Our panel of experts sees yet more trouble ahead – but there are good buys out there too for smart investors.
Our panel this month: Jonathan Compton, managing director at Bedlam Asset Management; Patrick Evershed investment manager, Hargreaves Hale; James Ferguson, chief strategist at Pali International; Tim Price, director of investment at PFP Wealth Management.
John Stepek: Is this a new bull market?
Jonathan Compton: For stocks, I don’t know. But the profit cycle is clearly still collapsing; it will bottom fairly soon then trundle along for a long time, I fear. This is going to be a bath-shaped recovery – we’ve gone shooting down one end of the bath, but it’s miles to the far tap.
Tim Price: My sense is that we’re likely to retest the lows – we just can’t be clear of the timing. The rally hasn’t been entirely ludicrous. One metric I’ve bored everybody rigid with is the Altman Z score, which has been very useful for identifying value. The performance of those firms that are among the highest rated by Altman and have other attractive attributes – such as no debt, notably in sectors such as metals engineering – is staggering. These are FTSE 250 firms, so they’re not tiddlers, but some are showing year-to-date performance of more than 400% [see below for an update on Tim’s ‘risky’ tips]. On the other hand, the stuff that has done poorly over the last couple of months has been the most-defensive blue-chips, because everyone’s been piling back into high-risk assets.
Jonathan: That tells you that investors are expecting a V-shaped recovery and so are buying cyclical recovery stocks. But a recovery is clearly not on the cards.
James Ferguson: I agree. Banking-crisis recessions are deeper than normal ones, and longer by about 40%-50%. Even when they end, growth is much slower – bath-shaped, as Jonathan puts it.
Patrick Evershed: Look at Japan. It had its recession in 1990 and nearly 20 years on the market has still barely recovered any of its losses.
Tim: But for investors just now, where the index goes is academic. It’s more about finding the stuff that will still be around in a few years’ time. In other words, be very, very selective.
“This is going to be a bath-shaped recovery – we’ve gone shooting down one end, but it’s miles to the far tap.”
Jonathan: The trouble with having a broad portfolio is that companies will have to raise money again and again in the coming year, so investors’ holdings will be diluted. I think too many people have held too many equities for too long. Should investors hold a stake in three or four businesses they understand? Yes. Should they have a portfolio of over-hyped stocks they don’t understand? Definitely not. To think that you can just throw money into stocks about which you know nothing and make a fortune ten years later is barking!
James: I think the rally is getting mature. Technically, we are looking very overbought, we are right at the top of the trading range. Seasonally, you are best to sell in May – the next six months are pretty lousy historically for equities, and especially after they’ve had a good run.
Tim: The trouble is that the expression is now, ‘Sell in May and go away… and come back some time around 2014.’ The big picture is pretty bleak – I don’t see how anyone can argue with that. The other big asset class we haven’t touched on is government debt. Until recently government debt was seen as a safe haven. In the UK market that story – if it was ever true – has turned full circle now. We’ve just been selling the last of our holdings in the iShares Gilt exchange-traded fund. We’re now concentrating solely on very-short-dated conventional gilts and index-linked gilts. This could yet be a really horrible crisis for any government that’s trying to borrow its way through this mess.
Patrick: Yes, all governments are trying to borrow record amounts at a time when savings ratios have plunged. I think this will push interest rates up quite sharply. The alternative is for governments to print money and keep rates down, but if they do that there will be massive inflation in a few years’ time.
James: This is where I pull my trump card. As Japan shows, all sorts of things change when you go into a banking crisis. Banks shrink their risk assets – private-sector credit, as we call it. At the same time they raise their exposure to government bonds – or as they would put it, they expand their risk-free assets. Now Patrick is right, we have a situation where the savings ratio is very low and the government wants to borrow an awful lot.
But the savings ratio is about to turn – in fact, it already has. The ‘borrow’ mentality has been replaced by the ‘save’ mentality. So while on the way up we had huge reliance on foreigners because we were all borrowing and spending, that’s just turned around.
Now, as foreigners who hold gilts decide to sell, that pushes down our currency, which brings in things like commodity inflation risk. But from here, demand for government debt will come mainly from the banks, as well as the household sector, which has record low exposure to gilts.
In Japan, we had a vast increase in government debt purchases by Japanese banks, which almost perfectly matched the contraction in private-sector risk assets. So the banks are basically just swapping risk assets for risk-free ones.
Patrick: But this puts much more pressure on the economy and the private sector.
James: Exactly. So it leads you to where you want to be. First, it makes the environment and outlook for gilts more attractive. Banks won’t be competing for different governments’ debt because they don’t want the currency risk. So I think gilts will perform much better than people expect, and that inflation is far less of a threat.
Jonathan: There’s an elephant in the room here: sovereign defaults. It would be unique in history if you didn’t have sovereign defaults go through the roof right now. There is a very good series on the Bank of England’s website that shows that at any given time since 1820 there have been around 15 nations in sovereign default (see chart).
Last year we hit a post-war low – it was just Ecuador and the Seychelles. But if you accept there’s not enough savings to take up all the debt, it would be incredible to go through a recession of this magnitude and not have a series of sovereign defaults emerging rapidly over the next 36 months. Who, where and why I don’t know, but it’s going to happen.
Tim: I don’t necessarily disagree. But if there is the risk of sovereign default, then corporate defaults will also be way higher than is priced in at present, and lots of investors currently stampeding into corporate bond funds will find they’re not as secure as they thought.
This really is a black outlook for private investors. They can’t have their money in cash because deposit rates have gone through the floor; equity markets have this huge cloud hanging over them; and we’ve now said there’s high risk in debt. We’re running out of asset classes.
James: Yes, but you’re still thinking about an inflationary environment. This is all very, very deflationary and that means you don’t need a high yield. I agree on sovereign defaults, but they’re more likely in illiquid emerging markets. They’re likely to be in areas where countries are borrowing outside of their own currency, particularly where they perceive that the borrowers they are defaulting on are foreigners, because it becomes political. So if you’re looking for a relatively safe haven, you want a government that’s looking to borrow domestically, in its own currency.
Jonathan: Yes, I don’t think the outlook is that bleak. You are simply returning to a world where dividends will be about half your total return, or in many periods all of your total return. I see lots of big caps – here and globally – yielding 4%-6%. They are in pretty dull businesses, but they’ve got every chance of paying their dividends for the next five years, or even mildly increasing them. It’s not the end of the world by any means.
Patrick: National Grid (LSE: NG), for example, has a very high yield. It’s almost inconceivable that it isn’t sustainable because people are spending more money on grid systems both here and in America.
John: What other tips do we have?
Tim: Sticking with safety first – you can’t buy Aldi or Lidl, sadly, but you can buy Greggs (LSE: GRG), a perfect recessionary play for the UK market.
Patrick: Over the last few years the whole Aim sector has been hammered. I’m convinced there are now lots of bargains there. One way to hedge one’s bets is to buy the Marlborough Special Situations Fund (tel: 0808-145 2500). You may think I’m a creep for tipping a fund run by my new employer, but it’s been top of its sector since Giles Hargreave started to manage it 11 years ago.
If you want an individual stock and believe overseas countries might do better than Britain, go for Velosi (Aim: VELO), which does safety checks on oil and gas installations. It’s on a p/e of about five and showing very good growth. Although the sector’s under the cosh, I think safety checks will be maintained and profits will be sustained and continue to rise.
Jonathan: For yield, I’ll go with Bristol-Myers (NYSE: BMY), a mid-sized US drug company. It will still be yielding 5% in three or four years’ time and I’m happy with that. I’ll also go for the Japanese unit of McDonald’s (JP: 2702). It’s a dull business, but dull is good – it’ll still be there in five years’ time.
For fun, I’ll pick up Ansaldo (Milan: STS) in Italy. It makes railway equipment. It’s very good at the computer equipment, the signals, and the lights, which aren’t going away any time soon, and its dominant growth business is in America, where the expansion is taking place. It’s quite cheap, it’s got no debt and it yields about 4.5%.
Tim: Infrastructure is a good bet.
Jonathan: And I must have a gold share. Everything we’ve been saying suggests gold shares could be interesting. I’ll go big – I’ll go for Canada’s Agnico-Eagle (TSX: AEM), which has mines all over the place.
James: The one area where I disagree with people is that I think this works out well for gilts. Everyone is underestimating the size of the switch the banks are going to make within their assets, so I would still buy the iShares Gilt ETF (LSE: IGLT).
Tim: You may be right, but my feeling is that this will go in the opposite direction.
James: Well, funnily enough, as the gold price has come down I’ve come round to your argument on using gold as an insurance policy, because I’m increasingly worried about the size of the job facing the world’s governments. There is a genuine risk that paper currencies lose all credibility, and we all rush out looking for real assets. Copper has been going up and up because the Chinese are buying it, even though it’s clear they have no need for it. So it seems they are buying copper because they don’t want to buy dollars or any other currency, yet they want their own currency to go down. So they are asking, what do we buy instead – copper or oil? Oil is difficult to store and copper isn’t – so it’s copper.
Patrick: I’m glad you mentioned China, as I have a Chinese company that I rather like. One thing that’s developing very rapidly in China is 3G. China Shoto (Aim: CHNS) produces batteries for the mobile-phone masts, and so it’s also growing at a very rapid rate. The shares are on a p/e of below five, and the company is generating lots of cash. In due course it may well be producing very efficient batteries for electric cars as well.
Tim: Going back to gold, I’m just staggered it hasn’t done better than it already has, given the severity of the world’s problems. In my world, gold would be trading at $2,000 an ounce.
James: But the severity of the problems isn’t currently topical, is it? The market is playing the other side.
Jonathan: Let’s just cut to a universal truth: we will all go short of gold when Gordon Brown goes long.
“This is going to be a bath-shaped recovery – we’ve gone shooting down one end, but it’s miles to the far tap”
Our Roundtable tips
| Stock | Ticker | Price |
|---|---|---|
| National Grid | LSE: NG | 584p |
| Greggs | LSE: GRG | 3,550p |
| Velosi | Aim: VELO | 69.5p |
| Bristol-Meyers | NYSE: BMY | $20.29 |
| McDonald’s Japan | JP: 2702 | ¥1,804 |
| Ansaldo | Milan: STS | €11.22 |
| Agnico-Eagle | TSX: AEM | C$56.07 |
| iShares Gilt | LSE: IGLT | £10.27 |
| China Shoto | Aim: CHNS | 182p |
Tim Price’s risky tips – how they’ve performed
At November’s Roundtable, Tim Price suggested a basket of beaten-down stocks for investors with a higher-risk appetite. Here’s how they’ve done.
| Stock | Tipped (28/11/08) | Now (12/5/09) | Gain |
|---|---|---|---|
| Cookson (LSE: CKSN) | 16.6p | 23.25p | 40.1% |
| Kazakhmys (LSE: KAZ) | 259.75p | 666.5p | 156.6% |
| Ferrexpo (LSE: FXPO) | 32.75p | 138.75p | 323.7% |
| Melrose (LSE: MRO) | 78.5p | 96.25p | 22.6% |
| DS Smith (LSE: SMDS) | 56.75p | 72.75p | 28.2% |
| International Ferro Metals (LSE: IFL) | 17.75p | 42.75p | 140.8% |
What to do now: Tim suggests that anyone who bought in take some profits in CKSN, KAZ, FXPO and IFL, but is still “comfortable retaining exposure to this basket of stocks”.
• Prices as at 12 May 2009