These are confusing times. On the one hand, anyone who follows financial markets can see that a slow-motion train wreck is unfolding before our eyes – the US economy is imploding, led by the housing sector, causing a recession. This recession will be deep; ‘stimulus’ packages and interest-rate cuts won’t be enough to avert it. The US downturn will be sharp and possibly prolonged. It will have ripple effects here in the UK, where we’re entering a stagflationary period of considerable length, exacerbated by the poor policy decisions of an incompetent government.
It’s clear to me that major equity markets are in a bear phase and corporate profits, inflated by years of excess credit, will fall freely over the next few years. The message is that major market indices, particularly in the West, are a sell, sell, sell.
And yet… this downturn is already throwing up anomalous opportunities of the sort I love. In certain instances, smaller company shares where there is lots of visibility of earnings – recession or no recession – look compelling. Among major markets, I’m keen on Japan. It is ridiculously cheap on almost any measure and has been through its own catharsis for so long that sooner or later a bottom has to be called.
So what to do? Investors should be defensive in terms of the UK and US markets over the next 18 months or so – and either be short on the major indices, or generally out of them. By contrast, certain smaller company shares should be accumulated simply for their internal cash-generative abilities and their dividend support. While the credit crunch persists they may not be “taken out”, but one day they will be – or will be rerated from levels that are becoming absurdly low.
Also, although I think most emerging markets are somewhat ahead of themselves, I like Brazil as an investment opportunity. Valuations there are alluring both relative to other Bric economies and to growth rates. With all this in mind, here are my specific recommendations for the year ahead.
1. Stay out of most “big name” stocks until a capitulation has occurred, marking the end of the bear phase. This might be as much as 20% below current levels. The one exception I make for this is some of the financial stocks that have been heavily marked down and recapitalised. In this respect, Citibank (US:C) looks reasonably attractive at the moment in the US, and Bear Stearns (NYSE:BSC) may well be taken over in its current state.
2. ‘Average in’ to certain smaller companies that have been indiscriminately sold. It is always dangerous to catch a falling knife, but a measured process of accumulation could be a good way to get into stocks such as Catlin (CGL). This insurer has great management, a dividend yield of about 8% and trades at a very low premium to book value. I also like IT recruiter Interquest (ITQ), which has great and proven management, and have a considerable interest in Speymill (SYG), a growing property manager involved in Germany and in Macau.
3. Be opportunistic with other investments. Japan is cheap and I agree with MoneyWeek that investors should re-weight Asian portfolios towards this country, hoping for at least a 50% upside over the next three years, including currency gains. Buy Brazil above all other emerging markets. It is a play on agriculture, hard commodities and high growth. I also still like telecoms payment clearing services firm Billing Services Group (BILL), which I’ve mentioned here before. It has sold half of itself and it can only be a matter of time before the other half is sold and cash returned to shareholders. It’s a lower-risk investment in the current climate.
4. Stay away from anything to do with UK or American property for a while. These remain toxic investments.
5. Recognise that bear markets tend to be grinding, dispiriting affairs that go on and on, defying hope. Already, siren voices are being heard about high levels of cash and pessimism. Ignore them. That having been said, there is always a bull market in something, somewhere. This is a great time for cash-rich value-oriented investors!
The author may own these stocks. The Top 10 Investments for the Next 10 Years, by Jim Mellon and Al Chalabi, is out now from Capstone Publishing (available from the MoneyWeek Bookshop).
The stocks Jim Mellon likes
Stock, 12mth high, 12mth low, Now
Citibank, $55.55 $22.36 $25.81
Bear Stearns, $170.23 $68.18 $79.56
Catlin, 535p, 288.75p, 351.25p
Interquest, 164.25p, 86p, 86.50p
Speymill, 126.75p, 36.50p, 40.25p
Billing Services Group, 26p. 11p, 13.75p