John Stepek chairs our panel of experts and asks them how they’d invest in the current climate.
John Stepek: Stockmarkets have fallen recently, but they’re hardly dirt cheap, are they?
Patrick Evershed: Actually, there are a lot of bargains in the market now – the problem is that there just isn’t a lot of cash. The savings ratio in the developed world is particularly low – it’s collapsed in America, it’s collapsed here. I’ve seen two or three good new issues recently, run by people who have been highly successful in the past. But even they cannot raise the money they want, because there just isn’t enough money around.
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Julian Pendock: Part of the problem is that everyone is chasing the emerging markets consumption theme. You can get exposure to it for a third of the price here. But instead, a lot of regional money is chasing those companies up to silly valuations in Asia, whereas in the West, there is a lack of liquidity – people are scared and they’re not sorting the wheat from the chaff.
Patrick E: Also, governments have these huge budget deficits and are raising vast sums of money. And actuaries are telling pension fund managers to put money into fixed-interest securities. So huge quantities of money are going into government securities, and the public sector is driving out the private sector. Yet government bond yields are ridiculously low.
If inflation goes up – which it will in due course – and bond yields go up, obviously bond prices will come down, so investors will lose money. Instead of buying overvalued fixed interest, people should be putting more into very depressed equities. The equity market is about 25% lower than it was ten years ago.
Tim Price: The nightmare scenario, of course, is that both bond and stock markets may be in secular bear markets.
Our Roundtable panel
Managing partner, Armstrong Investment Managers
Anthony Cross
Fund manager, LiontrustPatrick Evershed
Investment manager, Hargreave HaleJulian Pendock
CIO and founder, Senhouse Capital
Patrick E: Government bonds aren’t yet. But they might end up there. In the UK, which isn’t exactly a very strong economy, ten-year gilts are now yielding 3.5%, which is ridiculous.
Julian: But couldn’t they go a lot lower? When Japan’s bubble burst, Japanese government bonds started off at about 8%. They kept increasing supply, but the yield just kept falling.
John: So we’re back at the deflation/inflation debate.
Patrick Armstrong: We think inflation is the inevitable end game for every Western central bank. It’s the only way out, given their debt-to-GDP ratios. But in the short term, I don’t think you’ll see any inflation. You can’t have inflation when unemployment is this high.
Patrick E: The good news is that there is very little wage inflation here, which is likely to continue. On the other hand, we won’t be importing deflation from China anymore. Wages are rising there and that’s going to feed through to us. So we will be importing goods at higher prices, especially as freight rates rise. I think we’re probably stuck with roughly 3% inflation. But that’s not hyperinflation.
Anthony Cross: But what if we have a slump? Quantitative easing was all the rage, yet now it’s all about cuts.
Patrick E: If we double-dip, which I think is quite likely, then by the end of the year we might see more quantitative easing.
Patrick A: And in the longer run that will lead to inflation.
Tim: If you define inflation as a rise in the money supply, we’re already there. But there is no velocity. We are living in an environment of profound monetary inflation, but all the pressure is on severe asset price deflation. And that’s a particularly uncomfortable environment to live in.
Julian: Does anyone think stock markets could see another big slide this year?
Patrick E: They may be very volatile, but I don’t see them moving in any particular direction for two or three years.
Tim: That’s possible. But the problem now is that as the banking crisis morphs from a private-sector problem into a public sector one, governments have nothing left in the armoury. Interest rates are at rock bottom. There are no silver bullets left.
Patrick E: We’ve got quantitative easing.
Tim: Sure, but it hasn’t achieved a lot, except for not making a bad thing worse. In terms of anything more constructive, there’s nothing left. A US hedgie told me that if you had “US banking crisis Part Two”, and the government stepped in to support them, there would be a revolution in North America because the people are sick of bankers. As we all are, no doubt. So I have a dreadful feeling the situation is ripe for a major sell-off.
John: Getting back to emerging markets, decoupling was all the rage before the credit crunch and it didn’t happen, but the idea seems to have made a comeback.
Patrick A: On the way down they couldn’t decouple. But in the recovery you could see much more rapid growth from emerging markets, compounded by the fact that their currencies are going to rise sharply versus Western currencies, because of their fiscal surpluses and higher economic growth. That will increase Chinese consumption. Indeed, this is the biggest global imbalance right now. Half of what Chinese workers make, they save. But as their currency appreciates, eventually they will start to buy iPhones and things like that.
Julian: I’m wary on China. The perma-bulls have gone without blushing from saying “buy China, because it’s the most capitalist, dynamic society and market”, to saying “buy China, because it’s a fantastically Sovietised economy”. But if you believe the man in Whitehall doesn’t know better than anyone else, then why does the man in Beijing know better than anyone else? And as for Chinese consumption, it accounts for only 38% of the economy. Like us, they’ve tried to kick-start it. In dollar terms, ‘cash for clunkers’ is three times what it is in the US, and you’re getting a 25% discount on fridges. So people are stockpiling fridges even though they have no electricity, then hoping to flip them without unwrapping them when the stimulus ends. The policies in China are not so different from those we have here – it’s a game of catch-up.
Patrick E: Certainly, if the Chinese economy starts to slow it could result in serious civil unrest. But that’s why they have to keep their economy growing. They’ve got to persuade consumers to spend more instead of saving. You’ve got tens of millions of people leaving agriculture every year and you’ve got to find jobs for them.
We think inflation is the inevitable end game for every Western central bank. It’s the only way out.
Tim: But that’s not a trade you necessarily want to endorse wholesale. The difference between Beijing and Whitehall is that if we have an economic contraction here, there is not likely to be a revolution. But there may well be in China.
Anthony: But does all this lead? Julian, are you saying that China is going to blow up?
Julian: No. I was in Hong Kong recently, and met a lot of clever hedge-fund guys who deal with the small and medium-sized Chinese businesses that lack the connections to get capital from the big four banks. They give them capital, they teach them accounting. That’s the future – it will work in the end. But if you look at Taiwan, South Korea and, to an extent, Malaysia – in all these places, you had to have some form of upheaval and decentralisation to allow people the independence to pursue the wealth creation and innovation that’s needed.
The trouble for wider markets right now is that a lot of people say China will lead the world out of its funk. But I don’t understand how it can, because it accounts for less than 10% of global GDP. So I don’t think you can pin all your hopes on China in the belief that it will buy everyone’s debt and everyone’s goods and everyone’s BMWs.
Patrick A: Well, we think China will continue to grow just because of the billion people who are going to go from spending $250 a year to spending $350 a year. That’s a huge difference to global GDP when you’ve got a billion people spending an extra $100 a year. But right now we wouldn’t be long China. We’d rather be long Brazil because of its healthy fiscal situation, its emerging consumers, and its commodity-backed economy. It will also benefit from the devaluation of Western currencies. We also really like Canada.
Patrick E: So do I. Canada has had the strongest banks for the last 30 or 40 years and is full of all the commodities you can think of, from cereals to oil.
John: But what happens if commodity prices fall again?
Patrick E: While people are worried about all currencies being potentially weak for one reason or another, they will go for gold. But I’m not necessarily aboard other commodities. I hope China can keep going. But if not, and the world economy slows, commodity prices will come down, with the exception of gold.
Julian: Where do you think oil might go?
Patrick E: In the short term, anything might happen. But looking five to ten years ahead, the problems we’re having in the Gulf and cutting back on deep drilling means the price is likely to be higher.
In any case, oil companies are increasingly having to drill in very difficult places, making production a lot more expensive.
Our Roundtable tips
Investment Ticker Subsea 7 Nor: SUB Velosi LSE: VELO Lyxor Euro Stoxx 50 divs ETF Paris: DIV Brazil Foods US: BRFS Alpha Pyrenees LSE: ALPH Oxford Biomedica LSE: OXB Hargreaves Services LSE: HSP Aggreko LSE: AGK Weir Group LSE: WEIR Tognum Ger: TGM Zodiac Aero Paris: ZC Tullet Prebon LSE: TLPR RWS LSE: RWS
Julian: Are you familiar with Subsea 7 (Norway: SUB)? It’s a Norwegian oil services company. They’re the leading deep-water technical guys and they know how to get the stuff done, so they work very closely with Petrobras, for example. Their share price has been walloped on the back of BP, but they are not cowboys off the coast of Louisiana.
Patrick E: If they’re deep-sea experts, they should do well in the long run. One of my favourite small companies in this area is Velosi (LSE: VELO). It does equipment safety checks for health and safety and for insurance reasons.
John: Would anybody buy BP?
Tim: I did, a couple of weeks ago. We all know this litigation in the States is going to last for years and years, and it’s a huge black cloud. But for me, the balance of probability is firstly, that the company will survive and secondly, when the political row has abated, it will go back to being a huge cash cow. Anthony: It will also move from politics, which is all talk, to the courts, which is reality. The court process will go on for years. And as long as it’s taking time, you’ve got the cash generation.
Patrick A: We decided not to buy BP when we saw a US news report saying “BP funding Iranian nuclear programme”. The US government is starting a propaganda campaign to make BP public enemy number one. They’ve had Saddam Hussein and they’ve had Osama and now it’s BP. And you don’t want to make an investment where you are fighting the US government.
Julian: I agree. As soon as politics comes in I am out.
Tim: To me, BP is almost a microcosm of the investment world right now. It’s impossible to find any investment where you have a real chance of avoiding substantial short-term volatility. Investors increasingly ask: “What can I buy that’s not going to go down?” And the answer is: “Well, good luck, because there isn’t anything”. Put bluntly, we have to accept that the world is a risky place, and I think BP just sums that up.
John: If you could only invest in one asset class or sector right now, where would you put your money?
Patrick A: Implied dividends are a no-brainer right now.
John: This is the dividend swaps market?
Patrick A: Exactly. Every year for the next five years, futures markets imply that dividends on the Euro Stoxx 50 Index will fall sharply. Unless you’re a total bear, that’s not going to happen. Dividends typically go up at about 5%-6% a year. Yet you can exchange the 2011 dividend for the 2016 dividend, and you’ll get paid to take that trade – to bet that dividends won’t go up over the next five years you need to be very pessimistic on the economy. I think it’s technical factors pushing prices down – when volatility spikes, structured product providers have to hedge their books, so they sell dividends. But it’s a thinly-followed market, so no one thinks to buy them. So you’ve got a lot of sellers but no buyers. Retail investors can get access via an ETF, the Lyxor Euro Stoxx 50 Dividends (Paris: DIV), which tracks the implied dividends on the Euro Stoxx 50.
Patrick E: I think we’re in for a turbulent 12-18 months, or even two years, with huge sovereign debts and governments around the world cutting back. So I’d opt for companies paying safe dividends.
Tim: I’d normally second that. But a stock like BP would previously have qualified as a safe dividend play – not now. For me, it would be real assets in the form of precious metals, which I see as hard currencies rather than commodities. You can take the view that we are in the relatively early stages of a long emergency, a large part of which is going to be currency crisis led.
Patrick A: What do you call “hard currencies”?
Tim: Gold, silver, Singapore dollars, Canadian dollars, Swiss francs.
Julian: I’d argue for safe dividend stocks too. Telcos have had a hard time recently. You’ve got global telecoms companies with dividend yields of up to 9% – higher than their p/es. They’re pricing in falling demand, whereas in fact we’re seeing an explosion of data coming through the pipes. I read recently that by the end of 2010 more people will have access to a Smartphone than to a clean lavatory. So as Merrill Lynch dubbed it, ‘buy dumb pipes at dumb prices’.
I’d also be buying global franchises at a European discount. With all the problems in Europe, the baby has been thrown out with the bathwater. You can get, for example, Nestlé in Switzerland, which is global, trading at a third of the price of Nestlé in India, with three times the yield. However, the equity-risk premium for markets should be higher around the world. Governments are so entrenched in the global economy that the direction of all asset classes will be driven as much by policy as economics in the future.
Patrick A: On specific stocks, Brazil Foods (NYSE: BRFS) is our favourite. They own the largest chicken ranch in Brazil and the emerging consumer in Brazil keeps increasing their protein consumption as their wages grow. It’s on a crazy multiple but it’s very high growth and it’s the exact demographic we want.
Patrick E: In terms of high-yielders, I’ll mention one of my old favourites, Alpha Pyrenees (LSE: ALPH), which has been falling ever since I first mentioned it here – so eventually it must hit the bottom and start to go up. It invests most of its money in and around the outskirts of Paris, and its tenants are 85% blue-chip companies. It has cut its dividend right back, but it’s now well covered, and it’s got quite a lot of cash in the balance sheet.
The firm yields about 13%, and it’s got no problems with the banks. It doesn’t have to renew any of its covenants until 2014, by which time the asset value would, I hope, have gone up.
At the other end of the spectrum is Oxford Biomedica (LSE: OXB), which has no yield at all. But it’s got about £20m on its balance sheet and it’s developing various gene-therapy treatments. The main one, Prosavin, is for Parkinson’s. Recent results showed that patients first treated with Provasin two years ago have shown a 56% improvement. I can’t think it will be long before someone wants to do some sort of deal with them.
And I also like coal services group Hargreaves Services (LSE: HSP). It’s a high-quality, profitable, well-run company. The shares have been very depressed because the firm was rumoured to have been negotiating a merger with UK Coal. But the company has now said there aren’t any such negotiations. And I think the price of coal, coke, and everything it sells is going up.
Tim: A longstanding favourite of mine, which I hold, is Aggreko (LSE: AGK). It’s the world’s largest supplier of temporary power generators.
Anthony: I like that one too. By 2050 there will be more people in Africa without power than today because of population growth. And about 25% of the world’s power infrastructure needs replacing within the next seven to ten years.
Tim: My other tip would be engineering company Weir Group (LSE: WEIR). Both stocks are what I’d call blue-chip UK growth stocks and they’re both up 50% year to date already. So these are not value stocks necessarily, but as part of a portfolio, I can find no better ones.
Julian: Following on from Aggreko, I like Tognum (Ger: TGM). It’s a €2bn market cap company, 20% owned by Daimler and it has three business lines, one of which is on-site power generation. They did a good job of the Birds Nest Olympic Stadium in Beijing, and they are winning a lot of work supplying emergency power backup systems for Chinese nuclear power stations. Secondly, like Rolls-Royce, the more installed bases they get, the more maintenance, repair and operations revenue they get.
They sell diesel engines for locomotives for Bombardier and Siemens, so that’s also global. The third application they have is high-end diesel marine engines, for those of us – probably no one around the table – who have 70ft-plus Sunseekers or Pershing yachts. The bottom has fallen out of the market for the smaller yachts, but for the really high-end stuff, the backlog is as big as it has ever been.
Another tip is Zodiac Aerospace (Paris: ZC). They are hired by airlines to fit out the galleys, seats, slides, emergency systems, etc. Airlines are always fighting to have the newest fleets, the biggest beds, or whatever, so for them, whatever money they get in the front door goes out the back door. But one man’s corporate spending is another man’s revenue – and Zodiac does this for Boeing, Airbus, Bombardier, Gulfstream Jets – you name it, they’ve got a great niche.
Anthony: What we find interesting are the guys who benefit from all this market volatility, the interdealer brokers. So we like ICAP and Tulletts. Tulletts (LSE: TLPR), which is number two in the market, is particularly cheap. My second pick is RWS (LSE: RWS), which is the largest patent translation business in the world. It’s relatively defensive.
Patrick E: And it’s got piles of cash too.
Anthony: And a 4.5% dividend yield and a p/e of about 11. I’m a big fan of Intellectual Property (IP) and the growing demand for IP protection – and the biggest IP filer in the world now is a Chinese company. There was always this argument that China was only ever going to be copying other people’s products. But I think any country that wants to go from being a producer of simple plastic goods to being a bit more highbrow recognises they’ve got to invest in IP.
• This article was originally published in MoneyWeek magazine issue number 492 on 25 June 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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