Our panel of experts tell us where they would – and wouldn’t – place their own money.
John Stepek: Is the US recovering, or is it heading for a double dip?
Tom Beckett: In the short term the recovery has become entrenched – things are getting quite a lot better. Areas of the US economy are booming. In the medium term there will be difficult medicine to swallow as some of the extra stimulus measures are taken away. And in the longer term the structural debt issues have to be dealt with. But for the short-to-medium term, I think the American economy is set pretty fair.
Mike Hollings: In the developed world, it’s a case of who is in the ‘least bad’ state. In that context, the US is the best of a bad bunch. So we’ve been overweight the dollar for some time; not necessarily US stocks, but certainly US dollars. My worry now is that even though the US is much more entrepreneurial than Europe and, to an extent, Britain, one of their biggest competitive advantages – the undervalued currency – is now moving against them. How much of that will get priced in over the short-to-medium term, I don’t know, but some of the exporters will get hit. Yet if I had to put money into developed economies, the US would be way ahead of Europe at this stage. There are certain sectors in Britain we might look at, but the US will come out of this before the rest of us.
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Ian McCallum: We’re less gung-ho. We don’t think the recovery is sustainable. Corporations have been the big winners, the government and the consumer the big losers. We don’t see any broad-based pick-up in credit – neither from the supply nor the demand side – and if you’ve not got credit then you don’t have a sustainable economy. In short, it’s a jobless, creditless recovery. We saw a lot of these in Japan in the mid-1990s. They can last for eight or nine quarters before they roll over, usually because of an exogenous shock that hits profitability. For us, that shock is the threat of sovereign default.
Mike: America has got even more problems with individual states threatening to default.
Marcus Ashworth: Did you see that in a recent survey of restructuring experts, 90% expect a US city to default this year, while just 63% see a sovereign default?
Our Roundtable panel
Head of Asian equity sales, Execution Noble
Tom Beckett
Chief investment officer, PSigma Investment ManagementMike Hollings
Chief investment officer, Matrix Investment ManagementIan McCallum
Chief investment officer, Bedlam Asset Management
Ian: That’s the problem. There are cheap stocks in America, beyond a shadow of a doubt. But overall, the value has gone. It was cheap for about six months from the third quarter of 2008, but we’re taking money off the table now.
Marcus: And I thought I was going to be the most bearish here today!
John: So what’s your take, Marcus?
Marcus: I think a lot of optimism got priced into the market. Can the recovery be sustained at the current rate? I don’t think so. China is down 25% plus from the top. That’s telling you something. It’s the only economy in the world that can truly be controlled. The only thing the populace can do to vote with their feet is sell their equities, which they’re doing.
Is that leading America? It certainly led the US on the way up. Does that mean there is going to be a double dip? I don’t know. But the US economy is certainly very fragile and the stockmarket is reflecting that. The ‘flash crash’ the other week shows how nervous people are. That was a serious warning that if you haven’t already bagged your profits in the US, you should, at the very least, be looking to be underweight, if not short.
Ian: The whole sovereign-debt problem reminds me of 1997/1998 in Asia. When Thailand devalued, it was like a pack of cards – boom, boom, boom.
Tom: Yes, but, there’s a difference between economies and markets. As you said, you can still find a number of decent value stocks. The biggest challenge we face on an asset-allocation basis is trying to balance that ‘push-me pull-me’ of the bearish long-term economic issues, which are well known, with the shorter-term optimism one could find at a corporate level.
If one looks at the state of US corporate balance sheets, they are generally in bloody good nick. There’s a lot of cash on balance sheets, earnings are quite good – demand has actually surprised people on the upside.
Marcus: But do you think the top-line growth is sustainable? That’s the key for me. Because the bottom lines have looked respectable, firms have done everything they can to hack costs back down, but do they actually have the consumer-led demand?
Tom: Firms quite often get it wrong. But listening to what they’re saying, you get the impression that they themselves have been surprised by how strong demand has been. Sure, a lot of that has come from stimulus measures, tax cuts, the fall in the oil price from $150 a barrel, and so on. But if we’re not going into a European domino-effect scenario, then I don’t think equities are that bad value.
Ian: Hand on heart, I think equities are expensive. You look at the S&P 500 cyclically adjusted p/e ratio, it’s like 22 times. Right at the top end of its range. Asia, emerging markets – expensive. But within that, where I do agree with you is on individual stocks. The cash levels on balance sheets have never been higher. Everyone knows that. Government debt levels have never been higher. Someone’s got to save, right? So it’s the corporations. The good thing is there will be continuing consolidation and mergers and acquisitions (M&A). So from a stockpicker’s point of view, it gets really exciting. It’s fair to say that good-quality corporations are infinitely better credit risk than governments. But overall, the problem is that, if you think interest rates and inflation are moving higher, then by definition bond yields go up and valuations have to come down.
Mike: Well, I’m in the deflation camp. I could well be wrong, but I just don’t see where inflation is going to come from.
Marcus: China. When it revalues the yuan, it’ll have to hike prices. The world’s cheap labour has suddenly become expensive.
Mike: Well, China can either let the yuan revalue, or it can raise rates. It’s not going to let the yuan revalue, so surely it’s going to raise rates?
Marcus: I think it’ll be the other way round.
Mike: But export margins are wafer thin in China.
Marcus: Exactly. So prices will have to rise. That will feed through globally.
Mike: But there’s no final demand coming from G7 economies. I used to think that inflation might come through commodity prices, but now commodities are taking a dive too and the dollar is on a run.
Ian: The bottom line is, there’s not going to be any inflation for the next two or three years. That said, when it arrives it’ll be huge. Right now, supply is high and demand is low. Governments have tried to stimulate demand, but that ain’t happening. So what we’ve got to have is corporate restructuring and consolidation – in other words, supply-side destruction to balance the demand side. The good thing is, that’s already happening, and by definition it’s inflationary. But I think there’s still two or three years to go.
The other thing is that, as the Bank for International Settlements (BIS) has pointed out, historically sovereign default risk has always been aligned with rising inflation because governments effectively end up having to try and inflate away their debt by printing money. In Britain, I don’t see prices going down.
Tom: Absolutely not – they never have.
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Marcus: You’ve raised the point that corporations are cash rich. To the Western eye, that looks excellent. But if we go back to Japan and see what cash-rich corporations have done with their cash over the last 20 years – they’ve done absolutely nothing. What are American corporations going to do if they can’t grow their top line? Right now, we’re certainly not seeing a sufficient consumer-led recovery or anything like it.
Mike: And there are a lot of mortgage resets coming in the next 18 months or so as well, which isn’t good news for consumption.
Tom: But in Japan, we’re at least starting to see some of that corporate cash being used – dividends are going up, we’re seeing buy backs, M&As are taking place, as well as some corporate investment. It strikes me that if there’s going to be lower demand going forward, these cash-rich US firms must be sitting there eyeing up some of these high-quality European and British firms and thinking, ‘Well, perhaps we can get ourselves some profits by buying these companies.’ Do you think that could support markets? Cash-rich US firms looking at the rest of the world and thinking, where’s cheap?
Marcus: Well, Cadbury and Kraft has been an interesting test case. If the dollar carries on rising, I think you would get a lot of M&A coming this way. But I don’t know of anything specific right now that sticks out to me.
Ian: The feedback from companies we speak to, no matter where they are based, Asia, UK, the US – is that they all expect interest rates to head north. They’re all frantically refinancing their debt like billyo. And where they are loosening the purse strings, in terms of capital spending and so on, the main focus is on emerging markets and companies being exposed to that. That’s because they expect slower growth in America and Europe, while taxes and costs are also higher, so they are shipping production elsewhere.
Mike: It makes sense from a purely demographic point of view.
Ian: And you’ve got to focus on high-quality companies because those are the ones that will grab market share – either organically or through acquisitions – or they’ll be bought out themselves. After all, if you’re a big company and you see your top-line growth is a little bit subdued, then you’re not going to buy the third, fourth, fifth liners; you’re going to buy the good-quality brands that complement your existing brands.
John: So where would everyone put their money right now?
Tom: The good thing about the American market is that you can get exposure to a wide range of themes. We’re bullish on agriculture in the long run and Monsanto (NYSE: MON), which performed very poorly over the last year, gives us a way of playing that.
Ian: We just bought Monsanto too. It’s taken a hit on its herbicides – prices are down about 50%. And in its seeds and traits unit, it’s had to drop the prices of two new products. But I’d say it is at a low point in the profit cycle. It’s cut its costs and you’ve already had the bad news out. These two new product launches are big news. Overall, it’s a great quality company that has the number-one position in terms of what it does.
Tom: We also like the technology sector. It has exposure to emerging markets and it’s broadly underleveraged. So I’d opt for a big group such as IBM (NYSE: IBM).
Marcus: There’s a lot of capital spending in the sector coming up – $20bn over the next five years.
Ian: You’ve got to be excited about that.
Marcus: Yeah, but I do think you’ve got huge capital expenditure (capex) problems in Asia, where everyone is going for it all at the same time. You’ve got Sony, Sharp, Samsung and all these big Asian electronic firms wanting to double their share in TVs, LED, and all the other exciting things that are going on. You name it, lithium ion batteries particularly; Nissan is going to make them and so is everyone else. That’s my worry about technology. Everyone is loading in the capex at the same time. They’ve decided, this is the low; I can raise money here, I’m going to go for it. So I think you’ll see massive overcapacity coming up.
Ian: Sell the chips. Short the hell out of them. But I’ll tell you where is interesting in the tech sector: IT software. I like Check Point Software (Nasdaq: CHKP); 30% of the market cap is net cash, it’s grabbing market share – it has a 40% market share in network security, so it’s actually beating Cisco. It has great new products coming out and it’s very cheap. I don’t know why someone doesn’t take it over. On gold, Agnico-Eagle (NYSE: AEM) is a no brainer.
Marcus: So you think gold will continue to rally?
Ian: Yes. This is just the tip of the iceberg.
Marcus: What about things like Unilever?
Ian: I really like consumer staples stocks. On that I’ll give you Sara Lee (NYSE: SLE) – it’s restructuring and pays a good dividend. The sectors that stand out for me in this stagflationary environment are staples, healthcare, gold, and agriculture. On healthcare, I’ll go for Varian Medical (NYSE: VAR). They have a 60% market share of oncology machines – China and India are about to go berserk in this area, from a base of zero. A big player in the sector with a good dividend yield is Bristol Myers Squibb (NYSE: BMY).
Mike: I’m cheating here. This isn’t a US stock, but it’s quoted there: Brazilian water utility Companhia de Saneamento Basico (NYSE: SBS). It’s cheap as chips. Huge growth, trading on about five-times earnings, which would indicate there’s something wrong with the company, but there isn’t. It took a huge provision in January, about $150m for pension contributions, but that’s been taken now. It’s a really good one for emerging-market exposure. The other is a punt on the natural gas story. This stock has really underperformed – it’s Chesapeake (NYSE: CHK).
John: Is this on the basis that natural gas will close the gap with oil?
Mike: It already has. You can see oil has fallen sharply in the last couple of weeks. and natural gas has actually gone up.
Marcus: I think gas has bottomed.
Mike: Plus you might even get Exxon bidding for it if they want gas deposits.
John: Thanks everyone.
• This article was originally published in MoneyWeek magazine issue number 492 on 28 May 2010, and was available exclusively to magazine subscribers. To read more articles like this, ensure you don’t miss a thing, and get instant access to all our premium content, subscribe to MoneyWeek magazine now
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