The best investors we know tell us what they think about world markets, and what they would put their money into now. This week’s panel: Marina Bond, investment manager at Rathbones; George Lee, fund manager at Eclectica Asset Management; Julian Pendock, partner at Senhouse Capital; Tim Price director of investment at PFP Wealth Management.
John Stepek: Where are we now? Are there green shoots of recovery, or is this the worst recession in 100 years, as Ed Balls put it?
George Lee: I don’t know about the worst in 100 years, but we aren’t seeing any green shoots. People point to some rising indicators – the copper price or the Baltic Dry – but that’s just down to the fact that everything stopped in December, so anyone doing anything at all makes it look a bit better than it was. I think this will last for maybe two months and then we go back down again. And I don’t think stimulus packages in America will change anything.
Marina Bond: I’m positive things will improve in the second half of this year because of the unprecedented fiscal stimulus. Firms have also been slashing inventory, so just a tiny indication of demand will mean increased production because inventories are so low. So I think we’ll have a bounce, but a bear-market bounce.
Julian Pendock: People must wake up to the fact that this is a structural change with a cyclical overlay. It’s no good governments chucking a bit of money at pet industries and shutting plants down for a few days. They need to take a lot of structural capacity out of the system. Everyone is giving them good marks for being more proactive than in the 1930s, but the banking system is completely different to then – over 80% of global liquidity now comes from derivatives. It’s difficult to know how to start. I can’t see any sharp turnaround.
Tim Price: The thing I’m most concerned about is the broad consensus that government bail-outs are in the best interests of the economy – I’m not convinced. Everything I’ve read recently, particularly from ‘Austrian School’ economists, who I think are winning growing respect, suggests that it’s in everyone’s best interest to let the free market exert its influence rather than have politicians distort everything. Reliable price signals need to come back before people can invest sensibly.
Julian: Yes. And the last time I looked, Keynesianism was not about borrowing a lot in a boom and then borrowing even more in a bust. What I find depressing is that people are trying to say this is the fault of capitalism. But the seeds of destruction came out of government interference. Where did Fanny and Freddie come from? The government. And there’s our dear leader here saying “no more boom or bust” every five minutes – so gear up as much as you can because it’s a one-way bet.
John: So do you think all this intervention is inflationary?
Julian: I don’t know. You might have, say, $700bn going in, but all that’s doing is off-setting the capital destruction as debts are written down. The velocity of money has fallen off a cliff. There’s never been anything like it – not even in 1907. If you lock money in a room or on a balance sheet, it’s not buying goods, so it’s not driving up prices. I think that near-deflation or mild deflation seems the most likely outcome for the next year.
Marina: I think RPI inflation will definitely shock on the downside in the near term. I don’t think we can avoid quite strong inflation later down the line with the amount of printing that’s going on. But I wouldn’t be able to say when.
George: I think we’re far away enough from that to be safe buying bonds. I think the real yield on a two-year, or maybe even a five- or a ten-year government bond, will look very attractive in the next two or three months. If you are seeing RPI and CPI down at minus 3% or minus 5% and you can get a ten-year bond yielding 3.3%, or whatever, in Germany, then it’s a no-brainer.
Julian: Japanese government bonds bottomed at 43 base points four years after the bubble burst, didn’t they? And everyone was saying they were a bubble, all the way down.
John: So what else would you buy at the moment?
Marina: Well, I’m not playing the highly geared firms, because it’s a 50/50 gamble – it all comes down to their relationship with their bankers. I prefer firms with reasonably strong balance sheets that hopefully won’t need rights issues and should be able to trade through this.
Julian: Another red flag is vendor financing. If you have a look at BMW’s balance sheet, it is more like a bank than an industrial company. And look at Siemens’ recent results: it has gone into vendor financing and it’s a disaster. Its cash flow year on year has gone from healthy to massively negative.
George: I’d avoid anything where the business model relies on leverage – we are in a world where debt has gone from 100% of GDP to 400%, and it’s going to go back to 100%. So avoid banks, anything Spanish, and anything that has made a lot of money recently from buying up businesses and trying to consolidate them. It also rules out consumer discretionary stocks and anyone geared to those. Then you look at guys who haven’t got gearing and who haven’t had a bull market.
Julian: Which is who?
George: Pharmaceuticals, big telecoms – they had their bust ten years ago and are relatively undergeared. And the consumer staples firms that are on pretty low debt. They’re putting out profit warnings, but they are going to miss their numbers by 5% or 10%, not 50%. And – slightly controversially – agriculture.
Julian: Now that the bubble has burst.
George: Ignoring the bubble, if you go back two or three years those stocks are still ahead of the broad equity index and they and their customers have no debt.
John: What about oil?
Tim: I suppose oil may well keep falling, given that we’re in the early stages of a global depression. But taking the very long view (which I guess right now is probably anything beyond 12 months), I think the supply/demand theme argues in favour of having exposure to oil. BP (LSE:BP) or Shell (LSE:RDSA) strike me as being, if not ragingly cheap, then certainly close to fair value. And at least they are still going to be around in five years’ time. I can’t say that with certainty about – well, just about anything else.
Julian: But what if they cut their dividends?
George: Clearly, if we’re still here in two years’ time, the dividends go. But if this is a 12 or 18-month phenomenon, I think BP’s and Shell’s dividends are pretty safe. The majors design their entire outlook around projects that wash their face with oil at $20 or $25 – or even $15 a barrel. Anyone exposed to the Canadian oil sands, or some of the more exciting areas in offshore West Africa, hasn’t a cat in hell’s chance at this price.
Everyone has got gold coming out of their ears… gold is going to be down 20%
John: What about the outlook for gold and currencies?
Tim: The one I’d expect to be a poor performer next is the euro. Economic activity is continuing to fall off a cliff.
Julian: One reason people are bearish on the euro is that they think some of the periphery countries (Portugal, Italy, Greece and Spain, the PIGS) are going to spin out. But when the UK left the European Exchange Rate Mechanism (ERM), all our corporate debt, government debt and mortgage debt was in sterling, so it wasn’t painful. But if you’re one of the PIGS and you leave, all your debt becomes denominated in a foreign currency or linked to a foreign currency – so they will still be in a deflationary debt straitjacket.
Marina: That would surely lead to a banking crisis in that country?
Julian: Exactly. That’s what happened in southeast Asia and that’s what’s happening now in eastern Europe because all their mortgages are in Swiss francs and euros – it’s crazy. I think the European Central Bank will change its rules so that it can issue pan-eurozone bonds. Germany won’t like it, because it will have to pay more and the guys who have been building houses in Malaga get to free-ride off the Bundesbank. But it’s the best way forward, I think.
George: If the eurozone forces Germany to make good all the debt with the PIGS, then the euro will definitely sell off, certainly against the dollar and the yen. I thought sterling’s fall was a bit over done against the euro, but I’m not 100% – I find sterling/euro quite a difficult cross. But I would still be short of cable [sterling/dollar], short of sterling/yen, short of euro/yen.
Tim: And then you buy gold – it’s the ultimate currency hedge.
George: No, because everyone has got gold coming out of their ears. If you get a financial dislocation, gold is going to be down 20%.
Tim: It depends on how you look at it. Gold is the portfolio insurance par excellence. If you’ve got it as 10% or 20% of a balanced portfolio, it’s not a disaster if the gold price sells off because other financial assets would recover.
George: I still wouldn’t touch it here. If gold comes back to $700, I will be all over it.
John: Any specific stock tips?
Tim: My blue-chip pick is AstraZeneca (LSE:AZN). It has a high Altman Z score, it isn’t ludicrously geared, and pharmaceuticals is a nice place to be in a recession. A perpetual favourite of mine is oilfield services stock Lamprell (LSE:LAM) – if you liked it at £6, you have to love it at £1. I think it’s in the right kind of sector, it doesn’t have any debt, it’s trading on a p/e of about three and it has a high Z score. I do not understand quite why it has sold off as much as it has, other than that it’s a small cap and is correlated to oil.
Julian: Whether or not you think the stimulus packages will be effective, the government is going to spend the money, so it’s nice to have governments as your customers. So I like Alstom (Paris:ALO). Power consumption may be going down, but there is a move towards much cleaner power stations – believe it or not, Nimby-ism has arrived in Asia’s middle-classes. People across the region are demonstrating against dirty coal power stations, so that’s good. I am still quite in love with Piaggio (Milan:PIA). It owns Vespa, is not so dependent on vendor financing, and people are downshifting. And I recently bought Fiat (Milan:F). Italian companies have a bad reputation, but their management really brings home the bacon. Sure, it’s risky, but I think Fiat’s Cinquecento model is hitting the spot. It is also doing this deal with Chrysler where, basically, it gets free options on its dealerships, so they can break into the US market for free.
The other stocks I like are just boring things like Swisscom (Zurich:SCMN) – high-yielding stocks where you get a much higher, well-covered dividend yield than you get by putting your money in the bank.
Marina: It’s only £30m market cap so I am sticking my neck out here, but I like Education Development International (LSE:EDD). It assesses and awards vocational qualifications. Its customers are schools, further education colleges, training providers and corporates – it mainly gets funding from the Learning Skills Council. It generates lots of cash, it’s got very high margins and is quite highly operationally geared, so as long as the top line keeps going it has an amazing effect on the bottom line.
I still like Balfour Beatty (LSE:BBY), which has got cash and generates more, and also Serco (LSE:SRP). The rating is a bit ridiculous, but it’s going to get through this. The debt supercycle may be over in the consumer sector and corporate sector, but not in the government sector – the government will have to keep spending.
Julian: Hedging your personal tax bill.
George: I would look at Qiagen (Dax:QIA). It makes diagnostic testing kits. The big drug groups buy the kits to do various laboratory tests. It’s a very nice ‘razor-blades’ model – Qiagen sells a machine, then just sells a packet full of testing kits when they are needed. It has been growing at 10%-15% a year for donkey’s years.
If you want to be a bit more aggressive, try Monsanto (US:MON). It’s now trading on between 15 and 20 times earnings and is still growing profits at 20%-25%. And unlike Astra or Glaxo, it has actually got a pipeline. Compare the European maize yield with the US corn yield since Monsanto’s products started. European maize yields have been basically flat and quite volatile, while the US yield has carried on growing at 1.5%-2% a year, but with less variation from year to year. Genetic modification doesn’t necessarily improve the yield, but it does make the plant more resilient to various nasties that want to eat it. Admittedly, there has been no drought over that period. But it does look like there’s a clear benefit and the Europeans are just sticking their heads under the table.
John: Thank you very much.