortgage-equity withdrawal (MEW), and we know that MEW in the last 12 months has dropped by an amount equivalent to 3% of GDP. You can’t just walk away from a hit like that, not when consumption makes up two-thirds of GDP. We’ll be damn lucky if growth doesn’t turn negative soon.
JW: Yet mortgage stocks are still rising.
JF: It’s amazing the media still buys into the PR campaign from those with a vested interest in the housing market. They are told the worst is over and fed bogus stats to prove it and they believe it!
MSW: Is anyone positive on houses?
Mike Lenhoff: Sort of. I think there are signs of stability. MEW has turned up a bit and so have retail sales. Global growth looks fine. Estimates in Europe and Japan are being revised up. The economy in the US is also resilient. So the wash-back onto the UK will be positive. The outlook isn’t bleak enough to make one feel too negative about asset prices.
JF: I don’t think you can see the blip up in MEW as a good thing. In the last cycle, it didn’t peak when house prices peaked, but a year earlier than that. Then a few quarters later it jumped again before diving. The reason for this was that people had got into consumption habits they couldn’t break. They stopped cashing in on MEW when they found they couldn’t afford it anymore, but then went back to it because they weren’t able to change their way of life. Then they found they really couldn’t afford it. So it seems to me that the blip back up is more a sign that a lot of people are already in trouble.
JW: Maybe, but you have to remember the difference between last time and this time – interest rates were rising faster. One month, debt service payments were £600. Then three months later, they were £1,600. It was a shock.
JF: It’s not that different now. At the very worst, last time around the debt service burden as a percentage of disposal income in the UK was 22%. We are now at 21%. Rates haven’t gone up quite as much as they did last time around, but people have borrowed much more, so we are at a similar pain threshold.
JW: Yes, but it is more death by a thousand cuts than the sudden pain we saw last time. So I think that it will all play out more slowly than last time.
JF: You know, it wasn’t exactly fast last time. In our popular consciousness, house prices crashed, but from peak to trough it took seven years. House prices are slow and sticky. A fast crash is seven years. This one could take ten.
MSW: So are we bearish on UK equities?
JW: Not necessarily. There is still a chance rates will come down this year. That will keep the market buoyed up.
FB: It’s also worth remembering that much of what happens to the UK market is not determined by the UK. Something like 70% of the earnings of FTSE 100 firms come from abroad. So it isn’t really about the UK, but the world economy.
DS: Anyway, you can always find sectors doing well, however bad the overall economy is. Defence investments are picking up, for example, and I still think the service areas of the economy will continue to grow. One side effect of growth slowing and of cost pressures is that both the private and public sector do more outsourcing, so that’s a growth area.
FB: My worry would be that for the last couple of years we have seen a cycle of cost cutting and share buy-backs – firms haven’t reinvested in their businesses. The market has been rewarding this, but there comes a point when lack of investment means it will be tougher to grow profits and as a result earnings growth forecasts are just going to be too high.
MSW: So what are you buying?
FB: Consumer goods companies, utilities – companies that have predictable earnings or turnover growth.
MSW: What about the miners?
FB: Miners are difficult. It depends on your view of Chinese growth and I don’t pretend to be able to know about that. But there is more support in the oils. Oil was so cheap for so long that the rise to $60 has been absorbed fairly easily.
MSW: Jim, aren’t you a fan of metals?
JM: Yes. They’re currently in a very bullish trend. I’m a great fan of gold and silver. Copper is interesting. China consumes twice as much as Japan and the US together and that won’t change, given how many new cities are being built in China and the copper required for that. The metal miners don’t use current prices in their forecasts, they take big discounts in their planning. So if a current price is, say, $2, they’ll input $1 into their numbers for a few years out. That means they are more profitable than you think. So I’m still bullish on many metals and miners. I like uranium especially. It’s barely moved for 20 years, but here we are about to build a load of new nuclear stations all over the world. There are four or five firms you can invest in to take advantage of this. One I am a director of, Uramin (URA, 2.3p), has just listed and owns about £300m of proven uranium reserves.
DS: The other way to play nuclear upside is through the engineering consultancies that are going to have a field day in the planning. In the UK, it’ll take years for the public to accept nuclear plants, and there are five-year planning processes to go through. In the small-cap area in the UK, look at RPS (RPS, 177p), Ws Atkins (ATK, 741p) and White Young Green (WHYR, 122.5p) – all have nuclear consultancy divisions.
JF: Oil has been in an uptrend for three years and, if you extend that uptrend on the chart, it suggests oil will be $80 by August. It seems we are going to see $70 at least, given the disruption in Nigeria and political tension with Iran and Russia. There’s not even much concern on the demand side. Even if the US slows, China is going strong and Japan is in recovery. I’m still a big buyer of Royal Dutch Shell (RDSA, 1,906p). It’s currently the cheapest stock in the UK – it’s still trading lower than it was in 2000 and it offers a decent yield.
JW: Another interesting play on energy is gas storage in the UK – something we really need. I like Star Energy (STAR, 310p), which takes depleted fields and fills them up with gas. It’s the cheapest way to store gas.
MSW: Has anyone got other ideas?
Espen Baardsen: Like Jim, I’m interested in nuclear power and one to look at here is Duratek (DRTK, $17.7), which deals with the management of all kinds of radioactive and hazardous waste. On the energy infrastructure side, Washington Group (WGII, $58.8) is interesting. It’s got its fingers in all sorts of pies – design and engineering for the coal, water and nuclear industries. I also like some of the smaller insurance companies in the US that have been hit by the hurricanes and now trade more or less at their book value. One of them would be PXRE Group (PXT, $12.6). Also in insurance, I’m keen on some of the life insurers, such as Royal Sun Alliance (RSA, 127p), which has done nothing for 20 years and is now starting to look interesting. Finally, one speculative play in the energy sector would be Toronto-listed Grande Cache Coal (GCE, CAD$3.32).
JM: I’ve just been in Las Vegas for the Consumer Electronic show. The thing that struck me was that in a few years time, mobile-phone firms are going to be in trouble. You can now use wireless internet to make mobile calls. How will people who have got infrastructure networks, like Vodafone and BT, compete?
DS: Technology is eating into the profit streams of established media and telecom names. No one knows where this is going to end up, but we do know that is is bad news for the big infrastructure players.
JM: I’m also interested in Macau. In 1949, there were 5,000 people living in Las Vegas. Today, there’s nearly two million. It’s the ultimate gambling destination in the US, but Macau is going to be even bigger in Asia. You can invest in it by buying Shun Tak Holdings (SHTGF, $1.06) , which has all the ferries that go to Macau, all the casino licences and lots of property.
JW: My tip would be Homebuy (HBG, 240p). They sell TVs to people on a hire-purchase basis, but safeguard the debt by using meters. You get one of their TVs and the only way you can watch it is to put money in the meter. So no bad debts. Earnings are growing at 15%, yet the shares are on a p/e of only six to seven times. They’re also moving into other products. However, whatever you buy from them, they still come in and recalibrate the meter on your TV to reflect the level of the new debt. So the TV remains central. It’s a fabulous business.
FB: My pick would be Vodafone (VOD, 117p). I think it is one of the most-hated stocks around – look at the hostility here! I suspect the recent management change will affect the way the company views its allocation capital and I think a restructuring of the business will be enough to turn it around.
DS: My picks would be outsourcing firms. This is an enormous market and while the household names are currently expensive, further down the pecking order there’s a firm called Enterprise (ETR, 448p) that I like. It has a strong position in local authority outsourcing and is going to produce far better earnings growth than the market, yet it trades on a p/e of only 13 times.
Our panel
Espen Baardsen, analyst at Eclectica Asset Management
Francis Brooke, manager of Troy Asset Management’s Trojan Income Fund
James Ferguson, economist and stockbroker with Pali International
Mike Lenhoff, chief strategist and head of research at Brewin Dolphin Securities
Jim Mellon, chairman of Regent Pacific
David Stevenson, UK equity manager, Britannic Asset Management
John Walter, Manager of Metis Opportunities Fund