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: With inflation rising, do you think the Bank of England will raise rates?
Tim Rees: I think the Bank of England is quite happy with a bit of inflation to help with the budget deficit. But you get to a point where credibility becomes an issue. Also, when I look at the various bubbles around the world, the last big one that hasn’t been addressed is the British housing market. It really does suggest that a bit of a rate rise is sensible.
Julie Dean: Inflation is clearly a problem for the Bank and for the Federal Reserve, and for China – which is the only one that seems to be doing the right thing and tightening. The Fed says it doesn’t see price pressures building aggressively.
But there’s more to the world than US house prices. And what are the unintended consequences of the extreme monetary policy we’ve had over the last two years? The cost of debt is going to go up at a time when governments are in a tricky place, so government debt isn’t the place to be at all.
Tim Price: Yes, given the outlook is so poor for G7 government debt and we know that cash rates are negative in real terms, the only asset class that really makes sense for an active investor has to be high-class equity. And I probably haven’t said that in five years. Where else do you get a potential positive return and an opportunity for growth?
Anthony Cross: I don’t know what would be achieved by raising rates. Inflation is coming from commodities, food and tax. So if you put up rates then you will be punishing the consumer to try and bring down the price of things that the consumer hasn’t pushed up in the first place. I am concerned about what rate rises would mean for the average man in the street who has a mortgage and credit-card debt and has, I think, only got through the last two years because rates have been so low. The thing to watch is whether this rise in the cost of living pushes people to try for higher wages. But I don’t think your average worker’s bargaining power is strong right now.
John: Apparently manufacturers are having to recruit quite aggressively.
Anthony: Certainly, companies exposed to infrastructure and emerging markets have been doing well. But manufacturing is, what – 12% of the British economy? What about the public sector? Or retailing – they are not crying out for people.
Tim R: But clearly it’s an abnormally low rate of interest. In the 1990s and 2000s, the price of imports was effectively falling. So you had imported deflation in one part of the economy, while there was inflation in the UK domestic sector. That was conveniently excused because, for the economy as a whole, inflation was at acceptable levels. Now we’re seeing the reverse – the things outside of our control are rising rather than falling in price. Yet now the apologists are saying that there’s no need for the service sector of the economy to be slightly depressed in order to balance the overall inflation numbers.
Our Roundtable panel
UK equity fund manager, Liontrust
Julie Dean
Manager, UK Opportunities Fund, Cazenove CapitalColin McLean
Managing director, SVM Asset ManagementTim Rees
Equity income fund manager, Insight InvestmentTim Price
Director of investment, PFP Wealth Management
Tim P: The trouble is, the abnormally low rates are there to support the banks. Are the banks healthy enough yet to withstand rises? I’m not sure they are.
Colin McLean: I do think the Bank of England is losing credibility. It has said for a year that inflation will come down – it hasn’t and it’s becoming a problem. If you are running a wage freeze, you can do that with 2% or 3% inflation, but once it moves above that, it’s quite hard to retain the right people. So before fiscal policy bites later in the year, I think the Bank has to be seen to do something – but a token gesture rather than moving it up much.
Julie: Yes, one thing we haven’t seen yet is how much austerity will hit growth, which might bring down inflation.
Anthony: I am of the view that if China is tightening, commodity prices might well fall by themselves. I don’t see why we need to cut off our nose to spite our face.
John: Do you think a slowdown in China would be so bad? Might it help reduce food-price inflation, for example? No one saw the revolt in Tunisia coming, and that was at least partly down to food prices.
Julie: I think China is doing the right thing by trying to rein in rampant credit inflation. From a food-price point of view, there is nothing you can do about biblical floods and bad weather – but you can stop excessive speculation brought about by excessively loose monetary policy.
Tim R: But perhaps their aim is just to crack down on speculation in specific property markets within China, such as Beijing or Shanghai. The authorities are still fully aware of the need to roll out economic growth in the hinterland. On that basis, China’s demand for commodities will continue.
Colin: It’s an interesting point about Tunisia not being predicted. In general the City doesn’t forecast political change, but in times of austerity there will be more of that. Look at Europe. In any nation undergoing austerity, it only takes an opposition politician to say: “it doesn’t have to be like this”. In fact, just look at Britain – we’re already hearing from the opposition that we don’t have to cut back. So the potential for political change, even in a democratic way, is quite high.
Tim P: It’s interesting to compare Ireland – which is facing this crushing austerity regime because it has effectively been forced to take the euro bail-out – to Iceland, which has told all its creditors to go play in the traffic. Where would you rather be now? Probably Iceland.
John: What sort of impact do you think a eurozone sovereign default would have on British investors?
Tim P: From what I’ve seen of British banking exposure to Ireland, not a good one. But there’s a bigger question. I don’t think it’s remotely contentious to assume that over the medium to longer term, money will flow from debtor countries to creditor countries – ie, from the West towards Asia. One of the managers we use has a great metric for measuring the credit-worthiness of countries – you take net foreign assets as a percentage of GDP. Why use net foreign assets? Well, consider Britain. The UK will never have trouble paying back its sterling-denominated gilts because it can always print more money. But it would have problems repaying its dollar borrowings – it can’t print more dollars. So it’s vital that a country has foreign capital as well as domestic capital to service its debts.
Countries that rank highly on this measure have huge surpluses – they are literally rolling in money. They are: Qatar, Hong Kong, UAE, Singapore, Taiwan, Switzerland and Norway. All have a surplus in excess of 100% of GDP in terms of net foreign assets. Countries that score particularly highly on that metric are also likely to have currencies you want to invest in – the Singapore dollar is probably one of my favourites right now. As to the countries to avoid, you just look at the bottom of the list: Iceland, Bulgaria, Estonia, Latvia and New Zealand are in there, and so are Greece, Hungary, Portugal, Spain – a lot of Europe. So for a currency trade, you would be short Europe and long Asia. And that might work for stocks too in the long run.
Anthony: But there’s a difference between the economy and the stockmarket. I agree there is long-term rebalancing needed between emerging markets and the West. But plenty of companies on the UK market are hugely international and exciting in terms of where they can go over the next ten to 15 years. It’s probably the same with the US – any business that’s been tried and tested and rolled out across the US can probably succeed globally.
Tim P: Yes, large-cap, blue-chip stocks look quite good value.
Anthony: And they’ve often got 3% to 5% yields attached to them. But the annoying thing is, this was the story last year and they have underperformed.
Tim P: A professor in America recently did some research that suggested the average holding period for a US stock was now 22 seconds. There’s never been this degree of noise in the markets. So I think the price of entry into equity investing is that you might have to wait longer than before for your investments to come good. But if you’re picking up 4% or 5% a year in the meantime, you’re not in any rush to crystallise that value.
Anthony: Another frustrating thing is that you can sit there as a fund manager picking stocks, and there’s this wall of funny money from quantitative easing finding its way into the asset markets and distorting things left, right and centre.
Tim P: The first port of call for that funny money is the bond market, which is perhaps why the market has been trading at such a low yield. But that makes the choice quite straightforward in Britain. If true inflation is between 4% and 5%, you can discount gilt investments, because if inflation stays there, you’ll never make a positive return. So there has to be a more attractive game in town.
John: So where would you all invest now?
Our Roundtable tips
Investment Ticker Rio Tinto LSE: RIO Legal & General LSE: LGEN Aviva LSE: AV BP LSE: BP Weir LSE: WEIR Aggreko LSE: AGK Sage LSE: SGE Easyjet LSE: EZJ Morgan Crucible LSE: MGCR Greene King LSE: GNK GlaxoSmithKline LSE: GSK Royal Dutch Shell LSE: RDSB Unilever LSE: ULVR Next Fifteen LSE: RWS System C LSE: SYS Nautical Pet. LSE: NPE Diageo LSE: DGE British Airways LSE: IAG Croda LSE: CRDA Yule Catto LSE: YULC IMI LSE: IMI RWS LSE: RWS
Tim R: I’m continuing with the themes I’ve run with for the last two or three years – companies that will benefit from broad-based economic growth. Rio Tinto (LSE: RIO) is an obvious one. It’s recently struggled relative to the mining sector – I think the market worries about its exposure to China and iron ore. But if the focus is moving away from the Eastern seaboard and more into the hinterland, and on improving the standard of living for the broad mass of the population, then the government will be hell bent on maintaining its infrastructure and residential construction programmes. That’ll keep demand going and give more legs to the iron-ore price than feared.
I have played the financials too over the last couple of years, particularly life companies – Legal & General (LSE: LGEN) and, to a lesser extent, Aviva (LSE: AV). I’ve bought BP (LSE: BP) too – I was surprised by the extent of the political and media attack on them. Clearly they made a huge mess in the Gulf, but it seemed to me always to be a case of getting on top of the problem and they’ve done that. The company has started to stride out again more confidently.
John: You’re referring to the Russia deal?
Julie: It gives them a growth angle – long dated.
Tim P: And a nice bit of political risk as well. On the topic of oil, I’m surprised the market is as sanguine as it is, given the oil price. I’ll be upfront here – I believe in the ‘peak oil’ thesis [the theory that oil production will, or has already peaked]. I think it’s part of a broader investment theme: the world has made inadequate provision for energy and energy infrastructure over the decades, and some of those chickens are coming home to roost. I don’t think you can do better than investing in the picks-and-shovels stocks that will address this. I’m talking about groups like Weir (LSE: WEIR), which makes pumps and valves. Or a more cynical way of playing the world energy shortage is a stock like Aggreko (LSE: AGK), which is the world’s largest supplier of temporary power generators. They’re getting contracts from people who have literally left it too late to address this.
Julie: I’m not sure about peak oil. Won’t we just use oil more efficiently?
Tim P: Sure there will be fringe new energies, but the problem is that not one of them can replace the installed base of hydrocarbon infrastructure in our lifetimes. Even if you invented a free energy source to replace the light bulb, you aren’t going to stop people using light bulbs – it costs too much to replace them.
Colin: There are serious implications for food prices too. For other countries to match the US for agricultural productivity, they need to use more diesel and more agricultural equipment and more fertiliser. Food is basically oil plus fertiliser.
Anthony: Even if we find alternatives, if you look at Africa, for example, by 2050 there are expected to be more people without power than there are today because of population growth. It can take years to build nuclear plants and other infrastructure to sort out these problems.
Tim P: So buy Aggreko.
John: Julie, where are you investing now?
Julie: There are signs credit is getting through to US small firms, so perhaps businesses that supply them, such as Sage (LSE: SGE), will do better for a time. Some industrials probably haven’t yet reached their margin potential. Morgan Crucible (LSE: MGCR) might have further to go. There are some cheap domestic stocks too. Things may get tougher for the British consumer, but pubs group Greene King (LSE: GNK) looks fine and Easyjet (LSE: EZJ) looks very cheap.
Anthony: As a strategy, I’m keen on holding the likes of Glaxo (LSE: GSK), Shell (LSE: RDSB) and Unilever (LSE: ULVR) – the sorts of stocks that will yield you 3%-5%. You have these big caps at one end, then at the other you have small and micro-caps. There are some great businesses there that no one cares about until the day a bid comes in. I think you’ll see quite a lot of corporate activity at that end. So firms such as digital PR group Next Fifteen (LSE: NFC); RWS (LSE: RWS) in patent translation; and System C (LSE: SYS) in healthcare software.
Colin: Our biggest bets are some of the oil juniors, such as North Sea explorer Nautical Petroleum (LSE: NPE). We quite like luxury goods too. Diageo (LSE: DGE) is fairly bombed out, and British Airways (LSE: IAG) – British brands like those are worth more than they’re priced at.
When you look where British Airways was a year ago, we had strikes then and were supposed to get more in December and we didn’t get them. We had ash clouds and recently we had snow and they’ve dealt with it all. Now we’ve got the code-sharing agreement, we’ve got more prospects in America – there’s a lot going for it. Even now with the pension fund, it’s very cheap on the EBITDA-type multiples. We also like chemicals and I think there will be more mergers and acquisitions in the mid-cap areas, so we like things like Croda (LSE: CRDA), Yule Catto (LSE: YULC) and IMI (LSE: IMI).