The 18 investments to buy now for a prosperous 2010
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MoneyWeek Editor
John Stepek Dec 24, 2009
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John Stepek chairs our panel of experts and asks where they would – and would not – place their own money in today's markets.
John Stepek: Will we see a double-dip in 2010?
Patrick Evershed: I fear we might. Asset values have risen because of quantitative easing (QE), because Armageddon hasn't come and because destocking has been replaced by restocking. But when that ends and UK tax rates rise, things are going to get much more difficult.
Jim Mellon: In terms of valuations, we are clearly overextended in almost every asset category, except perhaps the deflationary ones. In the absence of a lot of credit creation, and given that a lot of people are fully invested, I think we're in for a very tough year. I would be short the market and most risky assets. And I'm looking for a big dollar rally in the New Year.
Jonathan Compton: Next year will be all about sovereign default. You're getting warning shots the whole time. You could see Dubai coming. You can see the UK coming. You can see Greece and Spain coming. I've never believed that central banks set interest rates. They're set by the people who buy bonds. At some point they won't be prepared to buy UK government bonds yielding 3.6% or US bonds at 3.4% – they'll want 4%. They're the ones who'll push up rates.
Our Roundtable panel
Jonathan Compton
Managing director of Bedlam Asset Management
Patrick Evershed
Investment manager at Hargreave Hale
James Ferguson
Chief strategist at, Pali International
Max King
Portfolio manager at Investec Asset Management
Jim Mellon
Chairman of Burnbrae Limited
James Ferguson: If countries believe they have to show the bond markets they mean business, they'll start cutting spending and hiking taxes. But there are two problems with this. Firstly, hiking taxes in Japan actually lowered the tax-take. So we really have to hope there are no tax increases and possibly tax cuts instead. But doing this leaves you in a difficult position. It looks like you are going to have runaway deficits. But we're in a post-banking-crisis scenario here.
What's happening is that banks need to move from risk assets to risk-free assets. They do this by shrinking what they lend to the private sector and buying government debt instead. Jonathan is concerned that buyers will want higher yields on government debt. But what the banks, the main buyers, really need is risk-free assets. So they won't be worrying about demanding higher yields.
Jonathan: But what about international lenders?
James: I agree with that. But there will be enough demand for future bond issuance to be taken up entirely by the banks, the domestic lenders. The market does not get what's going on. It's looking at QE and predicting inflation. But imagine a bathtub. With QE, the taps have been turned on and water is gushing into the tub. But the banks have pulled the plug. They are closing down their loans to the private sector. So the level of the bathtub is rising at the slowest rate in living memory. British bank lending in the last year has gone up 3.7%. American bank lending is down 8%. We are dangerously close to a deflationary situation in the real economy. Next year is when people will start to get that.
Patrick: I agree. But people have also been putting money into equities because they are getting nothing from the bank or building society.
Max King: That's nonsense. People have been buying equities not because money is burning a hole in their pockets, but because of two things: value and earnings. Consensus global estimates say that earnings will advance 30% next year, having gone down a little under 7% this year. That puts the global market on a p/e of under 14 times for next year. On a long-term basis that's pretty good value. So markets are cheap.
Now there's a strong chance they'll stay frustratingly flat next year, because they see too many issues ahead. There's also a reasonable chance that the issues start to be resolved, in which case equities will go up. But I think there is very little chance they will go down.
And I think a double dip is unlikely. The deeper the recession, the stronger the recovery. So history suggests we'll get a V-shaped recovery. But that would push up inflationary pressures, so interest rates would go up, which would leave firms struggling. What we've got to hope for is a modest, slow and steady recovery, rather than the V-shape.
Patrick: But look at Japan. They're still in serious trouble after 20 years.
James: Japan is in trouble because Japan didn't address the problem. And we're not addressing it either. You don't come out of a bank crisis until you've fixed your banks. People don't seem to understand that the banks are only turning a profit again now because we changed the accounting rules. We haven't really started addressing their bad debts. This is exactly what Japan did. They had a lot of problem loans, but they just tried to pretend they weren't there and extended the duration of the debts. You can see how well that's worked. The reality is that until you have forced loss recognition and replaced the capital that gets eroded by those losses, the banks will not be lending.
John: So where should we invest now?
Jim: Forget equities. There are record levels of short positions against the dollar. If you want to make money over the next year I would short the euro against the US dollar. That's the best pair. But you can have all sorts of more obscure things. I would buy the zloty against the euro. Poland is going to grow and euroland isn't, and the zloty is clearly undervalued.
Max: And the rouble?
Jim: I made my money in Russia. But I think you sell everything in Russia from now on. It's always going to be stolen from you. It's a big kleptocracy, basically.
Max: Like Britain?
Jim: Well, that takes me onto my next tip, which is to sell the banks. Whatever their prospects are, they will have to raise more capital, as James says. And the government is going to try and take any profits they make away from them. So I think they are a fantastic sell idea.
If you want a good equity pair in terms of broad positioning, buy the Nikkei and sell the S&P 500. It's a very, very good pairs trade. Japanese firms sell at about ten times earnings. The strong yen and the recession have forced them to cut costs and bring in huge efficiencies. The US on most measures is expensive, even taking an optimistic view of next year. So I would go long Japan and go short the US. But do the opposite on the currency – I'd be long the US dollar and short the yen.
As for stocks, I still like Billing Services Group (LSE: BILL). I own just under the takeover threshold in this company. It dominates the American telephone billing market. It's a very good payment solution. Over the next two or three years this will be a huge growth area for the company. It sends out 125 million bills a month and you can put downloads, such as iTunes, on to your bill. Doing it this way avoids all sorts of credit issues. There are many unbanked people and people with no credit cards in America, so I think it's going to be a very big market.
John: When you tipped this last year it was 8p, and it's 20p now. Still a buy?
Jim: Yes. The market capitalisation is about £60m; it makes $50m a year Ebitda; it's not got much debt left; and if the payment solution business gets traction, we'll get a $1bn or $2bn valuation on this, or one of the payment processing firms will buy it.
John: Do you still have a view on gold?
Jim: I'm out of gold. I think it's totally stagnant. When you see advertisements inviting you to send your gold ring in and get some cash back in an envelope, you have to wonder why you'd buy gold right now.
Jonathan: We are 14% in gold shares and we've had that since 2003, so it's hardly new. But I think I'll still run it. Central bank supply and demand has changed structurally. From 1972 to about 2007, apart from 1999, central banks were selling. But last year European central banks stopped selling. This year they're net buyers. I would now go for Canadian gold miner Yamana (TSX: YRI), because it's got a spread of mines producing at quite low cost.
John: What about oil?
James: If Jim is half-right on the dollar, oil goes down.
Patrick: There are two contrary factors at work here. One is that stocks around the world are very high with a whole lot of tankers absolutely full of oil. But on the other hand, oil is getting increasingly expensive to find and extract. So in the long-term, I think the price of oil will go up. But in the short-term I'm worried about the large stockpiles.
James: But isn't that always the case? The trend is always that the low-hanging fruit is taken. But technological advances mean that the costs of extraction, apart from the near-term volatility, constantly keep up. So in my experience, the short-term cyclical pressure beats the long-term trend every single time. If you think oil is vulnerable in the short-term, but that it's going up in the long run, you should get out.
Jonathan: We haven't bought an oil stock for two years because we can't work out the supply and demand dynamics. What I'm really after is sectors where there is a capacity shortage, such as the nuclear industry. Engineering giant Shaw Group (NYSE: SHAW) in the US is an interesting, highly-leveraged nuclear play, which seems to be doing all the right things. And Japan Steel Works (Tokyo: 5631) basically has a monopoly on making nuclear flasks.
Jim: There's a big nuclear consultancy – Redhall (LSE: RHL) – here in Britain as well. Their shares have bounced recently, but they are still very cheap.
Jonathan: I like infrastructure generally. Last year the world started building railways again for the first time in a long time. There you've got Invensys (LSE: ISYS) in Britain and Ansaldo (Milan: STS) in Italy. I like the drugs sector too. It's a natural play on an emerging-market world. Sanofi-Aventis (Paris: SAN) is my favourite. I like its research and development pipeline and the fact that the number of drugs that will be dropping off patent soon is quite low. It's got a cash flow I can measure and touch and take for the next four or five years.
James: I agree with Jim and Jonathan on most things, but I'd disagree with Jonathan on government bonds. When foreigners sell their existing holdings of government bonds, I think we'll see that mainly reflected in currencies. The problem is working out which currency goes in which order. The dollar and sterling have already had turns at being the whipping boys of the forex markets, so I agree that the euro looks vulnerable in 2010, as everybody in euroland realises they didn't escape unscathed. But actual net money growth is very low, which is very deflationary. And that's good for bonds. So I think you'll be surprised how well good old-fashioned government bonds will do in the big OECD countries, even in Britain. But US Treasuries will be better because you get the dollar play.
Jim: That's a fair point. You look at Japanese government bond yields and for years people have been saying short, short, short, and they're getting burnt the whole time. That's despite Japan's obvious deficits – it's because it is in a deflationary world and it could be the same here.
James: And because for as long as the banks aren't fixed, they'll take money out of the private sector and government bonds will do surprisingly well. When it ends that will flip, but not until then.
John: What about you, Max?
Max: Gold is a good place to start. The rising gold price suggests that people haven't got confidence in paper money. If they don't have confidence in paper money, their confidence in paper shares is limited too. So the key for next year will be a peak in the gold price. When it peaks, the tail wind will be behind equities again. It may not happen next year. It's quite possible that QE will restart and the gold price will go through $2,000, $3,000, whatever. But I think it's more likely gold will peak next year and that's your green light for equities.
So either it could be a dull, frustrating year in which equity markets go sideways, or you could see governments get their act together and the gold price peaking, in which case equities will give you a very decent return. So it's worth being in the market. And there are so many themes that work: emerging markets, pharma, Japan, small caps – you don't need to put all your eggs in one basket. I think government bonds will be dull. But I think corporate credit is still reasonably attractive and we like emerging-market debt as well. So buy risk assets, be prepared for a dull year, and be pleasantly surprised if you make decent money.
John: Any specific funds you like?
Max: You covered the Investec UK Smaller Companies Fund (020-7597 1800) recently. I think that's a good fund. On emerging markets, my tips this year were Russia at the start of the year and Argentina during the year. But don't get focused on hot stories such as China. China is a good story, but it's not a great one. Latin America is a good story. Africa is very good. India is probably expensive. The best thing is to have an all-round emerging market or frontier fund. The Advance Frontier Fund (LSE: AFMF) is good. Some private equity funds are cheap too – they've been left behind. I like Candover (LSE: CDI), Electra (LSE: ELTA) and Pantheon (LSE: PIN).
Patrick: The one thing that is absolutely certain is that tax rates are going to go up. That makes it more sensible than before to invest in Venture Capital Trusts (VCTs). The problem is that virtually all the VCTs around have been disasters. But over the last six months I have come across one VCT that is exceptionally good. It happens to be the Hargreave Hale VCT 2 (LSE: HHVT). It's gone up 22% since April 2007, while the Aim index has gone down 43%. As long as you don't put more than £200,000 in any one year into a VCT, all the capital gains and all income is tax free, although if you want to get the income tax allowances, you have to buy new shares.
On individual stocks, because I'm very bearish of the UK, I'm looking to China. One of my favourite stocks is Geong International (LSE: GNG), which provides software for banks and telephone companies in China. So far it has focused on the biggest banks. It's now going to expand into all the smaller banks in China and has raised the funds to do it. Short-term growth might slow down a bit as upfront costs rise, but it's on a p/e of 8.2, which looks very low for a company that has been growing at 20% a year.
In Britain I like Paragon (LSE: PAG), which lends to the buy-to-let market. It's brilliantly run – its debt and impairments have been much lower than almost any other firm in its sector. But it had big problems last year because it depends on borrowing from the wholesale market.
Our Roundtable tips
John: Has it restarted lending yet?
Patrick: It won't be able to lend on a significant scale until the wholesale market opens. But Nationwide and Lloyds have recently borrowed wholesale, so it looks as if sometime over the next few weeks or months Paragon will be able to borrow too. And the competition has effectively disappeared. Northern Rock were the big boys and they're gone now, because they were lending recklessly. Paragon, which only ever lent at 65% loan-to-value, remains strong, yet the share price is only a third of what it was. I think over the next two or three years it will recover.
John: What about UK property in general?
Jim: In Britain, regardless of whether there's a double dip or not, any recovery will be tepid at best. At worst, we'll sludge along the bottom like Japan for 20 years. In those circumstances, you are not going to get rising property prices. So except for the fact that we all have to live somewhere, I don't see any big upside. I love reading all these estate agents talking the market up and saying that commercial property is up 3.2% since the bottom – who cares? It's down 40% and it can go down another 30% ultimately. It's just a load of hype. My biggest personal investment remains in German property, although I am trying to find a way of hedging out the euro risk just now. German property has got lots of positive things going for it that we don't have in this country. It never went up in the first place, and seems to have held its own, which is good.
John: Do you see any catalysts to push prices higher?
Jim: The big one is that older Germans are concerned about getting no returns on their euros. So they're doing what the British did in the last ten years, which is buy-to-let. There is huge interest – it's a quasi-privatisation basically, from big portfolios into individuals' hands. For instance, in Munich, which is one of the richest parts of Germany, or Hamburg, the rate at which you buy property has gone from about a 7% yield gross to just under 4.5% in the last two years. I think that, on paper, I've probably made quite a lot of money.
The Germans have not traditionally been property buyers. But all it takes is a bit of unlocking of the mortgage market – which has been happening – and a desire to get a return on your money. Also on a net basis, they haven't built anything since 1991 in Germany. Even today, you are buying property at half replacement cost with no attribution for land value.
John: Aren't the rental rules quite tough?
Jim: They're not bad in terms of being able to raise rents – you can raise them by about 20% every three years. There is a reference in each zone about what you can raise your rents to and what the guidelines are. The problem is that tenants have a very strong entitlement culture. So you get lots of people not paying and you can't necessarily go in and throw them out. You also have a lot of complaints. A light bulb isn't in and they won't pay 10% of the rent or whatever. So there is a lot of micromanagement. However, I do think it's a very good investment. I put my own money into it, and I'm also involved in a company investing in German property called Speymill Deutsche Immobilien (LSE: SDIC). Last year its net asset value (NAV) was flat in euro terms, which for a property company is a rarity.
James: The question this year is not "why has property gone up a bit?", but "why hasn't it gone up an awful lot more?" The thing that drives UK property values is short rates, and short rates just went virtually to zero. If you can't generate the highest possible property prices from that scenario, you've got a problem. The trouble is, if interest rates stay low, so your mortgage remains affordable, then there won't be any inflation and the real value of your mortgage won't be eroded away.
Alternatively, it will be eroded away by inflation but interest rates will go to 15% in the interim and you'll be taken out and shot. Anyone buying property in this environment is almost guaranteed to lose. But of course, very few people are buying property right now. Mortgage approvals are still 16% lower than the worst month in the whole of the last housing downturn. That slump knocked 40% in real terms off house prices and lasted six years. So it's very clear that this is a temporary uptick in the middle of, or even at the start of, a generational structural drop in property values.
Max: Yes, I think it's a bad time to buy UK residential property. I also think it makes poor strategic sense for an investor. The key thing, given increasingly rapacious government taxation and all sorts of other threats, is to diversify your assets internationally. So if you do buy property, buy it overseas. Maybe somewhere you want to go on holiday, but also where you might want to live. Because the big story for the future, for our children and grandchildren, will be emigration. A lot of smart people in the 1970s emigrated and did very well. There weren't the opportunities in Britain, so they went to the Middle East, Hong Kong, America. The great advantage of globalisation to people in this country is that it opens opportunities. It's never been easier to move, buy property, work, start a business or acquire assets around the world. So you shouldn't feel as though you are tied to one country.
Jim: That's a very good point. The world has been opened up to all of us in the last 25 years and we can live wherever we want. Why not take advantage of it?
John: Where would you buy?
Max: Cape Town is great. Geneva is going to be a good location. Argentina is cheap. Hong Kong would be terrific if it wasn't so expensive right now. Singapore's a bit dull. Personally, I'd buy in Buenos Aires.
Patrick: I think the whole British economy is shot to pieces for the next decade or two. Buy Alpha Pyrenees (LSE: ALPH), which invests mainly in the periphery around France. The shares have fallen from around 120p to about 30p where they are yielding about 12%. Property values are beginning to go up in Central Paris. I don't think it will be long before they start going up in the periphery. That will help Alpha Pyrenees and meanwhile you've got a 12% yield.
James: That's a very important general point Patrick has made. If you are ever investing in property as opposed to living in it, you should buy with a view to never selling. You should make sure it will pay for itself even if it's based on 100% borrowing, and at the top of the interest-rate cycle. Then you just sit there being paid. If someone bids you out one day on a sufficiently low yield or cap rate, then you go "alright, you've twisted my arm".
Jonathan: The best for buy and hold is Venice. Yields start at 22%. Everybody says: "it's sinking", but we knew that 1,500 years ago. Where else can you let for 52 weeks a year?
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