Every month, MoneyWeek invites some of the best investors we know round to tell us what they would – and would not – invest in now. Here you can read the extended version of the latest roundtable, containing our experts’ full commentary on the US property market, oil prices, nuclear power and more – plus their top summer stock tips.
MoneyWeek roundtable panel
Bob Catto
Investment Director Williams de Broe
Jonathan Compton
Managing Director of Bedlam Asset Management
Tim Price
Chief Investment Officer at Union Bancaire Prive
Rupert Della Porta
Manager of the F&C North American Fund
MSW: The biggest risk to global markets is probably US growth. Where do we see this going from here? Is the housing market still a big worry?
MSW: The biggest risk to global markets is probably US growth. Where do we see this going from here? Is the housing market still a big worry?
RDP: Not as much as it was. The April data out a few weeks ago showed new home sales up 16%. Monthly data bounces around a lot so you have to take this with a pinch of salt but it was much better than people expected. The supply of new homes has also gone from 8 months down to 6 months. I always think that the US does have quite quick clearing mechanisms so I think the worst of the housing market is behind us – it has started to clear.
The most important thing about the housing market is the extent to which it impacts the consumer in general. But I specialise in US equities so I spend a lot of time talking these banks, insurance companies and mortgage insurance companies about what they are seeing and so far we haven’t really seen credit deteriorating. Unemployment is still low in the US, very low and that ultimately is keeping home delinquencies and bad credit low.
MSW: So what does stop the US consumer? Unemployment rising?
RDP: Yes, and we haven’t seen it yet.
MSW: And will we?
RDP: I don’t think so. We’re looking to see, from the larger economic picture, the US reaccelerate slightly next year. So, I think low unemployment in the US is OK for the foreseeable future.
JC: I’m not so sure. I’ve looked at the labour statistics for the last 48 months and as far as I can see the revision six months later averages about 40% either way. So the data on this doesn’t seem that reliable to me particularly given that as far as house prices go we appear to have had the most prolonged and the steepest fall since records began.
Right now the numbers suggest that this doesn’t matter but how can that be? Look at what happened on the way up. As house prices rose we saw huge equity withdrawal and massive consumer expenditure. So what happened to house prices really mattered on the way up. Surely it matters just as much on the way down. Everyone says we don’t need to worry about it but that makes me nervous. I take your point about America always recovering extremely fast – it is one of the great wonders of all our lives, but nonetheless house prices have been a prime driver of consumption and consumption has been a prime driver of the world economy.
The US economy may look like it is recovering again but that just means that the chance of rates coming down again is limited. That won’t help either. I think that as long as things are fine it is simply a problem postponed.
MSW: Postponed by how long?
BC: Well, that’s the question. I agree that there is contradictory evidence at the moment and there are certainly some indications that the US economy is reaccelerating and there are some encouraging signs on the housing thing but I’m still worried about the sub prime market. You see all sorts of hedge funds out there claiming to have made money shorting the subprime market but if someone has made money someone has also lost it. Who’s holding the losses? I think they are being hidden by European institutions that didn’t know what they were buying and are too frightened to admit it. That will have an impact in the end.
TP: Probably not just European institutions. I’m sure there are savings institutions, pension funds in the States doing the same.
BC: Also if the housing market isn’t right then the consumer eventually will cut back on consumption. I feel uncomfortable with just believing everything is going to carry on and the American economy will reaccelerate and they will all live happily ever after. It’s just not going to happen in my view. How long it takes to unwind is the question, I would suggest.
On the other hand one thing I am not worried about is China. There are a lot of people out there who think that not only will there be a collapse in the Chinese stock exchange but that this collapse will be the trigger for a collapse worldwide. I don’t agree with that – the Chinese stock exchange is tiny in terms of the Chinese economy and whatever happens to it the Chinese economy will carry on consuming lots and lots of raw materials. I still feel happy being invested in the minerals and energy area. Sure, it will be a volatile ride but I want to be there.
TP: There might just be fewer people in Shanghai and Beijing buying BMWs for a while if the market crashes in China. But I feel pretty sanguine about the Chinese economy too – a crash will affect a lot of small retail investors unpleasantly but it can’t have much of an effect on the real economy.
JC: That the Chinese economy carries on growing, that’s beyond doubt. It can’t afford recession – if growth falls below 4% per annum. But that doesn’t mean a collapsing market won’t affect global markets. Remember Thailand collapsing on July 2nd 1997? No one thought that would cause collapse in Russia and then Brazil in two years. But it did cause exactly that chain of events. It’s very unusual to have one market melting down and others not to move so we think that this could move out into other Asian markets. Exactly how I don’t know but in terms of turnover anyway China is quite a big market now and I think we are all being a bit too optimistic to assume that its meltdown would have no impact on the markets.
BC: I am sure it would have an impact on the markets, I agree with you entirely. It’s will it have an impact on the Chinese economy in the way that the housing market is going to have an impact on the US economy? Probably not.
JC: No. The interesting thing is the disconnect between the two. China is seeing massive fixed capital investment but it is mainly losing money. This is profitless growth. China does not need 350 refrigerator manufacturers for a market that’s about twice the size of the UK. China might be big but it’s not that big in terms of consumer expenditure. No one’s making any money – too much investment and too much competition. This is exactly what happened in America in the massive growth eras of the 1800 and 1900s. Then the one asset not to hold was equities. Hold anything else, you made a fortune. The equity market was beaten by the bond market eight decades out of ten. So to invest these fast growing economies you don’t want to be in the stock market but somewhere else. I like food myself.
MSW: You like a lot of commodities don’t you? But not oil.
JC: No. Most oil storage facilities are full, there’s no shortage of supply. We all know that the cure for high oil prices is high oil prices and everyone is now trying to switch away from oil. Utilisation changes dramatically. China today uses 20 times more oil per unit of GDP than Japan. There’s a lot of room for that to fall – I can see China growing but its oil consumption staying flat. That’s exactly what happened with Japan. Japan was a stunningly inefficient user of oil up to the first oil shock. That took a wee while and then they completely changed their usage. Then look at all the capital investment into energy and at the substitution coming in – tar sands, sunflower plants and so on. This is just a normal cycle.
TP: I think there is a lot of merit in this argument but I still see oil prices going higher. I can’t see biofuels being a proper substitution for oil – the whole thing is just a fad, an accident waiting to happen – but I can see a lot more oil being needed to really fuel the Asian industrial revolution.
At a bigger level my sense is that for years now everyone has been hypersensitised to seeing bubbles. After the TMT crash of 2000, everyone sees bubbles everywhere – whether they exist or not. There is a difference between a bubble which is, by definition, short term sustainable and a bull market which can go on for years. Some of the things other people see as bubbles I see as bull markets. It feels to me like we are living in a kind of golden age for capitalism right now and not least powered by this enormous economic restructuring going on in Asia. And even if the US economy softens, there seems to be genuine evidence of reacceleration in the Euro Zone, particularly Germany, which has been the world’s best performing stock market of the major markets this year, so that should pick up the slack.
BC: Tim’s right – there are a lot of nervous bears around, there is a lot of money on the side lines, the private investor has not yet been dragged in to the mutual funds in America. There are lots of reasons why you could make some bullish comments about the whole overall scene.
JC: In support of your case it is true that a lot of valuations aren’t that stretched.
TP: And if you believe that corporate earnings in the West are broadly sustainable at current there is no reason why we can’t be looking at double digit returns even from where we are now in emerging markets.
RDP: I think we are all agreed that the biggest story in markets and has been for five years at least, is what’s happening in China. This is the story of the decade – it underpins everything that we’re looking at. Obviously it’s been an enormous feature of what we look at in the development of the stock market. But when you look at the other side of the coin it does seem that an awful lot of cyclical companies are valued like growth stocks at the moment. There is a very narrow gap of valuation between high quality growth and what is normally a cyclical company – tractor companies, engineering companies and so on – over the course of so many years. I think that it isn’t just the commodities but the ancillary plays and infrastructure that are starting to look like they are at dangerous prices.
But there are good quality things that aren’t bad value that are being left on the side – some in the consumer area, some in financials. Coach (COH.US), is a US handbag company which is very high quality but inexpensive. We think McDonalds (MCD) is also a reasonably attractive stock. It’s big, its cash production is very, very high and it has finally got the menu right.
TP: What about General Electric?
RDP: General Electric (GEC) is for the first time in a very long time starting to look reasonably OK. It’s cheap on about 16 times earnings. Tyco (TYC.US) is quite a cheap company as well
TP: Don’t you think that this is really a market for stock pickers rather than sort of broader plays.
RDP: Yes, absolutely. We don’t really have any big sector views; we have some sub-sector views within areas. So we like food and we like supermarkets and we don’t like many of the big consumer product names because they are expensive for example.
TP: One of the problems is that there is no distinction between value and growth anymore. They’ve all sort of met in the middle.
BC: The conundrum for investors is that you’ve got the great and the good like Anthony Bolton, Warren Buffet, Alan Greenspan all sending out warning messages and yet the markets are paying virtually no attention. It has a half hour effect on Wall Street.
TP: Bolton is arguably making the most profound statement on the market by just leaving it.
BC: To be fair, he is retiring.
TP: Exactly.
JC: Do you know what worries me most? That regardless of the fundamentals these are very technical markets. Equities are being retired at an unprecedented rate (thanks to the M&A boom), which is technically very important. Apparently 13,000 M&A deals across the markets in the last five months. It’s record year after record year. This, along with fantastic cover of equity, fantastic company gearing up, fantastic M&A activity and benign bond issues has created almost the perfect place for equity investors and that’s why, basically, everything has gone up. This is so worrying because it’s difficult to forecast how it unwinds.
RDP: I’m also amazed by the buybacks we’ve seen. The most cash rich sector in the whole US market is the tech sector. Microsoft (MSF), Intel (ICO) and all these others have got tens of billions of dollars sitting on their balance sheet. But IBM (IBM) has just levered up their balance sheet and announced they’re buying back $15 billion of stock just two weeks ago. So there is a company which actually has had a very healthy balance sheets suddenly saying, “Right, we really realise what’s going to drive our stock further”. Then there was a semi-conductor company, Linear Technologies (LLTC), which did the same. And there are lots of other companies still to do this.
JC: Is this a good thing? It seems odd that the rate of buy backs has never been higher when stock prices on index measurements have never been higher as well. It’s extraordinary how there’s a universal, “Gosh, my share price has tripled, now I’m really bullish about my stock so I’ll buy it back.”
MSW: Could we move on to looking at specific stocks or specific markets. Anyone got a really interesting one they want to start with?
TP: I am going to break with precedent and not mention a commodities related business though this one is tangentially related. It’s called Terex (TEX.US) and is a US machinery company. Amongst other things they make off-road mining trucks and cranes and as far as I can see they are part and parcel of the supply of processes and machinery to the global demand for commodities and for mining and building machinery. It’s in the same kind of space as Caterpillar (CTA) and Deere (DE.US) and trades on a forward PE of around 15 times, which I don’t think is an extraordinarily pricey multiple.
RDP: Terex is a fantastic company. We don’t own it but we do own McDermott (MDR.US) which is a company in a similar field. Some of these mid-sized construction equipment-type companies are doing very, very well.
MSW: Tim, are you still keen on BHP (BLT), still keen on Xstrata (XTA) and so on?
TP: As we’ve been expecting the Chinese bubble to burst we have trimmed our holdings to some of those stocks, basically with a view to getting back into them at a later date hopefully at a cheaper level. But we are still long in Anglo American (AAL) and we’re still long, in portfolio terms, in Xstrata (XTA) and the levels these kinds of stocks are trading at now, I would love to keep buying them. So the thesis is intact and it’s a long term thesis.
BC: Well I agree. I would still go for big mining and I would go for Rio Tinto (RIO) and BHP (BLT) and I think it’s not impossible that private equity buyers might bid for Rio given the huge amount of money available to them now. I’d also go for a fund: I would go for the Geiger Counter Fund (GEIGF.US). I think uranium is the future. I think there is no alternative to nuclear power and this is a good way of getting a large portfolio of uranium stocks. It comes from New City Investment Managers and is well managed and growing very rapidly. Looking to the juniors, I’d go for Rusina (RMLA) which operates mainly in the Philippines exploring for metals – nickel laterite, platinum, copper and so on. It’s tiny – a market cap of £84 million and it could easily attract a bid from a major.
Next Medusa (MML). I think there is going to be consolidation in the mining area and that means that producers with low levels of debt that are producing cash flow, such as Medusa, are likely to be targets. There also Canada listed Uruguay Mineral Exploration (UGY) It’s on a very low multiple, it has strong cash flow and no debt in the balance sheet, and it is working in a solid area. It is bound to be taken over sometime in the next eighteen months to two years.
MSW: Great, thank you. Jonathan, anything interesting?
JC: I’d like to point to the first three stocks we are getting for our new fund (the Cherry Picker Investment Trust). One is Entertainment Rights (ERT), which holds the Postman Pat brand. Recession or boom this is a very stable and growing market – Postman Pat now speaks 64 languages including Urdu and the firm is now No 2 in the world in childrens programming. It’s a small company with a big position. The shares have gone no where in the last 12 months but the business is clearly loaded to the second half of the year and to Christmas.
The second is Kverneland (KVE.NO), a Norwegian agricultural machinery maker. Farmers make money, the first thing they do is buy kit and with food prices rising they are going to make money. We’re also in Commerzbank (CBK.GR) because there we can see the German dynamics, we can see the consumer expansion, and we can see the movements in housing market. With all that Commerzbank really appeals.
MSW: So you are keen on the German market as a whole?
JC: I think it’s great. I guess probably most of us are- restructuring is releasing value the whole time. No one is immune from any trouble in the US of course but all the data shows the German dynamic is undoubtedly accelerating. Oddly UK investors seem to have an anti-European bias. They always seem underinvested in Europe whatever the point of the cycle. The problem for us is just that while we like the market over all we do have trouble finding good value plays on German construction, German consumption and German property. Being an active fund manager I think that share trackers are the work of the devil but if I was going to buy one I’d buy one on Germany.
RDP: I’d like to pick two stocks that are in our portfolios. The first one is Cadence Design Systems (CDNS.US) which creates software and tools for chip designers. We know the company well. It has a good management team and is in a good market. I’m sure that we’ve all noticed that the phone handsets seem to only last a year these days or one feels impelled to get something a little bit more modern and cutting edge; that we are buying an awful lot more consumer electronics, and that we bother much less with the warranty business than we used to because we expect things to have a built-in redundancy of eighteen or twenty four months. Each of these devices has chips especially designed for it. The faster the chip can be designed and the more specific it can be, the faster the product can get to market. This also lower its heat dissipation and energy use so the batteries last longer. So electronic design automation is actually a very strong area of technology capital spending. We see expanding profit margins here and are very comfortable holders of that stock.
The second is Carpenter Technology (CRS.US). It is not really a technology stock at all but a titanium and specialty steel company. We love the titanium story because it is allied with the commercial airline cycle, which we think has got very strong underpinnings. Boeing (BA) in the happy position of seeing customers they never even appreciated they had before – low cost European airlines and Asian airlines springing up from nowhere to buy planes – but they should soon get orders from their legacy customers, the big European and the US carriers who have been mired in bankruptcy talk and difficult union negotiations for a while but now may emerge to order. The 787 which will benefit from all this is much more intensive on carbon fibre, titanium alloys and very light metals. There’s a large manufacturing shortage of these in the US and that’s where Carpenter Technology comes on: it’s a titanium alloy company but it is also it’s doing a lot of specialty design for the components of the aircraft.
MSW: Thank you.