John Stepek chairs our panel of experts and asks where they would – and would not – place their money in today’s markets.
John Stepek: Let’s start with Europe and its debt woes. What’s going to happen next?
Paul Harwood: People are right to be sceptical about the state of the banks and government finances. Look at the mess Britain has got into – there is no reason to suspect that Europe isn’t at least as bad. The problem is basically the exchange rate. Anybody who’s been on holiday to southern Europe knows that. Not only are things too expensive, but places are very quiet. Something has to give. But it will rumble on for a long time, so sterling will probably creep up against the euro, certainly until European politicians get the message and do something.
Jane Coffey: There won’t be a short-term solution. But I don’t think the euro will break down, or anybody will leave. We’ve just had the regional elections in Germany and in Spain. Nobody likes austerity, so it’s hardly surprising that the incumbents did badly. But now the elections are over, they can focus on what to do about the most pressing problem – Greece. I think there will be a fudged long-term bail-out, or ‘re-profiling’ – in effect, a default. It’s in Germany’s interests. A lot of their banks are exposed to other European debt.
Paul: As I understand it, if they re-profile, the banks don’t have to write down the debt, which is what is really important.
Jane: But the problem isn’t just going to go away. Governments still have to sort out their deficits, and some, like Greece, or even Spain, really haven’t got the revenues to service their debt – particularly not at current interest rates.
Charles MacKinnon: We think the euro will survive because its survival is good for Germany. Germany now has a soft currency – BMWs are falling in price in China. That wouldn’t have happened ten or 20 years ago. But what will change is that, in future, investors will not buy Greek bonds thinking they are the same as German bonds. So when the Greek government has to raise money in the future, they will have to pay 10%-20% more than others, which is as it should be.
John: Might it be easier to sling Greece out of the euro?
Simon Marsh: Well, ultimately Greece’s debt is unsustainable. You can’t expect a population to repay that amount of debt. The eurocrats have this vision that they want to keep alive as long as possible. They hope some growth will return to these economies, which will buy more time to recapitalise the banks. But re-profiling just pushes the problem further out. At some point, it’ll be haircut time.
Charles: The real problem for Greece is that people can riot all they like, but wages have to fall. These things tend to sort themselves out one way or another. It’s similar to the way everybody in the West wants a weak currency to keep their economies moving, but Asia, and China particularly, hasn’t wanted a higher exchange rate. So the imbalance has come out in commodity prices.
John: China is the other big worry just now. Will it have a soft landing?
Paul: Probably. A big chunk of the gains in soft and hard commodities has been due to cheap money rather than supply and demand. Anytime there is a sell-off, we think: “this is something to do with China”, but it probably isn’t. Investors get lots of false signals these days because there are so many speculators around.
Charles: I do think there is a secular case for rising commodity prices. As people get richer they consume more commodities. The problem for investors is that while you can buy shares in a company and own them for a decade, you can’t do that in commodities. We do see commodities as a vital part of inflation protection, but we have to tell investors, you are going to have 25% ups and downs.
Our Roundtable panel
Head of equities, Royal London Asset Management
Paul Harwood
Investment adviser, Unicorn Asset ManagementCharles MacKinnon
Chief investment officer, Thurleigh Investment Managers
Simon Marsh
Partner, Killik & Co
John: Do you agree with Jeremy Grantham’s view that we are running out of everything, so commodity prices will be permanently higher?
Jane: All evidence suggests most metals are getting harder to find. Whether prices have been strong or weak, most companies have disappointed on the production side – they’ve been unable to get the anticipated grade or amount of copper out of the ground. But it’s mega-cyclical – when prices are very high, that attracts more investment, and you can end up with a bit of a glut.
Paul: I would differentiate between energy and everything else. If there is a problem with oil, then there is a big problem all round. The only way to get government and bank finances sorted out is through growth. If that hits a wall, it’s likely to be because of the cost of energy.
Charles: I agree that more capital will go into commodity production – the world will not run out of copper. But producing it gets more and more expensive. Going back to Grantham – the world population has surged from 800 million in 1800 to seven billion now. Crop yields are only growing by 1% a year, whereas it used to be 3% or 4% a year. We can keep growing, but it’s getting harder.
Paul: It’s the nature of the growth that bothers me. Everybody wants a Western lifestyle. That takes a huge amount of energy – and that is the frightening bit.
Simon: But the world will change and technology is a wonderful thing.
Paul: Yes, but the bottom line is that we in the West will get poorer and that’s hard for people to take. US living standards have been static for the last couple of decades. Will the average guy in the street with his mortgage behave sensibly when the politicians say: ‘tough luck mate, your living standards are going to fall’?
Jane: That’s why having a bit of inflation is the best way to get through this. It’s still painful, but because they get richer in nominal terms, people don’t notice quite so baldly that their real [inflation-adjusted] standard of living is falling.
John: How will austerity affect Britain on top of all this?
Paul: The Conservatives have talked about all the cuts they’re making, but they are actually doing very little. Any cuts are being made to capital expenditure, not the cost of staff. So they haven’t really faced up to the problem of public-sector wages inflating versus private-sector wages over the last decade – my local MP told me, ‘we just can’t be that honest’. That’s where I think the Conservatives could come unstuck in future – they talk the talk, but don’t actually do anything.
John: Is that bad for the pound?
Paul: Not necessarily. It’s all relative. I’ve said some negative things about our politicians, but I don’t have a lot more confidence in other people’s. Besides, to some extent we took the hit to sterling early, after the credit crunch.
Charles: Long term, the growth currencies win, but I’m quite positive on the pound in the short term. Our debt is relatively long duration, so we haven’t got to roll it over all the time, and it’s 99% in sterling. Plus we have a very good revenue collection business, called HMRC. If you are a very large international investor – be it a sovereign wealth fund or large corporation – looking to diversify your currency holdings beyond the dollar and the euro, you might start adding to your pound holdings. Sterling still accounts for 15% or 20% of global trade, after all.
John: So how can our readers protect themselves from a collapsing standard of living over the next five to ten years? Inflation in Britain is already high.
Jane: The index-linked National Savings & Investment (NS&I) certificates are good. I bought my allocation as soon as they were released. But there is a limit [£15,000] to how much you can put in. Otherwise, equities offer pretty good value. You can get dividend yields of up to 6% in secure firms that are well covered by cash flows.
Charles: I’m with Jane on NS&I – we told clients to buy as soon as they came out – your readers should do the same. We also like emerging markets. You’re getting a 2.5% yield on the MSCI Emerging Markets index. That’s half that of Britain, but you’ve got the chance to make real money and you’ll get some currency protection.
John: Lots of people are tipping Asian currencies – how do you get exposure?
Charles: A short-dated emerging-market bond fund – Pimco has one.
Simon: There are some funds that are short sterling, dollar, euro, yen, and long a basket of emerging-market currencies, although a lot of these are designed for professional investors rather than the man in the street.
Paul: You’ve got to be careful of lumping all emerging markets together as ‘safe’.
Simon: You do need to take a basket approach. But inflation is certainly the play of the year. Our debt is at the same level as it was after World War II: 40% of that was written off due to inflation. Politicians won’t advertise the fact, but that’s why inflation will be allowed to run.
John: Will it rise much further?
Paul: It will take a while for prices in the shops to catch up with commodity-price inflation. But with the VAT increase dropping out at the end of the year, inflation could be quite benign next year.
John: On wealth protection, what does everyone think of gold?
Simon: I’m not a gold bug, but for me the price of gold is only going higher, because the dollar is going to depreciate. But it’s not going to be a straight line. Right now, I would rather buy gold mining shares.
John: Do you think there will be more quantitative easing (QE3)?
Simon: Yes. I think it’s in Ben Bernanke’s mindset and I don’t think you’ll get the recovery in the jobs market that politicians will need short term.
Charles: All politicians are venal – they’ll do what it takes, including QE3, if they think that will put off the evil day. The market is acting on the assumption that the Americans will keep going until somebody tears up their credit card, and everyone loses faith in the dollar. So I think gold is going to $3,000 an ounce. Not because I am bullish on gold – I just think the dollar is going to hell.
John: $3,000 is by no means the most extreme estimate that’s out there.
Charles: The real question is, how many barrels of oil per ounce of gold? How many Brazilian real? How many grains of rice? That’s a much harder question.
John: Does anyone think there won’t be QE3?
Paul: If it’s needed, it will happen – if it’s not, it won’t.
Simon: Arguably, what’s happened in Japan was QE3.
Jane: But I think that if you look at the statistics that were coming out of the US before the Japan disaster, things were improving. The employment numbers were getting better – everybody said it’s a ‘jobless recovery’, but it’s always a jobless recovery for the first year. As Paul says, we won’t get QE3 if we don’t need it, and I think maybe we won’t. But if we do need it, we’ll get it. So whatever happens, we won’t get a massive fall in US growth.
Paul: Yes, I wonder whether we are all too pessimistic. In the early 1990s there were riots and huge numbers of unemployed, and streets full of empty shops. That was what was supposed to have happened this time – we’ve had none of that.
John: Would anybody buy US property just now?
Jane: I don’t know enough about it, but allegedly there are places where you can buy property for zero land value.
Simon: If you go to the Rust Belt they are giving it away.
Charles: I’ve spent quite a lot of time looking at this. The problem is that the places where you’d want to buy are still surprisingly expensive. Apartments in New York have not collapsed in value, for example. Elsewhere, you have to remember that if you buy one house on a development of 300 and the other 299 are vacant, your house is going to be worthless. And there are whole square miles like that in southern California that need to be wiped out.
John: Let’s move on to stock tips. Paul?
Our roundtable tips
Investment Ticker Castings LSE: CGS Renold LSE: RNO Thomas Cook LSE: TCG Holidaybreak LSE: HBR Rio Tinto LSE: RIO Experian LSE: EXPN iShares S&P 500 LSE: IGUS iShares EM LSE: IEEM MC China Fund N/A SGL Carbon Xetra: SGL Schindler Xetra: SHR Parity LSE: PTY
Paul: I’ll start off with Castings (LSE: CGS). It makes and engineers castings, which mostly go into heavy vehicles – trucks, etc. It operates out of the Midlands so it can get plenty of skilled people to work hard for not too much money. It has won lots of new business and has grown through the recession. I suspect that both its turnover and profit margins might surprise people. It’s an unglamorous stock for the patient, with a great balance sheet.
A similar play is chain and gear manufacturer Renold (LSE: REN). It’s not as well run as Castings, and will be even more cyclical. But it is invested in China and India, and I think it’s probably being cautious on its outlook because it got caught out in the last recession. So I’m hoping it will beat everybody’s expectations. If it was to make the money it ought to make, the share price will be a lot higher than it is now.
For something a bit different, I’d go for Thomas Cook (LSE: TCG). I can’t think of another business that has been hit by so many bad things in such a short period of time. There are all sorts of reasons why in the long run this sort of business isn’t going anywhere. But it could just be lucky and have a couple of years of good growth. For example, if the cost of living in southern Europe falls it would be in a good position. Obviously, if something went seriously wrong in the Middle East that would do a lot of damage, but as investors you’ve got to gauge risk and reward, and I think at the current price – it’s yielding 7.5%– you could get lucky.
Jane: Well, I’m going to choose Holidaybreak (LSE: HBR). It has also been hit by negative sentiment towards tour operators, yet it has actually diversified hugely into education. It owns the PGL centres that run outward-bound breaks for school children. These things are booked up year after year by the same school, so they have greater earnings visibility than on the normal leisure holiday business. It has recently bought a firm in Germany so it can now do exchanges between Germany and Britain.
The firm also still has its old Eurocamps business, the campsites in France that middle-class British families visit when they’re looking for a good value holiday. The other part is Superbreaks, which runs package trips down to London to see shows. It’s had some downgrades to its earnings, but I think the market has forgotten the quality of the earnings coming from the education division.
At the opposite end of the spectrum we have mining giant Rio Tinto (LSE: RIO). I recommended it here last August. The share price is a bit higher now, but its profits are much higher. We still think it offers good value, and good access to the metals that you want to be in.
Finally, I like credit-scoring company Experian (LSE: EXPN). It’s in a very good niche. In Britain and America all the banks give it their lending data free, and it can then sell it back to the banks so they can get an amalgam of the market. That’s a good business model. It’s also targeting mobile-phone companies and governments. Plus it’s selling more interactive services direct to the consumer, such as identity protection, where, for a monthly fee, the company notifies you if anybody tries to use your name and address to get credit. People can also pay to find out what their credit score is.
John: You can get a free report on that anyway can’t you?
Jane: Yes, but it’s not very user friendly. It’s also doing great business in Brazil and other emerging markets – it recently bought a Colombian credit-checking business. Surprisingly, Australia didn’t really have a credit bureau business, so they’ve just set one up. So there’s lots of growth potential – 10% minimum top-line and mid-teens earnings growth. It’s also highly-cash generative so it can easily finance its growth and raise dividends at the same time. I like that kind of business.
Charles: I have three ideas for you. The first is iShares S&P 500 hedged (LSE: IGUS). This is the S&P 500 hedged to sterling. We think the dollar is going to fall. If that happens, it will be very good for American multinationals because they make everything abroad – so buying IGUS is a good way to take advantage, while protecting yourself from the currency fall. Next, the i-Shares Emerging Markets exchange-traded fund (LSE: IEEM). That gives you exposure to equities in Brazil, Korea, China, Taiwan, and also to that basket of Asian currencies.
I am still a long-term bull on China – we own the Martin Currie Greater China Fund (0845-602 5016). It is 40% China, 34% Hong Kong, 21% Taiwan. Over several years, I think that’s going to work out well.
Simon: SGL Carbon (Xetra: SGL) is a fascinating business. Its main products are graphite and carbon electrodes, which you use in hot furnaces for producing steel and aluminium. But the most interesting point is that they’ve got what we think could be a transformational position in the whole area of carbon fibre. In the automotive and aerospace industries, you are seeing attempts to make cars more economical and to reduce their carbon footprint. The easiest way to do that is by reducing the weight of a vehicle.
BMW is producing a new sub-brand of cars due to be launched at the end of 2012/2013, called BMWi. SGL Carbon is their partner. The car’s passenger cell will be made of carbon fibre – you can hold it up with one hand. The reduced weight of this vehicle will be transformational. You’ve also got Boeing’s much-talked-about Dreamliner, which has 35 tonnes of carbon-reinforced plastic within it. SGL is one of Boeing’s primary suppliers. So there is potentially a whole new industry to be built around these new materials, and SGL is at the centre of it.
Secondly, I’ve a play on one of the today’s big themes: urbanisation. Half the global population lives in cities, and 60 million more join them every year. When you get a high concentration of people in a smaller land mass, buildings go down or they go up, and transit systems become ever more crucial. Schindler Group (Xetra: SHR) is number one in escalators in the world and number two in elevators. It’s a great business – it not only supplies the lifts, but services them too.
The lift business is the closest thing to an oligopoly you can get – you’ve got Otis, Kone and Schindler. They go into a local market, buy the top player, then basically take the plans of what they produce in Switzerland and introduce it locally into an installed customer base. It’s a simple model, and a great play on one of today’s enduring themes.
My third choice is a turnaround play called Parity (LSE: PTY). There are three parts to the business. It supplies IT consultants to various companies and the government; it has a systems business that has been going nowhere for many years; and it’s got a very small business supplying graduates to the Foreign Office. So why buy now?
Well, Philip Swinstead, who founded Parity, and has a great track record, has come back to the company – he took a 25% stake in the firm last year and ousted the board. They have just had a successful fund raising, raising about £7m on the back of a £10m market cap. So now you’ve got a business that’s got tried and tested management, and has effectively been recapitalised.
The IT sector is very cyclical and never really recovered from the internet bubble. But we see a very interesting turning point ahead: mobile internet. A lot of big corporations recognise that they need to understand the mobile internet and how it can be used to engage with their customers and their workforce. Parity will be repositioned as a business that can help them. The firm has got a fantastic client base – companies such as Marks & Spencer – and it has got the raw talent. Yes, it’s fairly speculative, but Philip Swinstead openly says this is a three-to-four-year plan for him to make a lot of money and he has a very good track record.
John: Thanks for coming along everyone.
• This article was originally published in MoneyWeek magazine issue number 540 on 3 June 2011, and was available exclusively to magazine subscribers. To read all our subscriber-only articles right away, subscribe to MoneyWeek magazine.