Every month we ask the best investors we know for dinner and ask them what they would – and what they would not – put their money into now. Here are their recommendations for housing, oil, Europe and Japan
Merryn Somerset Webb: Let’s have a quick look at the UK property market.
Bob Catto: It’s been interesting, hasn’t it? Anecdotal evidence suggests that prices in central London have actually firmed up again and the agents are claiming that they had their best August and September for years. The top end in particular seems much improved – there is a lot of money about, both domestic and foreign.
Adrian Ash: But the rest of the market – the lower end in London and the rest of the UK in general – doesn’t look that good, does it? We’ve just seen Hometrack numbers showing that overall prices have fallen for 15 months in a row. And while transactions have gone up a bit, this is more down to the fact that sellers are finally giving in and slashing prices. Can the top end of the market really disconnect from this kind of situation?
BC: Not for any length of time, but in the short term it can and clearly has. That said, of course the rest of the market doesn’t look too good. I’d also be wary of the US housing market. The housing index looks ominous and the insider selling of mortgage companies and house builders is hardly encouraging. I think you would have to say that that market had peaked.
MSW: What about the UK-listed housebuilders?
BC: I wouldn’t be buying them, but I wouldn’t expect them to collapse either. We are building very few houses in the UK and they are on very low multiples. And they’ve got good, strong balance sheets.
Tim Price: You could argue that what’s really important, both here and in the US, is not so much house prices themselves, but the effect house prices have on consumer confidence. House prices on both sides of the pond aren’t going to be rising, and in the US we know that consumer confidence has already been severely affected by the hurricanes. Some of the images of New Orleans – corpses floating in the streets – have been genuinely damaging to the American psyche, and if the wealth effect of rising house prices disappears now, it will be worrying. In the UK, the wealth effect is long gone. I’d be steering clear of the retailers – with the possible exception of Tesco. All Sports has collapsed, Furniture Land has collapsed. There’s not a whole lot of good news out there.
Oliver Russ: Retail collapse doesn’t seem like good news for commercial property. It’s an area that has been attracting a lot of hot money, but recently we were speaking to people at Anglo Irish Bank – who do a lot of commercial property lending in London – and they were saying that the smart money appears to be getting out. It seems that a lot of people were pinning their hopes on upcoming rent reviews, but with vacancy rates shooting up, the reviews aren’t turning out well. Just walk up and down King’s Road and you can see it for yourself – there are quite a lot of empty bars and shops. Empty shop fronts are starting to pop up more and more regularly.
BC: This shouldn’t be a surprise. The consumer is finding life very difficult. His property has not been going up at the rate that he has been accustomed to, and he is also spending a lot more money filling up his tank and on utility bills – that means less cash flow for spending in the high street.
Richard Oldfield: I wonder if all this bad news isn’t in the prices of the retailers? The figures have been terrible, but the shares have all been extremely weak. That said, I notice how resilient Marks & Sparks shares are.
OR: I’m not convinced they should be. I went into M&S’s Islington branch and they had all these ex-display pieces of underwear in a basket on sale, and the label they had over the top was “soiled packs”. It doesn’t show much thought.
MSW: What about Tesco expanding into Europe? Does that make it a buy?
OR: I think Tesco will find it tough. If you go into a French supermarket, you’ll find they have, for example, a sea-food counter with live lobsters, and so on – which is better than anything you’ll find in any Tesco. I’m not sure that the Continent is ready for the Tesco proposition. The bottom end is well covered by the likes of Aldi and they can’t compete at the top end.
MSW: Well, we won’t invest in retailers. What about the oil sector?
BC: I’m probably more keen on the mining sector than on the oil sector. In the short term, the oil price looks like it’s peaked. We’ve had Katrina and we’ve had Rita, but the price hasn’t regained this year’s high. Long term, I still like the oil sector, I’d just be a bit wary right now. The gold sector has had a lot of attention recently – it might be a bit overbought, but when you’ve got the US President saying that he will spend as much money as it takes to sort out the US, and that means $200bn just for Katrina and Rita, you do want to be holding some kind of long-term store of value. I think that gold is going to get significantly higher over the next year.
RO: For anybody who believes in reversion to the mean, the chart of the gold/oil ratio is tremendously persuasive. Gold is historically cheap relative to oil, so either oil is going to go down, gold is going to go up, or both. I don’t really have a view on gold, but I’d go against the crowd here and say that I see the oil price coming down. There is no real shortage of crude oil – inventories in the US are very high. A year ago, the oil price was too cheap at $30 or so, but now, at $60, I wonder if it still is. It’s not that any of the facts that support the argument for long-term oil-price strength have changed, it’s just that the price has moved so much that it’s all priced in. Also, consumption growth in oil was 4% last year and I think that was a one-off – we won’t have 4% growth in demand like that over the next few years. I’ll tell you what else makes me nervous: a colleague was rung up by a friend the other day who has never invested in a stock in his life, but he had an energy tip sheet and wanted to know whether he should buy shares in Falkland Oil & Gas.
OR: I’m not convinced the oil price will fall. I think supply is still very much constrained. The market is expecting a lot of extra Saudi production to come on line over the next ten to 20 years, but there are rumours that the Saudi fields are in decline, and if that’s the case, where is the extra production going to come from? A lot of the US service companies are saying that the Saudis are asking for new technology to increase output from wells. That’s anecdotal evidence, but it suggests they aren’t pumping oil like they used to.
RO: I agree with you that Saudi reserves probably are, as Matthew Simmons says in his book Twilight in the Desert, much lower than many people think, but that doesn’t mean that the current market price is the right one. The price has just gone up too much. People such as John Brown of BP still steadfastly say that there is a vast amount of speculation in the price. In short, on the one hand you have reality, and on the other hand how that reality is perceived. A year ago, we had the same reality that we now have; the facts were the same in terms of production and Chinese growth, and so on, but the perception was that the oil price should still be low. Now we have the same reality, but the perception is that the oil price is going to remain terribly strong for a very long time, and I think that that perception has become extreme.
BC: But you would surely have to agree that there are huge political risks at the moment? We could see a revolution in Saudi Arabia, a complete breakdown in Iraq and likewise in Iran. Venezuela is a complete political disaster, as is Bolivia. And so much of the world’s oil comes from these places.
RO: You can’t bet on these horrible things coming true, though.
BC: No, but what I’m saying is that you wouldn’t be surprised if they did.
TP: I’d say the gold/oil ratio is more likely to move back into its range via massive, further gains in the gold price. My argument has long been that, in an environment where it’s hard to have much confidence in paper assets (thanks not least to Greenspan’s easy money policies), logic suggests you want exposure to non-paper assets, and oil and gold seem reasonable options. That said, while there will always be some base demand for gold because of its long-term track record of being a store of value, oil is not in the same boat because in the end it will be replaced with an alternative energy of some kind.
RO: It will also be replaced by itself. The Canadian tar sands become economic at $20-$25, so with prices at $50-$60, that oil will come on line and boost supply.
TP: I think we can agree there’s no shortage of oil, just of cheap means to access it. But there’s a shortage of refineries. I see a much bigger story ahead for oil infrastructure than for oil itself .
MSW: Richard, how far do you expect the oil price to fall?
RO: I don’t have any feeling about how low it could go, but I have a strong feeling about its direction, which is down.
MSW: So you would be out of oil stocks?
RO: Yes.
MSW: Tim, you would still be in Shell and BP?
TP: Yes. They’re solid long-term plays.
MSW: Are there any other interesting commodities for us to keep an eye on?
BC: Uranium. The long-term supply and demand situation is good and the cost of uranium as a percentage of the overall cost of producing nuclear energy is minute, so demand doesn’t fall if the price rises. It doesn’t matter if nuclear power stations pay $30 a pound or $175. Of the micro-cap stocks, Forum in Canada has interesting properties. In Australia, Marathon has moved from 18 to 60 cents, but there’s plenty to play for.
MSW: Let’s look at European markets.
OR: Our key overweight is Norway – not that we are particularly driven by countries, it’s just where we currently find all the best firms. This is partly driven by the resources boom, which makes oil service firms interesting. Ours is a highly speculative one called APL. It’s a gas and oil loading assistance company with a new type of technology for offshore gas loading or unloading from a vessel that lets you pump the gas directly without having to have a re-gasification plant built onshore. It works, but most tankers aren’t geared up for it yet. Still, Norway isn’t just about resource stocks. Its economy is booming and the stockmarket and property markets are hitting new highs. Some of the financials might make interesting investments – Norwegians have a lot of money, but they keep most of it in the bank. So we’re looking for firms that could benefit from increased purchase of investment products.
MSW: What about shipping firm Frontline, suggested at a Roundtable some time ago by your colleague Barry Norris?
OR: We sold out of that because the shares had gone up so much and because the firm was making noises about changing the dividend policy. They also might be going down the acquisition route and we were a bit uncertain as to how the market might take that. Selling the shares wasn’t a vote of no confidence in the shipping sector though. We’re still pretty bullish on crude carriers: as demand for crude rises, you’ve got to get it from the Middle East to China, and you need a ship for that.
MSW: Ed, what’s going on in Japan?
Ed Cartwright: The market has been doing fantastically, but there’s more to come. I’ve spent 20 years involved with Japan and I haven’t been this excited for about 12 or 15 years.
TP: I’d be enthusiastic too, but why hasn’t there been much domestic buying?
EC: There will be. The interesting thing, and the thing that at the very least will stop the Japanese selling their own market, has been change in the equity payout ratio. The top 1,100 stocks in the market were yielding only about 0.35%-0.40% 18 months ago, but last quarter that was up to 1.37%. Twenty-five per cent of companies raised their payout ratio in the first quarter of this year alone. I think that at some point that means the huge life firms will no longer regard equities as a wasting asset. Equities will have yielded enough of a return for long enough that the market will look compelling to them. Things are heavily underpinned by the fact that real estate prices aren’t falling any more. We had the first uptick year on year in 15 years in August. Morgan Stanley recently put out research worrying about a real estate bubble in Tokyo. That’s insane – go back 15 years and you can see what a real bubble looks like – this is just a stabilisation. Also very important is that the zero interest rate policy of the Bank of Japan is coming to an end and that this prime minister is all about fiscal rectitude, reformation and privatisation.
TP: So Japan is out of the woods?
EC: It looks like it to me. For a long time, Japan has just been seen as an exporter, and thus a play on global growth, but with all the excellent data coming out, it has become its own story again. Will it last two years or five years? I don’t know, but it’s not going to last six months. That said, the market might be a bit overbought in the short term, so I wouldn’t be surprised if there was a correction before Christmas. 2006 is going to be a fantastic year for Japan.
RO: I completely agree. I’ve been a Japan bull for far too long – I can’t be accused of jumping on a bandwagon, because for most of the time that I’ve been on it, the bandwagon has appeared to have square wheels. But now, everything is coming right. Normally, if you get a terrific consensus on a market – as we currently have with Japan – you want to be pretty wary of it, but I think just occasionally there are these very major changes during which the consensus is right. Everyone may be bullish on Japan, but they are bullish for good reason.
MSW: So how do retail investors get good exposure to Japan?
EC: We are about to launch the first ever Asia Fund of Funds on the London Stock Exchange in conjunction with Dresdner Kleinwort Wasserstein – so that is one way. It’ll be a closed investment trust specialising in investing in hedge funds in the region. I’ll also give you a few other ways in. One is an insanely speculative fund, Dejima. It’s run by a firm called Stratton Street and is a fund of the optionality stripped out of convertible bonds – that means that it is basically a very long dated, very cheap Japanese option bond stock. It’s very risky, but I reckon that for every 10% movement in the Nikkei, the net leveraged returns should be somewhere between three and five times. Do be aware that there’s a huge health warning on this one though. It halved last year, but in the last three months has moved from $58 to $126. But if you like Japan, it’s interesting. A more boring play, and one I own as a 12- to 24-month play, is Sony.
RO: Another good Japan pick is Kao Corporation, a Japanese cosmetics and household products firm. It’s very well run and has made profits for the last ten or more years, despite deflation – it’s unusually aggressive for a Japanese firm and recently bought Molton Brown. If there is now a little bit of reflation, their revenues and operating margins will rise and that will make a huge difference.
MSW: What other Asian markets are looking interesting?
EC: I’m not an expert on it, but Korea looks interesting. The markets keep hitting new highs, but the currency, interest rates and the general economy are all moving in the right direction. Korean technology is fantastic – if you look at this great new Japan bull market, the one sector that really hasn’t done very well this year is technology. That’s because the Koreans do it better. Conversely, a market that might give concern is Australia, where real estate prices are falling fast.
BC: I have to disagree with you on Australia. It offers high standards, high-quality management, transparent accounting and big firms, as well as huge exposure to mining. There’s enormous natural wealth in Australia. In terms of feeding raw material to the growing demands of China, India and so on,no one is better placed. Look at the cash flow of BHP Billiton, for example – it’s phenomenal.
TP: It’s difficult to get away from resources when you’re talking about markets these days, isn’t it?
BC: It has to be. We’ve had a 20-year bear market in resources. Now the odds are it will be a 20-year bull market.
MSW: Any other good tips?
BC: Catalyst Media. It’s a London-listed, Aim-quoted company that has just spent £23m buying 20% of SIS – the company that provides all the outside broadcasts for the bookies. This has been a sensationally successful business over the years. The stock is trading at 3.5p, but the management are absolutely adamant that they will produce a penny of earnings in 2007. It’s a punt, but I could see it at 10p by January.
OR: In Europe, take a look at Roche. The company seems to be transforming itself into a pure oncology company and its drug, Avastin, is very interesting; it is being trialled on a number of types of cancers and if they all come through, that could really affect the firm. There are also bad things coming out of Asia, such as avian flu, and Roche has a preventative, Tamiflu, up its sleeve. Unlike his predecessor, the new head of the Disaster Agency in the US won’t want to be accused of lack of preparation, so if he has any sense he will be negotiating a big deal with Roche to get supplies of the drug. That would be a massive deal. Private firms are buying too: we know that BP are buying private supplies of Tamiflu for their own key workers.
RO: There’s a dog that hasn’t barked at this Roundtable. No one has mentioned the US market. I think the stockmarket is not nearly as overvalued as people claim it is. Lots of people quote a man called Robert Shiller – always referred to as “Yale economist Robert Shiller”. He talks a lot about a normalised p/e, in which he averages the earnings over the last ten years. On that basis, the market looks expensive. But it has been a very extraordinary ten years because of the two huge write-offs in 2001 and 2002. So I don’t think it is normal to look at a p/e on that basis and I think there are some extraordinarily attractive quality growth opportunities in the market. The S&P is up 50% on March 2003, but a portfolio that consists of Coca-Cola, Microsoft, Colgate-Palmolivex and three other quality names has given a zero return. They’re now not expensive, and I think there is value there.