Each week, a professional investor tells MoneyWeek where he’d put his money now. This week: Daniel Hemmant, senior portfolio manager, European equities, BNP Paribas Investment Partners.
Just five years ago, the world seemed a very different place. Growth was strong and inflation quiescent. The Greek government could borrow ten-year money at a premium of less than 1% to Germany and banks were still regarded as acceptable investments. Now, though, Goldilocks has vanished and we are left with the bears. Practically the only certainty is that many aspects of the current environment are unsustainable. Three big themes stand out.
Firstly, China’s growth model needs to change. Recent growth has been driven by massive fixed-asset investment at the expense of consumption and this must be rebalanced. The second issue is that with a budget deficit of 10% of GDP the fiscal situation in the United States is going to have to be addressed, paving the way for a normalisation of monetary policy. The negative real (after inflation) interest rates offered by US Treasuries will not persist indefinitely. Last, but not least, the fault lines in the euro have been laid bare. Any lasting solution will involve Germany shouldering the burden of financial responsibility for the eurozone’s weaker members.
As stock-pickers we face the risk that even our best ideas may founder if any, or all, of the three nettles above are not grasped. That said, we can still find companies whose industries provide a high degree of insulation from these global uncertainties.
Take the issue of precarious state finances and rock-bottom bond yields. From an investment standpoint, the earnings yield (earnings as a percentage of market capitalisation) in the equity market offers a much more attractive return than the government bonds market so long as it can be relied upon. To take advantage of this an investor should look for a combination of pricing power and international diversification – partly to spread risk, but also as protection against higher levels of domestic taxation.
One industry that offers this is brewing. It also benefits from the steady trend towards higher levels of industry concentration and rising profitability. As of next year, Anheuser-Busch Inbev (Euronext: ABI) will have reduced debt back to target levels and should offer a dividend yield in excess of 5%. Any excess cash flow distributed in the form of a share buyback could add another 4%.
China remains the main engine of global growth, so any cyclical stock is exposed to the risk of a hard landing for the Chinese economy. Assuming a worst-case outcome is avoided, Swatch (SW: UHRN) looks especially well-positioned to benefit from a rebalancing of the economy towards consumption. Profitability is driven by a portfolio of high-end brands such as Omega and Tissot. The company provides the mechanisms for much of the rest of the Swiss watch industry, leaving it as the key beneficiary of the growth in Swiss watch volumes.
Neither of these two stocks is compellingly cheap. So here’s one that is from the European financial sector. Lloyds (LSE: LLOY) trades on a similar multiple to the better Italian banks and at a substantial discount to the biggest two Spanish banks. It has minimal holdings of European government debt and the process of writing down problem loans is progressing well. Non-core assets are now down to 30% of its overall book while the core business has a dominant share of the UK market.