Every month we invite the best investors we know for drinks to tell us what they think about world markets, and what they would – and wouldn’t – put their money into now
Merryn Somerset Webb: Patrick, you’ve been bearish for a while now – it looks like all your worst fears are coming true.
Patrick Evershed (Manager, New Star Opportunities Fund): Yes. I had dinner with Alistair Darling recently and listened to him say that we in the UK are fortunate because, even as we head into rougher waters, our economy is so strong. But nothing could be further from the truth. Government revenue is in a mess, we’ve got a record trade deficit, individuals are more heavily borrowed than ever before and there’s a record low savings ratio. So in rough waters we will probably suffer more than any other economy.
Merryn: More than the US?
Patrick: Yes, the dollar has come down and the US trade balance is sorting itself out. They’ve also had a much stronger government, in that their budget deficit has been less than ours so they’ve been able to cut taxes. We can’t. They also have fewer regulations to deal with: they are a proper capitalist country. So it’s possible that things there aren’t as bad as here.
Mike Hollings (Chief investment officer, Ansbacher): I was agreeing until you said America is a proper capitalist country. Is it? Look at the way they seem to be prepared to do anything to bail out the market – smacks of socialism to me!
Merryn: Patrick, I know that in an ideal world one wouldn’t start from here, but what would you do to fix the UK?
Patrick: I think interest rates have got to come down, but only slowly, and I think we’ve probably got to let sterling keep falling to bring life back into our manufacturing sector. We also have to get people back into the savings habit. Fewer than half the under 35s have any pension schemes and only a small proportion of them are on the housing ladder. So taking a long-term view, the situation is even worse.
Merryn: How do we get people to save with interest rates coming down and a perception that inflation is rising?
Patrick: I think we’ve got to lecture to the masses. They must start saving. The savings ratio has got to go from 2% to 12% if our children aren’t going to live in abject poverty.
Mike: I’m not sure that fixing the economy is about interest rates. I think it is fiscal. We have to stimulate the economy here and in America – and not just by sending everyone cheques for $400 to spend in Wal-Mart, which buys 90% of its stuff from China. That doesn’t sort the problem out. Instead, spending should focus on the chronic state of infrastructure, spending it domestically so it creates jobs domestically and the money stays in the system rather than being sent back to China.
Merryn: So you would do that and keep rates relatively high?
Mike: Yes. If we cut rates too fast and have negative interest rates, who’s going to save?
Patrick: One of the big problems of the last ten years has been the massive transfer of wealth from the Anglo-Saxon world to the Indians and the Chinese. Instead of saving we’ve spent our money on a flood of imports from the Far East. But the producers of these goods have been saving like mad. Now they are using their reserves to buy up all our assets.That’s been fine for a while – we’ve been able to live well beyond our means – but in the future it won’t feel so good: our children are going to be spending their lives slaving to pay dividends to the East.
Mike: The problem is that if you consume more than you produce then the only way you can finance the spending is by mortgaging your assets – dipping into the piggy bank, your house or whatever. So at some stage Patrick is right. There is a generation that has no pension – they think their houses are their pensions. But they need more than that.
Charles MacKinnon (Chief investment officer, Thurleigh Investment Managers): I’m not sure things are that bad. According to research from Bank Credit Analyst, as of May 2007 46% of all UK households had no borrowings. Now that does not tell me that we have a massive savings problem – a lot of wealth has been created in the UK. Even in America, 35% of all homes have no borrowing against them. And while a record number of houses have been foreclosed on, it is still a small number.
Anyway, if we are pessimistic on the US and UK we aren’t compelled to invest. If we think there is better to be had in Asia – if they are happy to reap other people’s foolishness, then surely that’s where we go.
Patrick: I’m not sure that much wealth has been created recently in Britain. It is just that asset prices have shot up. I bought my house in 1970 and it’s now worth 100 times more than I paid for it, but that doesn’t mean I’m any better off. It’s still too small and I still can’t afford anything bigger. That is not wealth creation.
Mike: What the current crisis comes down to is the fact that rates have been too low for too long and that at the same time we have seen massive creation and securitisation of debt. In fact, just about anything that you can securitise has been securitised and sold on. The result is not an equity crisis but a credit problem. In the US there are some world-class companies and the weaker dollar with lower share prices is going to make buying Intel, Apple, Microsoft, or whatever, at a bargain-basement price look pretty compelling at some point. So what worries me isn’t equity valuations, but credit and how we sort that out.
Tim Price (PFP Wealth Management): But the credit problem can make a banking crisis and banks are at the heart of the modern economy. And if you can’t trust banks, then there are all kinds of economic structures and processes that stop working. How you resolve that easily isn’t remotely clear. So it doesn’t remain simply a credit crisis.
Merryn: I think we can all agree that both the US and British economies look a bit iffy. What about Asia?
Mike: The problem lies with America. With the US being 26% of global GDP, and the US consumer being 70-72% of US GDP, if the US consumer can’t spend then we’re all in trouble.
Charles: There is no such thing as decoupling. All global economies are firmly coupled together. That said, there are counterbalances to a slowdown in the US. There has been huge growth in wealth in China and the Middle East, so while consumption may be falling off in the US, consumption there will step up.
Mike: China now is roughly 4% of GDP, so it would have to grow a huge amount to compensate for, say, a 10% drop off in US consumption, and it can’t grow much faster than it is already. There may be marginal increased spending of the middle-classes in China, Russia and India, but there is still a huge mismatch between any fall off in the US and consumption rises in China. That may not be the case in three years’ time, but it is now.
Tim: There is still an argument – however good these stories are – that you don’t want to be long on equities in any form right now, on a short-term tactical basis. One of the frightening things about the recent volatility has been that pretty much every part of the stockmarket has been obliterated. It’s very difficult to find sectors that have held up at all. If you take a long view, you might think that everything now looks cheap, but wind the clock back to 2000 and you will see that markets in Europe could easily come off another 20% without batting an eyelid.
Patrick: It’s quite right that retailers should have fallen, given that inflation is now running ahead of wages, especially if you take into account taxation. It makes sense that housebuilders should fall too – their costs are rising and prices are falling – and most of the banks are in a mess.
Tim: But why, say, drug stocks and pharmaceuticals should be caught up in this is a bit baffling.
Merryn: So where is there value now?
Patrick: In companies that have specific reasons to continue to grow, regardless of the economy. Last time I attended a MoneyWeek Roundtable, I was talking about Bioquell, which is now firing on all cylinders. It’s dealing with MRSA, producing filters for radiation and bugs in the case of biological and nuclear warfare, and is even working on a cure for leg ulcers. Small companies have been very hard hit, but there are quite a lot that are going to maintain growth, however horrendous the economy is.
Charles: I probably have less than 3% of my assets in the UK. There is opportunity in America, huge opportunity in Russia and fantastic openings in Asia. There are cheap companies in places where we know the population is growing and the economy is strong, they’ve got the savings habit and they manufacture real things. It would be a Herculean task to make the UK like this, but the Chinese, Singaporeans and Vietnamese are already there and we can buy their economies.
Merryn: Tim, where do you see value?
Tim: The real prospects are businesses, albeit they might be small ones, that are still exposed to the global infrastructure theme and which now trade at something of a discount. In the short run, anything can happen, but in the long run that theme is as relevant now as it’s ever been. The populations of China and India are not going to go away overnight and nor is their demand for infrastructure.
Charles: The question for me at the moment is just how long this credit crunch will go on for. Will it be a year, or will it be a Japanese experience, 16 years, before we can say, “Gosh, that was it”?
Tim: We met a Japanese hedge-fund manager five years ago who suggested that Japan in the 1990s was the dress rehearsal, but that the rest of the world would be the real event. Five years ago that seemed an extraordinary thing to say, but it doesn’t seem so fanciful now.
Patrick: I remember in 1990 predicting the Japanese were going to be in a fearful mess for a long time. Everyone thought I was nuts, but it happened. I hope it’s not going to be as long as 16 years, but I think we could easily have a long recession, simply because government and personal finances are in such a mess.
Mike: At least we have the luxury of not having a currency that’s pegged to another one. We’ve can devalue our currency, which European countries cannot do.
Patrick: It is a great fortune to have nothing to do with the euro. It is the only issue on which I agree with Gordon Brown.
Merryn: So you wouldn’t invest in Europe?
Mike: Again, it comes down to the individual company. But if you want to look at the big picture, Germany is fine, but Ireland, Spain, Italy, Greece? No. Going back to how long this all takes, the answer lies with governments. If they engineer a Japanese solution, it will take a lot longer. If they allow capitalism free rein and let Northern Rock go bust, for example, it would be faster.
Merryn: But they won’t.
Mike: So it will take at least a year for this to work its way through. Now whether the market discounts that and falls 50% in the next six months, I don’t know, but I do think the credit story has a lot further to run.
Merryn: So what does all this mean for the commodity supercycle?
Tim: The logical conclusion is that industrial metals get whacked: it’s difficult to envisage a rosy scenario for them in a slowdown. Long term, the theme is valid, but this could be a tough year. The agricultural side of the debate is a little bit more nuanced: it’s a longer-term theme that relates to Asia as much as it does to the rest of the world.
Patrick: Soft commodities are the thing to go for. The first thing that happens when cereal and grain prices go up is that farmers can’t afford to feed their livestock, so they are all sent off to be slaughtered and the prices of cattle and pork are driven down. But then the herds get small and prices are then forced up. This is where we are now. And this is almost exactly the right stage of the cycle, I think, to get into soft commodities – and livestock in particular.
Mike: You have to be selective on grains. We’ve sold out. Wheat may keep going, but corn and sugar are in massive oversupply right now because of all the extra that has been grown for biofuels. And with the oil price falling, biofuels aren’t going to look so good.
Charles: I think that hard commodities are still attractive, thanks to industrialisation. Can you name the largest city in China? No? Chongqing. And its population? 45 million! The Chinese need to move 200 million people a year into urban centres.
Merryn: But why do they need to?
Charles: Because they’ve got to have people earning to avoid social unrest.
Mike: But that doesn’t necessarily mean urbanisation on the same scale as in the past few years. Now that soft prices are rising, there is more incentive for the farmer to stay where he is.
Tim: I think there is a subtler side to the debate there, which is that there is only a limited amount of capacity the commodities market can absorb over a given period. My sense is that even now institutional investors haven’t embraced this sector, let alone started actively investing. So while commodity markets might have gone a bit too far and too fast, in the long run they look good. One of the key problems we’re all facing is the way people have packaged, sold and bought instruments that are so opaque and complex that nobody, including the originators, has really understood what the hell they were doing. So now there may be a premium for anything that’s transparent, and which people can understand.
Mike: Cotton plays into another great theme: water. It takes ten times more water to grow cotton than it does to grow wheat or corn. So with dwindling supplies of water, people have been under-producing cotton. That might see good price rises. I’m also interested in shipping stocks. They’ve been decimated in the wake of the Baltic Dry index (considered a lead indicator of shipping demand) falling 30%. Now some trade on eight or nine times earnings, seven or eight times cash flow, with no real debt. It might be a bit early to buy, but we’re not going to stop shipping goods around the world completely.
We like Overseas Shipholding Group (US:OSG). Oil services is possibly another oversold sector. You want to buy firms that have secured positions within the industry, are still generating cash, don’t have bloated balance sheets, and don’t need to refinance debt.
Merryn: So what is your best tip?
Mike: I would go for Noble (US:NE), an offshore oil-rig supply company. Price to book isn’t that cheap – 2.8 times. But at 8.5 times cash flow and on a ten times p/e, that’s good. The stock is down 20% this year. That’s a stock to buy if I want to put some money to work.
Merryn: Tim?
Tim: I reiterate my concern that this is not a great environment for equities, full stop. So maybe cash or index-linked bonds. I suppose, from an equity perspective, I endorse the whole broader infrastructure theme. There is a UK stock that ticks some of the boxes – Aggreko (AGK), the world’s largest supplier of temporary power – and which is not trading at taxing levels. Access to power is comparable to the whole debate over access to water. It’s a hot topic that’s unlikely to go away because it’s endemic in developing markets.
Patrick: I’ve already mentioned Bioquell (BQE). I remain very keen on that. I also like Immunodiagnostic (IDH). It tests for Vitamin C, which is important as populations age: if you have a deficiency of it you can get brittle bones. They have been expanding geographically into new areas, which has given them strong growth, and are now bringing out testing equipment that will cut costs. Brokers are forecasting something like a five-fold rise in profits in three years’ time.
Otherwise, I own Healthcare Locums (HLO), which provides doctors and nurses on a permanent and part-time basis to the NHS and the private sector here and overseas. So far, the firm has grown by acquisition, but it is now going for organic growth. It should see a very strong rise in profits and is being put on a p/e of nine for the year just finished, and six for this year.
Charles: I am buying iShares’ MSCI Far East ex-Japan (IDFF). I think that it has all the characteristics that Patrick craves in the British economy. It’s a great long-term play. I am also long on the iShares Eastern Europe (IEER), which is essentially a play on Russia and Gazprom, and the Jim Roger’s Market Index (M9SA.GR) – that’s 35% crude, 7% wheat, 5% corn – and that’s something I think we can hold for three or four years.
I also think this environment creates huge opportunity in private equity and so I like Princess Private Equity (PEY), recently listed in London and now trading at a massive discount.
Mike: What do you think of gold?
Patrick: I’m invested in gold mining shares with good growth prospects. They are planning to increase their production rapidly over the next two or three years.
Merryn: Tim, you like gold, right?
Tim: Yes, you can buy gold as a commodity that’s going to rise in value, or you can buy it as an element of portfolio insurance – so if the worst happens, you become the last man standing. I’d be happy to be one of the last men standing. If the proverbial hits the fan, I am a lot more comfortable holding gold than any other financial asset. We may be overbought near term, but I can see gold easily trading above $1,000 this year, or certainly doing so as this crisis unwinds.
The Roundtable tips
OSG (US:OSG), $65.16
Noble (US:NE), $46.66
Aggreko (AGK), 558p
Bioquell (BQE), 192p
Immunodiagnostic (IDH), 211p
H/care Locums (HLO), 82p
MSCI Far E’st xJpn (IDFF), 44p
Eastern Europe (IEER), 2,179p
JR Market Index (GR:M9SA), e31.37
Princess (PEY), e7.08
Our panel
Charles MacKinnon
Chief investment officer, Thurleigh Investment Managers
Patrick Evershed
Manager of New Star Select Opportunities Fund
Tim Price
Director of Investment, PFP Wealth Management
Mike Hollings
Chief investment officer, Ansbacher