MoneyWeek's Roundtable: Fifteen turnaround plays and defensive stocks
By
Deputy Editor
Tim Bennett Oct 23, 2009
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Tim Bennett chairs our panel of experts and asks where they would – and would not – place their own money in today's markets.
Tim Bennett: UK consumer price index (CPI) inflation has fallen to its lowest level for five years. Is inflation dead?
Steve Russell: No. I think it's very much alive. I think we've now passed what is probably the low point for UK inflation in this cycle. Indeed, we're concerned about the bigger threat that inflation poses – monetary devaluation. As quantitative easing [QE] and all the government-sponsored programmes continue, inflation is probably the only end result possible.
Tim Price: I agree. And it suggests you should have some interest in gold.
Steve: That's true – gold is fantastic as an inflation hedge and as a hedge against the US dollar losing value. However, the price is extremely volatile and it's worth remembering that gold's fundamental value is zero because no cash flow is associated with it. I would point people more towards index-linked bonds at the moment, even if they look expensive.
Chris Wright: People always say gold is a good hedge against inflation, but I've never seen any definitive evidence. Maybe the numbers correlate well, but I'm not sure whether that's just gold bugs data mining or whether there is a real causal effect. If you're really worried about inflation and the slightly higher interest rates implied by that, you could play high-yield equities. You can buy, both in the UK and around Europe, 35 or 40 equities with very good balance sheets, creating huge amounts of cash, yielding over 5.5% and probably on a p/e of ten or less. In a gently rising inflation environment in the UK, that mix isn't going to hurt you very much.
Simon James: I agree that inflationary pressures are building, but I question whether the transmission mechanism is there. Demand in the UK and elsewhere is weak, and likely to remain so. Meanwhile, there is excess capacity in many areas of industry, and high and rising levels of unemployment. So while I agree inflation will be a problem long-term, I don't see how it can kick in for quite some time.
Our Roundtable panel
Simon James
Partner, Gore Brown Investment Management
Paul Marriage
Fund manager, Cazenove Capital
Tim Price
Director of investment, PFP Wealth Management
Steve Russell
Investment director, Ruffer LLP
Chris Wright
Senior investment manager, Premier Asset Management
Steve: I'm not sure. We think a lot of the under-utilised capacity out there is actually useless and won't come back. An extreme example would be air cargo traffic or freight, where you mothball an aircraft in the desert and then can't bring it back in time for Christmas, so people are left scrabbling around for capacity on a very small upturn in demand.
But what really concerns us is a systemic loss of faith in paper money. That's going to happen under any demand conditions – weak or strong. As yet there's no sign of that, but as governments keep printing money we think its arrival could be very sudden and very shocking.
Simon: So is your thinking driven by the fact that it is potentially easier for policy-makers to inflate their way out of trouble than to deal with their difficult fiscal positions?
Steve: Yes – especially seeing as there is no visible exit route from what they are doing just now. Were they to withdraw QE, the market and the economy would collapse and we'd be back to square one. I think as people start to realise that there's no way out, then that's when there could be a crisis of confidence in the value of money.
Tim B: So bad news for sterling and currencies in general?
Steve: Sterling is leading the way down in a masterful manner, which is lessening the direct impact of the recession on us. But in general it's all currencies. The same pressure is on the dollar and I assume the euro will eventually be dragged kicking and screaming down the same route.
Tim B: Are there any currencies anyone feels bullish on?
Tim P: Gold. Once there is little confidence in money, people migrate to other stores of value. We could debate the merits of gold versus silver, platinum or palladium – I think oil probably works as an 'anti-currency' vehicle too.
What really concerns us is a systemic loss of faith in paper money. Its arrival could be sudden and shocking
Steve: Emerging-market currencies would be the right place to be. The trouble is they don't really exist in an investable form – they are either linked to the dollar or too small to get exposure. So the best bet might be Western firms with exposure to emerging markets. Unfortunately, Unilever is already quite expensive.
Tim B: Is there anything cheap that fits the criteria at the moment?
Steve: Kraft (NYSE: KFT), if it doesn't pay too much for Cadbury, will have done a quite transformational deal. And if it doesn't, then Kraft is already priced very cheaply. I also like Johnson & Johnson (NYSE: JNJ) and Tesco (LSE: TSCO), which I think in three years will be generating the same level of emerging-market sales as Unilever, but is rated rather more cheaply.
Chris: I am not as worried as some. Judging by previous recessions, recovery was always going to be patchy. The normal pattern is that a big monetary-supply boost results in equities going up – and I can't think of many times when that hasn't been a forward indicator of economic growth. Indeed, economic growth forecasts for the US and the UK next year have been going up since May, with inflation subdued. That used to be called a Goldilocks economy when we were bullish. But now we're all bearish, we're not allowed to say that!
Steve: The counter-argument to that is that every recession associated with a banking crisis hasn't panned out well – you tended to have a recovery then a significant setback. We haven't had the economic growth that comes through after an ordinary recession.
Tim B: Do you think the stockmarket rally can continue?
Simon: I think it's run as far as it has because of excess money. But I think QE will be extended. I don't think the policy-makers, whether politicians or bankers, want to contemplate not continuing to feed the system.
Tim P: My concern is that while QE may well have to be sustained, it's distorting every asset price in the world. It is distorting the real price of money and the availability of credit; it's distorting the bond market, and by extension the corporate bond market and spreads there; it's distorting equity valuations, if you believe that investment professionals measure equity valuations against bond valuations; it's distorting currencies, and I think we may end up with a continuation of competitive devaluation globally.
Tim B: So you're a bear?
Tim P: Trying to predict the movement of the major stock indices is now, even more than normal, a fool's game. But I don't care what happens to the indices because I'm not buying the indices, I'm trying to buy individual value situations.
Paul Marriage: The fact that you and everyone else is looking for value means the market must carry on going up, though clearly at a slower pace. There is a heck of a lot of money out there chasing pretty high-risk scenarios and it doesn't feel to me like it's going to roll over in a hurry. So for a quarter or two I'm pretty relaxed about buying value.
Tim B: So where's the value in equity markets now?
Tim P: It has to be in the defensives.
Simon: Does anybody think anything different to that? Because obviously those aren't the companies that are going through the roof.
Tim P: With the benefit of hindsight, if you wanted to generate the absolute hugest returns, you would have bought the crappiest companies back in March.
Paul: Well, you've got to be very careful with the whole 'dash to trash' thing because when people bought low-quality earnings at the beginning of the year, they were buying on extremely low p/es of one or two times. But these were businesses that were worth three or four times two months later, and now they are worth eight or nine times. That's probably fair enough because they are high single-digit p/e businesses that were just massively oversold. So people who bought the dash for trash were correct, because these companies were fundamentally trading at the wrong price. You don't necessarily need to buy them now, but you have to be very careful about saying the trash was wrong – the trash was right at that price.
Steve: If you're going to invest now, make sure you buy things that won't hurt too much if the market halves. That brings us back to those defensive high-yield stocks. They can perhaps fulfil the role that cash was supposed to – which is giving you about a 5% yield to make up for the fact that asset inflation, if not actual CPI inflation, is currently reducing the value of your money by that sort of amount.
Buy things that won't hurt if the market halves. High-yield stocks can fulfill the role that cash was supposed to
Tim B: On high-yield stocks, are you worried about Neil Woodford's concerns that the oil majors might have to cut their dividends?
Chris: Oh, I think that's been in the price for some time. When something is yielding 6.5% or 7%, the market is telling you that there is a risk of a dividend cut. But even so that risk is of losing 25% or 30%. So instead of 6.5% you are expecting 4.5%. Well, 4.5% and growing is not bad.
Tim P: I don't think I'm as concerned as Neil Woodford is, but I accept that these are cyclical industrials and they are struggling to replenish their reserves. But the likes of BP and Shell recognise the role that their dividends play to shareholders, so they will be the last things to get cut.
Steve: We're rather more optimistic, at least on BP. We think it has a more sustainable model than people believe. The Russian unit, TNK, has gone very quiet, always a good sign for that business. So we think BP's dividend is probably sustainable. We can't necessarily say the same for the other majors.
Chris: Getting back to the wider market, the general view seems to be that the recovery is anaemic and we should all buy defensives. But profit forecasts are going up, economic forecasts are going up, and we've seen some phenomenal cash generation by companies alongside some equally phenomenal deleveraging. So companies are getting safer and they are behaving better; they are not as arrogant as they were. Take Regus, the office space provider, which nearly went bust last recession. It's come through this one fine. It's generating a lot of cash, and seeing turnover pick up everywhere but in the UK. Citigroup sees both the European and UK markets on p/es of about 10.5 next year with forecasts rising rather than falling. So if I can buy something on a p/e of ten that's starting to grow, generating cash, why is that not fundamentally a buy? There are a lot of stocks out there which are reasonably sound.
Tim B: So what would you buy now?
Our Roundtable tips
Chris: Regus (LSE: RGU) is a global market leader, it's doing great deals at a time where landlords want them in, and it's generating loads of cash. It's a genuine growth stock. Tate & Lyle (LSE: TATE) is interesting – it's a bit of a turnaround play. All the underlying bits of its business are going quite well at a time when it's been one of the last great mismanaged companies in the UK – over £1bn spent and nothing to show for it in the last few years. Consumer goods group Reckitt Benckiser (LSE: RB) and engineers IMI (LSE: IMI), and Charter (LSE: CHTR) look good too. And if you want to go defensive, you've got GlaxoSmithKline (LSE: GSK) and AstraZeneca (LSE: AZN), on near-single figure p/es with 5% yields. Even if much of the world goes to hell in a handcart, they will still be generating cash.
Steve: The trouble is while it's not difficult to look at stocks in lots of markets and see how they can rise 20% from here, it's also easy to see how they could halve. That makes us more cautious even though we do think the rally will continue.
Paul: I like insurance, where you find dollar earnings and 70% pay-out ratios. Omega Insurance (LSE: OIH) is one I would mention. We also like biotech. It's very high-risk, so I look for Phase III drugs [those in late-stage trials] and plenty of cash – Antisoma (LSE: ASM) comes to mind. Then there's BTG (LSE: BGC) which has been around for years – a very well-managed, quite large biotech.
Simon: I own the International Biotech Trust (LSE: IBT), so I agree. We've also put a lot of money into infrastructure, which has predictable cash flows and is a relatively conservative, inflation-linked investment. It's gone up a bit, but one option is International Public Partnerships (LSE: INPP), which used to be called Babcock & Brown, and invests in PFI-type projects in Europe and the US.
Tim B: Is there value in corporate bonds?
Steve: I'm not sure there was any to start with. People are buying into illiquid markets with fixed nominal yields. It's a dangerous game. If inflation rises as we fear it might, these things will not only go down in value but there will be no buyers. That is potentially dangerous for the equity market because if you can't sell your illiquid corporate bonds, the logical response is to dump equities.
Tim B: What about property?
Paul: When we speak to property professionals they are very, very pessimistic. The sector has rallied hard to some pretty punchy premiums over net asset value (NAV). I would be pretty wary of quoted property right now.
Steve: Commercial property is in for a very rough ride – unless you can secure something with a yield north of 10-15%, I would say it's a very dangerous trade. As for the housing market, it has nowhere near seen the worst. But there's an outside risk that housing, as a real asset in a negative real interest-rate environment, could see an almighty bubble over the next couple of years before things turn really nasty. As I am renting, that is quite a concern.
Tim B: So you are bearish overall but bullish in the short term?
Steve: Bearish but scared of being wrong!
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