John Stepek chairs our panel of experts and asks where they would – and would not – place their own money in today’s markets.
John Stepek: The big fear now seems to be the double dip. Are any of you concerned?
David Taylor: I’m not worried. I’m an equity fund manager and I think equities are the best asset class around right now. If anything, recent worries make them even more attractive. The one point at which I’ll start worrying about equities, all other things being equal, is when interest rates start going up in the US. The recent fears have probably put any rise further into the future. Yet while the economic numbers have got worse, there’s nothing yet to suggest we’re going back into recession.
Mark Williams: The European financial crisis and a double dip are the two biggest worries. I’m worried, but think we’ll pull through. Assuming we do just end up with low growth rather than a recession, then I’d stay happy with equities and very happy with Asian ones.
Neil Shah: I think there will be a double dip. The full hangover of our collective 20-years credit binge hasn’t yet kicked in. Last quarter we saw some healthy corporate earnings, due to the massive injection of liquidity. But on the ground, consumer discretionary spending is coming under pressure. I live next door to a carpet shop. It is run by sensible people who’ve been in business for 40 years. Two weeks ago, though, they didn’t have anyone come through the doors. It’s a tangible sign of what’s ahead. Look at the economic models used by the likes of the International Monetary Fund (IMF): they don’t account for the fact that households are paying down debt and hoarding cash. Quantitative easing is one thing – but money needs to move around the system faster if it is going to stimulate demand. That’s not happening. Cost-cutting might hold up profits for a while, but demand is going to dip.
Chris Wright: Cost-cutting has helped, but sales have also been better than expected. Whether that’s restocking or not, we don’t know. But a repeat of the kind of financial crisis we had two years ago is unlikely. As long as stocks are not expensive, they will do all right if we get a slowdown.
Jane Coffey: The deleveraging we need to see, both from the consumer and from governments, is bound to weigh on economic growth. But because governments are so focused on avoiding deflation, they aren’t going to raise interest rates. So the deleveraging will go on for longer than it might otherwise have done. That means it’s going to be pretty boring for investors looking for growth. There will be mini cycles, but I don’t think we’ll see another recession next year. I believe equities are the best value asset class. Dividend yields for some individual firms are above both corporate and government bond yields. That implies that we’ll see no nominal dividend growth for the next ten years. I can’t see that happening.
John: Aren’t you at all worried about Britain’s sticky inflation?
David: A bit of inflation for the firms we invest in isn’t a bad thing.
Chris: And it’s a different kind of inflation. It’s not the endemic post-war inflation where unionised workers demanded ever-greater salary rises. Rising wheat prices are tough on poorer countries, but that kind of inflation is neither here nor there in Britain.
Jane: A little bit of inflation – up to 5% – is what you need to make deleveraging happen more quickly and with less pain. It’s pain in the sense that real house prices won’t go up. But that’s what you want.
John: But can the Bank of England really get away with saying, inflation may be at 5%, but we’re going to keep interest rates where they are because that’s what we need?
Our Roundtable panel
Head of equities, Royal London Asset Management
Neil Shah
Director of research, Edison InvestmentsDavid Taylor
Fund manager, Chelverton Asset ManagementMark Williams
Fund manager, Occam Asset ManagementChris Wright
Senior investment manager, Premier Asset Management
Jane: Some would say that that’s exactly what the Bank is doing. It is trying to anchor inflation expectations while allowing for the fact that it knows it’s going to be high for a year or a year and a half.
David: And if the bank started putting rates up now, it would choke everything off. That would be the one thing that would send us into a double dip.
John: Yet interest rates have never been this low and the Bank of England owns a big chunk of the gilt market. The idea that we’re somehow going to muddle through seems very optimistic.
Neil: But that’s where we are. I think when inflation comes, it will come fast. That’s the reason people are buying gold. But I don’t see inflation soaring for a few years. I think we probably will see a double dip, but corporate profits will be fine because the labour market is going to remain very weak, and so you’re not going to see wage-price inflation.
Mark: The timescale is important. I don’t think we’ll see a double dip. But we could get a sovereign debt crisis in a few years. All low interest rates are doing is pushing the crisis further into the future and giving everyone a chance to muddle through. It might not work, but I don’t think we need to worry about it too much for now.
Chris: I’d love to know when people didn’t muddle through. Did people ever plan and actually get it right?
John: What do you think about emerging markets?
Mark: We’re broadly optimistic. Domestic demand seems very strong and recent wage rises are good news. We’re not positive on anything that depends on consumer spending in the developed world, for obvious reasons, but employment will probably rise in the US and Europe, which will lead to an increase in company spending, and that’s good news for Asia.
John: Are you concerned about China tightening up?
Mark: Everywhere in Asia is tightening. And that’s an incredibly positive sign. Asia has put in place the same loose monetary policy as the rest of the world, but it didn’t have a financial crisis. Singapore had more than 14% second-quarter GDP growth annualised. This is an artificially high level of growth that needs to be contained. So policy needs to be normalised. The fact that governments have the confidence to do so is a sign that they believe there’s a relatively broad recovery.
Neil: Exposure to China is now a key component of Western corporate growth strategies.
Jane: That’s been a big differentiating factor this earnings season for European and American firms. A lot of top-line growth is coming from Asia, China and Latin America. Investors should continue to look for that, because you’re not going to find much top-line growth in the developed world. But you don’t just have to invest in emerging markets: a vast amount of UK earnings is dependent on overseas markets and commodity prices.
David: Yes, but I can buy British earnings that are probably going to go sideways for a year on a price/earnings (p/e) ratio of seven and a yield of 8%, or I can buy overseas earnings on a p/e of 18. A lot of that growth is already in the price. At some point over the next 18 months the focus will come back to Britain.
John: The big worry for a while was that Greece would go bust. But how do things look now for Europe?
Jane: Europe’s austerity programmes have been remarkably good and have pushed things through that you couldn’t even dream of getting through here, such as public-sector pay cuts. But one of the key points for European equities is that corporate earnings are very sensitive to the euro. This year’s euro weakness will more than offset any fiscal tightening, so European earnings have been revised up, alongside corporate earnings elsewhere. So despite austerity and domestic demand problems, we think corporate Europe is looking reasonably healthy.
Chris: Europe is the ultimate example of economies muddling through. Economic growth has been a bit weak there for 20 years now. But the underlying companies – Siemens, Philips, Novartis, whoever – are world-class companies, and they are quite lowly valued. Sure, you don’t want to buy Greek retailers. But there are plenty of other options.
John: Does anyone think government bonds look good value?
Neil: No. The next bubble.
Jane: There are plenty of positive technical factors. That’s always a warning sign – you never know when it’s going to stop. In ten years’ time we may look back and say bond yields were obviously at ridiculous levels – governments were buying in, rates were anchored really low because short-end interest rates were practically at zero, and pension funds had to buy them. For me, if you’ve got a long enough timescale, you just have to stick to fundamentals and buy equities over bonds.
Neil: The timescale is key, of course. We could’ve made the same arguments about bonds three months ago, and if you had bought in then, you’d have made about 20%.
John: On commodities, oil is still at around $70-$80 a barrel and food prices are in the news too. Will we see another commodity boom?
David: Oil inventories are pretty high. You’d need a big pick up in demand, or a real catastrophe, for the oil price to go substantially higher.
Chris: Isn’t this a bit like what we saw in 2004-2007? Loose monetary policy had people treating commodities as financial assets. I suspect that’s what we’re seeing now, although I’ve no idea exactly how much of the price is due to financial demand.
Jane: But you’ve also got China and India continuing to grow at 8%-plus, creating long-term demand growth for oil and commodities. There’s a copper shortage and supply is just not responding. Most of the production reports we’ve had from miners have had production falling below expectations. I’m not sure I believe in Goldman’s prediction that oil will hit $200 in the next two years. But I certainly think commodities will generally drift up over time and that this is not any kind of bubble.
David: The big miners have all committed quite large sums of money to investing in more capacity. They wouldn’t do that unless they honestly believed copper prices were at least sustainable.
John: How about gold?
Mark: If there really is a sovereign-debt crisis in a few years’ time, then gold is the only obvious place for people to invest. But I have no idea whether it’s overpriced or how you would measure whether it is or not.
Jane: You should only buy gold if you really fear the Armageddon scenario, not if you’re worried about inflation at 10%. Gold is not a hedge for inflation, it is a hedge against the whole financial system collapsing.
David: Another banking crisis, basically.
Neil: Yes, given how fragile things are, that is the real concern. It only takes one more shock to prove the gold bulls right.
Mark: It probably won’t happen – there are enough structures in place, and enough people scared about it, for it to be prevented.
David: Yes, there’s enough collective will at government level for it not to happen. The same goes for the double-dip scenario – the governments in the developed world simply don’t want it. One thing we’ve seen in the last couple of years is coordination on a scale that we never thought possible.
John: So, what sectors and companies are you investing in right now?
David: In the developed economies, there are two types of firms you should buy, assuming a ‘muddle-through’ scenario. You can pay a lot of money for out-and-out growth stocks that may or may not pay off. Or you can buy solid, boring cash-generative businesses that pay decent dividends and grow those dividends by more than inflation every year. There are a lot of those around.
John: So what are your favourites?
David: I’ll give you three. They’re all on p/es of about seven, with good yields, and have just put their dividends up by 9%-12%. They’re cash generative with no major capital expenditure (capex) requirements for the next couple of years. The industries they work in are getting slightly better than they were last year. First, shipbroker ACM Shipping (LSE: ACMG), which focuses on the tanker market. It’s on a p/e of seven and yields 5.6%. A big chunk is owned by the management, which is always a good thing. It’s very cash generative. The second is newspaper and magazine distributor Smiths News (LSE: NWS). Again, it’s on a p/e of seven and yields just over 7%. The rate of decline in newspaper and magazine circulation has slowed down. As the economy improves and more newspapers and magazines get bought, that’ll boost profits. The final stock is direct marketing group 4imprint (LSE: FOUR). It’s on a p/e of 7.5 and yields 6% or so. It’s very cash-generative and geared to an upturn in business levels in the US. You are not going to retire on those three companies, but you won’t do too badly over the next few years.
Our Roundtable tips
Investment Ticker ACM Shipping LSE: ACMG Smiths News LSE: NWS 4imprint LSE: FOUR Lonking HK: 3339 China Mobile HK: 0941 ASOS LSE: ASC Kcom LSE: KCOM Rockhopper LSE: RKH N Brown LSE: BWNG Lloyds LSE: LLOY Majedie Investments LSE: MAJE Rio Tinto LSE: RIO Compass LSE: CPG
Mark: I’d recommend getting exposure to the growth in Asia, especially the mid-caps. The exporters look good, although nothing that’s directed towards developed-world consumer demand. The firms that look good have got to be more exposed to capex, or Asian domestic demand – but that’s the one area where you’re seeing quite high valuations, which I find rather hard to stomach. So I would probably go for Lonking (HK: 3339) in China. It makes wheel loaders – they look like diggers, but just move stuff around. It is one of the largest companies in that area, and a big beneficiary of China’s growth. It is managing to pass through some price rises as well.
Another tip would be China Mobile (HK: 941). Last year was terrible – it underperformed by about 45%. People were very nervous about the amount of capex it would have to contribute as China developed domestic 3G technology. That seems to be out of the way now and the group is trading on about 10.5 times earnings. One area I have confidence in is the growth in domestic consumer spending in China. When you’ve got most areas of the country increasing wages by about 17%, and certain companies by up to 100%, it’s hard for that not to spill over into very basic discretionary spending – and mobiles tend to be in that range.
John: What is your take on the wage inflation?
Mark: A lot of it initially came from areas that weren’t tied into the government-related unions. So this is independent workers saying they want a wage increase. If you are one of the firms involved, it’s relatively frightening. It’s one reason why we don’t invest in textile manufacturers, for example, because they have high proportional labour costs and that could hurt overall margins. But with technology, labour tends to be about 10% of the overall cost base. So even if you do see a 15% rise, that’s manageable.
John: And higher wages are good for domestic consumption.
Mark: Yes, particularly on low-end discretionary spending. And that is the base that you really want to increase if you want to get a mass middle-class.
Neil: I’m in the fast-moving growth camp – something like online retailer ASOS (LSE: ASC).We also like stocks with deleveraged balance sheets, improving demand, and decent yields. I’ve spent some time looking at the oil sector – those are the stocks that will potentially double or treble.
John: How does this tie into your view on a double dip?
Neil: Well, people will continue to pay for growth and pay for oil companies that are finding oil. Every time we talk about ASOS everyone points to the chart and says it’s near a 52-week high. But the firm has a great track record and the ability to scale up. It’s expanding into Europe and is putting in a warehouse, which, over the next five years, will hopefully allow it to double its revenue base. It’s innovative too – you can now resell your clothes via the ASOS website. It’s not cheap on a forward p/e of 28, but that’s what you have to pay for that sort of growth.
Kcom (LSE: KCOM) we like because it’s a very simple story. It’s an infrastructure play with effectively very little capex going forward. The balance sheet is more or less deleveraged and it’s paying a decent yield. It’s a rock-solid company with the potential to surprise on the upside with earnings, given the BT deal. So that is a nice, safe play.
On oil, we think Rockhopper (LSE: RKH) could make a name for itself. We have petroleum engineers on our team and once you get into the technicals of what Rockhopper has found in the Falklands, the actual find has the potential to be much bigger than what they’re looking at right now. But it’s high risk.
Chris: We like N Brown (LSE: BWNG). It sells basic clothes to people who don’t go shopping at Burberry or on Bond Street, or whatever. It’s been moving online from its old catalogue-distribution business over the last ten years, so it’s becoming more efficient. It has a p/e of 8.5, a yield of 5.5%, and churns away growth year in, year out. That’s a super safe, nice compounding business that will just tick away.
More controversially, I think Lloyds (LSE: LLOY) is extremely cheap. It’s probably on a p/e of around six two years out. UBS reckons that between now and 2015 it will produce more than £15bn of free cash – that’s over and above the Basel II capital requirements. The market cap is still £45bn. The third firm is Majedie Investments (LSE: MAJE), an investment trust. It’s on an 18% discount to net asset value (NAV) and paying about a 6.5% yield. Of that NAV, 20% is a company called Majedie Fund Management. That’s valued on a p/e of eight – other fund managers range from 11 to 12. The rest of the business is made up of sensible, low p/e, high-yield stocks, such as GlaxoSmithKline and HSBC.
Jane: The miners look cheap – most are on seven or eight times earnings and generating a lot of cash. My favourite is Rio Tinto (LSE: RIO) – iron ore looks particularly good. This Australian tax problem has been hanging over the company, but that looks like it’s going to be resolved. You also want structural growth in your portfolio, so I’d go for caterer Compass (LSE: CPG). Good management has turned it around, and margins can grow still further. Its business is 85% outside the UK, and the US operation has a lot of room to improve. It’s on 12 times earnings, it’s cash generative, and it’s got a good yield.
• This article was originally published in MoneyWeek magazine issue number 501 on 27 August 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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