Every month we invite the best investors we know for drinks and ask them what they would – and would not – put their money into now. Our panel this month is made up of: Kristian Cassar, manager of the Fitzwilliam Strategic Bond Fund; Max King, portfolio manager at Investec Asset Management; Cressida Pollock, partner at Somerset Capital Management; and Tim Price, director of investment at PFP Wealth Management.
John Stepek: Let’s start with quantitative easing. Will it work?
Max King: Quantitative easing (printing money) is a political and economic fraud. It will do nothing to stimulate the UK economy or bank lending. The government has a huge borrowing requirement for the coming year – around £150bn. Rather than raise that from taxation or selling gilts, what it proposes to do is basically monetise the deficit for this year and backload it on to next year. So next year the government has to raise not £150bn but £300bn – and guess what? Next year the government will be out of office and it will be somebody else’s problem. That’s why it’s an economic and political fraud. I can’t believe that so many people are even giving it the time of day. Ultimately, printing money is only going to be good for gold. It’s the one currency you can’t print.
Tim Price: Yes, I suspect that this will just set us up for the mother of all currency depreciations. The threat of inflation is probably not something we need to worry about for the rest of this year, but taking a long view, I back gold over any paper currency now.
Cressida Pollock: I agree. From the US point of view, I don’t think Federal Reserve chief Ben Bernanke cares at all what is going on with the dollar. Right now it is strong, as capital has flowed back into the US, but long term that’s not going to continue.
Max: To its credit, the European Central Bank has said it’s not going for quantitative easing. The US authorities also seem to have postponed the idea. I think it’s occurred to the US administration that, unlike the UK government, it will have to pick up the pieces when it goes wrong in a year or two. Creating money in a world which basically needs to contract will not resolve our problems; that will take a bit of belt-tightening and a bit of long-term, strategic thinking.
Tim: We have already seen that cutting interest rates down to effectively zero doesn’t have a positive impact if people are desperately trying to cut their debt. At the end of last year, we were hearing about very wealthy people who were hugely cash-rich, yet even they were really reigning in their discretionary spending. It made you think: “What do these people know that the rest of us don’t?” And now we’re seeing everyone else doing the same. What was Unilever saying – people aren’t bathing now, they are having a quick shower instead.
Max: How do they know?!
Tim: Well, if anyone knows, it’s the biggest soap maker. What’s scary is that this recession has only just started. We’re months in and already we’ve hit a brick wall in terms of consumption.
Cressida: So would you disagree with the idea that we’re nearly through the bear market?
Max: On the economy, I suspect the US will actually start a sluggish recovery before very long. Mortgage payments have fallen and petrol prices have come down around the world. People who still have jobs are getting modest, but positive pay rises, so disposable income is actually quite good. I think in Europe and Japan the same is true; I also think emerging markets will come out of the downturn pretty strongly. It will end up having been a severe recession, but it’s not endless.
“The UK economy is in a long-term downward spiral – and will probably follow the path of Argentina.”
I think the UK is in the worst position – my view is that it is probably in a long-term downward spiral and will probably follow the path of Argentina. The UK is a country which habitually spends beyond its means, which has expectations beyond what it is prepared to deliver, and where short-lived periods of austerity just give way to another binge. So I’m not positive on the UK economy. But markets are a different issue. You have to realise that this is actually the worst bear market ever. There have been outliers – the 1970s was worse for the UK, the 1930s for the US – but on a global scale the evidence is that in real terms this has been, by a clear margin, the worst of all time.
Tim: Presumably one of the fastest too.
Max: And it started from a lower level. Previous bear markets started from a period of overvaluation, not from what we thought – at the time! – was a fair valuation. If you buy for the long term now, you might not be buying on the lows, but you will make a great deal of money over the next ten years.
John: What about corporate bonds?
Kristian Cassar: There are opportunities, definitely. Short term, if we are going through a deflationary or disinflationary period, then earning maybe 6% for a year or two in investment-grade bonds is a good tactic. Once the economy starts to recover and defaults peak, high-yield bonds will be the ones to go for. That’s the more exciting area, but it’s too early right now.
John: What about emerging markets?
Cressida: China is still a good story. It’s seeing a lot of growth domestically – exports look bad, but everything else is fine, pretty much. You can get some great companies there now at much better valuations than you could have hoped for any time in the last five years.
John: Will it go into recession this year?
Cressida: That’s a risk, but just look at the sheer firepower the government has. You’ve got a huge amount of fiscal stimulus coming from the state up to 2010 alone which people aren’t really factoring in.
Max: This the first economic crisis in which Latin America has not blown up. Argentina is the exception that proves the rule, but countries like Chile, Peru, Colombia and particularly Brazil – even Mexico is doing better than you might expect, given its proximity to the US. And in Russia I think the market and the rouble have bottomed. It’s gone from boom to bust and will go back to boom – that’s my punt of the year.
“Equities look like they are going to offer very good long-term returns from here.”
Tim: It makes sense not to bet the ranch on any one horse. Short-dated government bonds work, high-quality corporates work, and as Max said earlier, equities look like they are going to offer very good long-term returns from here. There’s this expression: “You make most of your money in a bear market, you just don’t realise it at the time.” We’ve come such a long way so quickly, I would be minded – for the first time in about two or three years – to be very, very bullish here. But selective.
John: What about property?
Max: I think the risk for anyone buying property now is a medium-term one. When the global economy picks up, inflation pressures will rise and so will interest rates. As a long-term buyer of property in the UK, you could well be looking at interest rates five years from now of 7%-9%. So I would urge anyone thinking of buying property to do their sums on the basis of much higher rates.
Cressida: I don’t think you want to buy back into London yet – you haven’t had the impact of what will probably be a huge exodus of ex-pats. We haven’t seen the foreclosure rate here that we’ve seen elsewhere. As for other areas – I grew up near Corby, Northamptonshire, and I think that might be hitting a pretty big low – but would I want to invest there? I think there are better places to put my money just now.
Max: Commercial property is interesting. The Investment Property Databank (IPD) future has picked up strongly in recent weeks. No one is claiming we’ve seen the bottom – the IPD still forecasts falls in values – but that is increasingly reflected in the prices. It might be early, but quality property majors such as British Land (LSE:BLND), Hammerson (LSE:HMSO) or Segro (LSE:SGRO), which have now got sound balance sheets, are getting interesting. Or Shaftesbury (LSE:SHB), which is exposed to tourist destinations, so is much more dependent on foreigners than on bankrupt Brits.
John: What other tips do we have?
Tim: We’re told that proper engineering is back and financial engineering is gone, so consider Weir Group (LSE:WEIR), a diversified play on energy services. Using its latest figures, its Altman Z score (a measure of the overall strength of its balance sheet) is above five, so it’s largely bulletproof. It is also one of my largest personal holdings.
Max: I’ll stick to funds based on three themes. One is the ‘safe’ theme, and that’s gold. You can buy physical gold via exchange-traded funds [such as ETF Securities Physical Gold (LSE:PHAU)] or gold mining shares, which are very cheap relative to the gold price. So I think a gold fund, such as our own Investec Global Gold fund (tel. 020-7597 2000), is a great place to put your money. It holds physical gold and platinum, as well as gold shares.
“Everyone was hot on Africa 18 months ago but now it’s been forgotten again. It’s an interesting story.
As I said earlier, I also fancy a punt on Russia. The Baring Emerging Europe Trust (LSE:BEE) has a lot of exposure to Russia, but it’s also got Turkey and eastern Europe – so it hasn’t had the thrills and spills of a pure Russia fund. I also like Africa. Everyone was hot on Africa 18 months ago and at Investec we were stepping back and saying, “cool it everybody”. Nobody listened. But now Africa has been forgotten again, it’s an interesting story.
John: What’s going on there?
Max: It’s a mix of things: commodities, tourism, services. We made a lot of money in Nigerian banks, for example. My third theme is the UK market, where small caps now look attractive relative to large caps. My two favourite funds are the Investec UK Smaller Companies fund (tel. 020-7597 2000), which has had two positive months in the year to date. Or the BlackRock Smaller Companies (LSE: BRSC), which is is a very, very good fund on a huge discount [currently 20%]. Despite the economic backdrop there are some very good companies on the UK market. In both cases, the managers can see what’s coming, so leave it to them to find the quality stocks.
Cressida: We’re quite positive on South Africa. Yes, there are elections coming up, but that’s likely to provide an opportunity to get in there. I like some of the retailers, such as low-cost consumer staples group Tiger Brands (JSE:TBS). Another interesting story is generic pharmaceuticals. Israeli stock Teva (NASDAQ:TEVA) has done very well. It’s the world’s largest generic pharmaceutical company. Its markets are expanding in the US – I think you are going to see a big push from the new administration towards more generic use. I think that’ll happen globally, in fact, because it’s the only way to bring healthcare costs right down. Japan has barely any generics penetration, yet it’s the world’s third-biggest pharma market. Teva has a good joint venture starting there which gives it a foothold.
Kristian: I’ll stick to fixed income. The Cazenove Strategic Bond fund (tel. 0800-015 9592) focuses on the area between investment grade and high yield. The bias is now more towards investment grade and the yield is around 7%. The fund has been good at avoiding some of the blow ups we’ve had in the last year and has come out in reasonably good shape.
I also like the RWC Global Convertibles Bond fund (tel. 020-7227 6000). Convertible bonds are interesting – a lot of bonds have been sold for technical reasons as hedge funds sold up. They owned about 70% of the market but, as a result of last quarter’s deleveraging, they now have only about 30%. Many convertibles are trading cheap relative to straight bonds. So you can get a yield to maturity which is more attractive than on some of the straight bonds. And you get the option to convert the bond into equity. So if we get a recovery, you’ll participate. If we don’t, you still have the upside of the bond. And the maturity date of the bonds tends to be short too, so many can be put back to the issuers in two to three years.
John: Any thoughts on Japan?
Max: Japan is a conundrum. It looks cheap. It looks as though you are buying all the companies at less than book value, and some at less than cash, and it looks as if the yen, which was far too high, is coming back. So, it ought to be a positive story. But the trouble in Japan is that the equity culture has been destroyed – it may have been destroyed around the world, I don’t know, but it has certainly been crushed in Japan. Will it come back? Unless Japanese people start buying equities, and there’s no sign of that, the worry is that Japanese companies just pull up the drawbridge. They have no risk of takeovers, and no pressure from outside shareholders, so they can just stick two fingers up to investors and say: “We are running this company for our own benefit – investor accountability be damned.”
Tim: A bit like the American model!
Max: Well, perhaps it’s where the US is going. It does bother me. What is the value of a company with huge earnings but no dividend and no intention of ever paying one? Probably not very much. The Japanese dividend pay-out ratio was never high, and now it’s being cut back. I am drawn to the value, but I’m not sure I trust Japanese management to work for the benefit of shareholders. So I suppose I’m broadly neutral. I want exposure in case it goes up and I don’t want to be disappointed by having too much.
Cressida: Korea is the same as Japan: firms there don’t pay dividends and they are going to become more entrenched.
John: Could it happen here? There have been quite a few articles in the press here recently on the ‘death of equities’.
Max: At the bottom of the bear market in the 1970s, people believed that the stockmarket was coming to an end and capitalism was dying. At the time the concern was real. And I think you have to keep in mind that there are a lot of people in the country, and in a position of influence, who would like to move away from the market economy towards a more state-sponsored economy. And it’s not impossible that they will succeed.
Tim: It seems to me that the discussion is itself a great buy signal…
What about Europe?
Kristian: There are clear stresses in Europe. You have the eastern Europe problem, which has a direct impact on the EU because of the countries that are already members, such as Hungary; and an indirect impact via the likes of Austria, Sweden and Italy, whose banks are heavily exposed to eastern Europe. Then you have Ireland, Greece, Spain and all their problems. In short, you are getting countries moving in very different directions – not ideal for a monetary union. I wouldn’t go so far as to predict the breakdown of the euro, but it is something to watch. I am particularly surprised at the current strength of the currency.
Max: The betting market gives a probability of any country within the euro leaving by the end of next year as about 25%. I think that’s a bit high.
Kristian: You don’t have any incentive if you are a basket-case country within the eurozone. Not to mention names…
Tim: Name names. Portugal, Italy, Greece, Spain, Ireland…
Max: Italy is far from bust. Italy is the one country which hasn’t embarked on some stupid fiscal package in the last year.
Cressida: What about the bridge to Sicily? That’s Italian prime minister Silvio Berlusconi’s equivalent of a fiscal package.
Tim: At least Sicily is a nice place to go – it isn’t a bridge to nowhere.
“Spain is going into depression – and it’s going to be very painful. Ireland is the same.”
Cressida: I think Spain is going into depression – and it’s going to be very painful. Ireland is the same. But I don’t think they will leave the euro. I’m not saying it’s impossible, but I agree 25% is probably too high.
Tim: It’s not as if leaving’s an easy option.
Kristian: That’s true. The trouble is, if a country leaves the eurozone, it presumably creates a new currency. But its debt is in euros, so the currency gets hammered. The risk, then, is that some country actually defaults on its euro debts.
Max: Long term there is a risk that the UK will default on its debt. But I think people are being too bearish on Europe. Eastern Europe has hit the headlines, but I think those countries will come out all right. They’ve seen the downside – they saw it between 1945 and 1989 – and they are not going back there. Their problems are an issue for certain Western banks, but like most emerging markets, eastern Europe will sort it out and get it over with. About a month ago, Hungary was supposedly bankrupt and in the arms of the International Monetary Fund. Yet the Hungarian forint has appreciated against sterling by 10% to 15% over the last year. More recently, it’s given that back, but it’s not obvious that its problems are as bad as they have been.
Cressida: Unless you’re saying that the UK’s problems are worse!