Every month we invite the best investors we know to tell us what they think about world markets, and what they would – and wouldn’t – put their money into now
John Stepek: When we last met four weeks ago, the Fed had just slashed interest rates, Bear Stearns had collapsed and everything looked very gloomy. How do you feel things are developing now?
Tim Price (Director of investment, PFP Group): There’s a kind of uneasy calm. In the short term the Bear Stearns rescue has drawn a line in the sand. What that largely represents is – bluntly – the nationalisation of the banking industry. There seems to be a perception, at least in the equity market, that the worst has passed. But after last week’s profits warning from General Electric, my sense is that a financial-sector problem has spread more into the overall economy.
Max King (Investec Asset Management): We think the Bear Stearns rescue marked the bottom for the equity and credit markets. No doubt there will continue to be earnings downgrades – usually downgrades continue for six months after market bottoms. But now it’s a case of buying both equities and corporate credit when the opportunities arise on bad days.
Nick Greenwood (Chief investment officer, iimia): I’m in a similar camp to Max. I think we are well into the bottoming process. There are pockets of value, so it’s a period for building your portfolio – so I’m an optimist.
Alex Illingworth (Insight Investment): We’re not prepared to go out wholesale and buy the market yet. We’re a little worried that this is the calm before the storm. General Electric said March was very tough for them, and that despite all the bail-outs and capital raisings many banks are still at their all-time lows. That gives us some concern.
John: Do you really think that equities can thrive in this sort of environment?
Max: Yes, because equities depend on the global economy and that is still growing. GDP growth will be 2.5%-3% this year, even in dollar terms. America is in poor shape and Britain, Europe and Japan are having a slow year, but there’s no reason why equities can’t prosper. Corporate balance sheets have been strong and that should protect equities.
Nick: I think financials is the area where you can really have your head handed back to you on a plate. It’s better to go for less reward in other sectors rather than aim for the potential big one by buying Citibank, for example.
Tim: I think there are good reasons why financials are at all-time lows. As Nick said, it’s either going to work, or it’s not going to work. But as rights issues are still to come, then trying to seek support, say, from dividend yields, is completely the wrong way to go.
John: Consumers here and in America seem to be giving up the ghost. What are the prospects for Britain?
Tim: This is where I really struggle with the bull argument. Start with America: 70% of GDP is consumer spending. The housing wealth mechanism has been turned off and we know that that market is almost certainly going to deteriorate further. Britain is just a few months behind, so sterling has got real issues. As a sterling investor you’d figure that just about any other currency looks preferable, including something in South Africa.
Nick: I take your point, but we need to be careful – there are lots of reasons to be worried about Britain, but maybe not so much about global stockmarkets. Max: You should also be wary of this talk about profits warnings, because newspapers are always biased towards reporting the bad news. There is a down-draught of earnings surprises, but actually it’s a sort of a 58/42 mix – it’s not a massive downgrade avalanche.
John: So where would you all invest?
Max: The trouble is that the areas we like best are the ones that have already done well, and the ones that have done badly we’re not ready to buy yet. I think there will be a great story in banks, but it’s not there yet, and so one’s left flogging relatively stale stories that have done well, but will go on doing well.
Nick: Technology is interesting. A lot of capital expenditure is going on in the developing economies and much of that is actually tech spending. Yet you can buy Herald Investment Trust (HRI), which is a tech specialist, on a 24% or 25% discount to prices that have already been completely trashed. So you’ve got this enormous buffer.
Some of these discounts are saying that we’re in a deep recession and markets are going to fall off the cliff. So if things go horribly wrong, you don’t lose anything, and if things are just all right you can actually make some spectacular money.
Tim: For readers willing to give their money to managers, I would agree. Not only is there some good value in closed-ended funds, but there has also been some very good performance. The two I’m looking at in Britain are British Empire (BTEM) and RiT Capital (RCP). The FTSE 100 is down year-to-date and both those funds are up.
Max: One attractive area is private-equity funds. A year ago they were all having difficulty investing their money – the price of deals was high, shares were trading at more demanding valuations, the funds were cash rich. Now competition has disappeared, deals are much cheaper, funds are up to their eyeballs in opportunities and across the board private equity is underowned, underliked and unappreciated. All private client investors should have a significant exposure to that.
John: Are there any particular funds that you would recommend?
Max: Pantheon (PIN) is a great fund of funds, trading on a 20% discount. The Standard Life European Fund (SEP) is also very good quality. Candover Investments (CDI), SVG Global Fund (SVI) and 3i Group (III) are good too.
The other interesting play is commodities – I know it feels like a stale story, but it still looks good, whether it’s mining shares, the precious metal miners or some of the oil stocks. We are waiting for the oil price to come down for a huge buy into energy stocks, but it’s not showing much signs of doing so.
Petrobras (US:PBR) is cheaper than the so-called majors and is lower risk because it’s not running out of oil. We think soft commodities are overpriced and highly cyclical. There is a case for buying some of the stocks that help farmers raise productivity, but stocks like Monsanto and Syngenta are pricey.
Tim: But the underlying inventories are also low – I mean 30-year kind of levels. On that basis it’s not a bubble, it’s justified by supply and demand.
Max: I think the entire soft commodities boom is predicated on one thing: the insanity of biofuels. And so it’s a bet on the governments being stupid and shortsighted enough to go on pouring money into them. When the European and American governments cancel all subsidies for biofuels, I think the world will be a better place and the soft-commodities boom will go into reverse.
Tim: There is just one other factor that hasn’t really materialised yet – we haven’t had any substantial crop failures recently. If there is a wild card that might go some way to justifying some of the current levels, then that would be it.
Max: Everybody talks about drought and crop failures in Australia, for example, but South America had a bumper harvest last year and Russia, which was a huge importer of grain 20 years ago, is now a big exporter. So again, people tell you bad news that supports the story.
Tim: But in terms of agricultural commodities it’s not a globalised world. These things don’t flow the same way that capital does – everyone is raising tariffs now because there are a lot of countries that are very concerned about securing supply. So it’s a long way from being an efficient market.
Nick: Betting on an individual soft can be quite dangerous. Biofuels, let’s say, could face a backlash and everyone could switch out of grain – if you’ve got a long position in grain, you could get hurt.
Alex: But one lower-risk way into softs is through Brazil, for instance. You can buy a bank in Brazil, which means you are buying an emerging-market company that is benefiting from the wealth being created. If you think emerging markets are going to continue to be OK, then that is one way of getting secondary exposure.
Max: We think emerging markets are probably going to have a dull year. There has been a bit too much enthusiasm over emerging markets in the short term. The returns are great, that’s why investors piled in, but Brazil was discovered after already having had a fantastic performance for five years. When that happens it’s right to be a bit cautious. If you are a long-term investor, then emerging markets are great – if you are going to worry about what your investment is going to be doing next week or next month, you want to be a bit more careful.
John: So if you had to choose, which stocks would you invest in now?
Alex: There are two power generators I would mention, both in America. One is AES (US:AES), which operates in 27 countries. The firm has disappointed recently because it pushed profitability back for a year longer than investors had hoped. But earnings growth is still there; it’s just going to take some time to come on. The problem with this kind of firm is that you are doing deals with governments to allow you to build a power plant, then get a purchase power agreement in place for the next 20 years. That process is fraught with difficulties.
Tim: On the other hand, governments are quite nice to have as customers.
Alex: Sempra (US:SRE) is another utility-like company based in Los Angeles. Most of its business is in regulated power generation and gas distribution. But its areas of opportunity are in transmission lines, L&G terminals, and gas pipelines. These are capital expenditures that the government of California in particular realised need to happen; they are prepared to pay for it. Again, the earnings growth is not actually here today – it’s to come over the next year to three years.
Nick: Here are some of my more esoteric ideas – just don’t bet your shirt on them! One is Lewis Charles Sofia (LCSS). Everyone hates Bulgaria, everyone hates property. Essex man has been sold the Black Sea coast – but temperatures there get down to –14˚C at night for six or seven months of the year, so it isn’t Torremolinos, which is how it’s being sold.
But the industrialisation of Bulgaria means the population is shifting towards the capital; and that’s where Lewis Charles invests. It’s selling high-end developments to Russians, locals, and people who work for multinationals. The net asset value is 121p and the shares are around 63p – a 50% discount. If it goes wrong, it’s got to go really wrong for the NAV to get even close to the current share price.
And another one – Prospect Epicure J-Reit (PEJR). The Japanese Real Estate Investment Trust market is fascinating because it was owned by a lot of the global property hedge funds and now we’re getting massive redemptions. If you’ve got Goldman Sach’s Global Hedge going in and selling £2m-worth every day, which is about the usual daily turnover in that market, these things just keep sinking and sinking. So your average Reit in the Prosepect portfolio is at a 43% discount. Yet the fund reckons it will pay a 7p annual dividend, which, given the share price is now down to 49p, seems incredible.
But at the end of the day, the share has a relatively safe dividend yield because the underlying assets have been going up. So the returns are asymmetric: if things go wrong, you’re still getting the assets cheap, but if things go right, you can get some gangbuster returns without anything really having happened.
Tim: My tips won’t be a surprise to anybody – one is oil and the other energy services. ConocoPhillips (US:COP) is one of the cheaper oil majors, trading on a p/e of around seven. I am mystified as to why the City and Wall Street have lost the plot in relation to the oil price – I don’t know what you need to do to get analysts to revise the oil price up. I think ConocoPhillips is dirt cheap and could well get taken over at some point.
The other is Weir Group (WEIR) in Britain, again one we’ve spoken about in the past, but a classic provider to most of the hotspots in the energy sector – power generation, oil production, water supply, utilities, mining. It’s fantastic.
Max: Well, I’ve already mentioned Petrobras. And I think that rather than trying to be too clever and cherry pick the best areas, just buying general global funds is a good idea. British Empire and RiT are great examples. Scottish Mortgage (SMT) is another.
Nick: Going global and getting out of Britain and out of sterling is a good idea. Sterling has been overvalued, which was down to high real interest rates. Now that the housing bubble is not a concern anymore, rates could keep going down. Any truly global fund will get a wind-fall from currency gains over the next year or 18 months. It’s all part of the change in the world order. Different people have the money now.
The MoneyWeek Roundtable tips
Stock, Ticker, Price
Herald Inv. Trust, HRI, 288p
British Empire, BTEM, 479p
RiT Capital, RCP, 1,182p
Pantheon, PIN, 821.5p
S. Life European, SEP, 220.5p
Petrobas, US:PBR, $126.96
AES, US:AES, $17.60
Sempra, US:SRE, $57.32
Lewis Charles Sofia, LCSS, 65.25p
Prospect Epi. J-Reit, PEJR, 49.5p
ConocoPhilips, US:COP, $84.89
Weir Group, WEIR, 805p
Scottish Mortgage, SMT, 646p