Our newsletter writers and experts give us their views on the outlook and big themes for 2014. James Ferguson is still betting on a euro collapse, but agrees with Tim Price that Japan is looking good. Swen Lorenz picks a big blue-chip that is set to succumb to a takeover bid, and David Stevenson looks at how to play ‘fracking’ in Britain.
Fundamental shifts will rock the euro
MoneyWeek editor John Stepek reminds me that for 2013 I confidently predicted the euro would collapse, as banks in the region slashed lending, risking a deflationary slump in the broad money supply that would force the European Central Bank to adopt quantitative easing (QE).
I was wrong, or at least several months early – which in our profession is pretty much the same thing.
In quantum mechanics, physicist Werner Heisenberg proved you can never have absolute knowledge. The more accurately you can pin down the position of a particle, the less you can know about its momentum. Something similar to Heisenberg’s Uncertainty Principle is at work in finance.
You can know what will happen, or when it will happen – but the more confident you are that something must eventually happen, the less certain you can be about when it will take place.
That’s why these forecasts are so tricky: go with what will happen, but risk being a year or two out? Or stick with a trend and hope it has legs? My own preference is to look for fundamental shifts, even at the risk of being too early.
With that proviso in mind, I still think the euro area is rolling over in a very deflationary way. In October 2012 the eurozone measure of broad money supply (M3) was growing at just 3.5%. In October just past, it was down to less than 1%. That’s the sort of level you associate with recessions.
The cause? Bank lending is starting to shrink and there’s much more to come. So either Europe’s economy deflates – which means a painful depression – or the Germans re-write their law books and adopt QE. Neither outcomemakes for a strong euro.
As for Britain, most people expect the economy to accelerate in 2014 after a ‘surprisingly’ strong 2013, hitting perhaps 3% annualised growth. Yet as recently as late April the papers were predicting a triple-dip recession. What’s changed? There are two likely culprits behind this surge. One is QE, which finished a year ago, but has a lagged effect.
The other is the ‘fading’ of government austerity. Many believe that fiscal austerity fades next year. But in fact 2012 was the only year where spending fell (hence the QE) – it dropped by £13bn (less than 2%) from 2011.
For 2013, government spending has already rebounded like a good ’un, and is on track to grow by almost 5.5% (an extra £37bn). That will account for more than half the growth in nominal GDP (ie, GDP before adjusting for inflation). Austerity, it turns out, is more a political than an economic concept.
However, this year, according to the plan, government spending will add a much more sedate 0.6% (£10bn) to nominal GDP. So I wouldn’t get too excited about the UK’s prospects.
The US is the one bright star in the economic firmament in 2014, with all sorts of headwinds falling away. But that implies that QE has outlived its purpose. The end of QE should be good for the dollar and we should also see a rally in Treasuries (which always fall when QE is being deployed). But it is not good news for US stocks.
In the six years since July 2007 when the crisis struck, US equities have only ever gained during QE. Without QE, stocks struggle to mark time at best; and now they are starting to look expensivetoo.
So what does all this imply for asset allocation? Be long the dollar and short the euro, but long European stocks rather than US ones. Gilts and Treasuries will rally when US QE ends, but the shockwave won’t be kind to stocks.
The one place where QE, an economic recovery, and stock valuations compliment each other is Japan, as Tim Price points out next – just remember to hedge the yen (see below)!
• James Ferguson is a founding partner of the MacroStrategy Partnership LLP.
Time to buy Japan
The tail end of 2013 was marked by a flurry of stock-market bears capitulating in the face of ever-rising markets. In an investment world where relative valuations are badly distorted by Niagaras of easy money, it’s profoundly difficult to distinguish between fundamentally attractive markets and momentum-driven disasters in the making.
Fund manager Hugh Hendry, one of the recent converts, wrote in his December letter to investors: “Just be long. Pretty much anything.”
At the risk of appearing old-fashioned, given the magnitude of those monetary distortions and the trillions of freshly minted dollars, pounds and yen that have caused them, it probably pays to be just a touch more discriminating. Market corrections, when they come, are likely to be particularly unforgiving to momentum-driven froth.
A year ago I tipped Asia as a compelling stock-market opportunity. But not just ‘anything’ in Asia – rather, attractively valued, consumer-focused businesses across the region. I used Greg Fisher’s Halley Asian Prosperity Fund, which has returned roughly 30%.
The beauty of value stocks is that they never go out of fashion. And the extraordinary thing about Asia – provided you go ‘off piste’ rather than follow the benchmarks – is that despite having the world’s best fundamentals (including demographics, economic growth, banking and currency stability), it also offers some of the world’s most compelling valuations. There are fast-growing companies in the region that are objectively cheap.
Now that Fisher’s fund has closed to new investors, I feel obliged to look at new opportunities in Asia. One he particularly likes (as does Hendry, in his defence) is Japan. There are several reasons to love Japan, and most of those are due to the fact that so many people hate it:
1. Japanese stocks have been going down for 25 years.
2. The Bank of Japan has promised to double the monetary base. As QE has shown in America and Britain, if you print lots of money, you can make the stockmarket go up. (But be aware of the impact printing will have on the yen.)
3. Two-thirds of companies in the Topix index have no research coverage from a broker. For the third-largest economy in the world, that is extraordinary. It is akin to the bombed-out nature of the American stockmarket in the 1940s when Benjamin Graham, the father of value investing, wrote The Intelligent Investor – perhaps the most useful investment manual ever written.
4. The market is under-owned. Japanese pension funds only have 11% of their assets in domestic stocks. For households, it’s just 5%.
6. Japanese tax-efficient Isa-style accounts are to launch this month. You cannot accuse the Japanese government of not priming the equity-market pump.
So while I think the Asian equity story has legs, the Japanese story in particular looks set for a happy ending. If you buy a Japanese equity fund, just be careful that the manager hedges his yen exposure. How to invest sensibly in stocks amid a QE world gone mad? Japan just might offer the margin of safety we all crave.
• Tim Price is director of investment at PFP Wealth Management. He writes The Price Report newsletter.
Hedging the yen
The point of hedging yen exposure as a British investor is to get the full benefit of rising Japanese share prices without the falling yen dragging on your returns. Remember that this also means that, if Japanese shares fall, you won’t get any offsetting gain from a stronger yen.
The iShares MSCI Japan Monthly £ Hedge ETF (LSE: IJPH) is a cheap way to get hedged exposure to Japan. The exchange-traded fund tracks the MSCI Japan index, which comprises 300 of the largest Japanese firms. The total expense ratio (TER) is 0.64% a year.
If you prefer an active fund, Hideo Shiozumi is one of the top-rated managers just now, with a AAA-rating from Citywire. His Legg Mason Japan fund offers yen-hedged ‘Class X’ shares. Costs are on the low side with a 1.31% TER.
The Lindsell Train Japanese Equity fund is another attractive option. It is very focused, aiming to have no more than 35 companies in its portfolio. The hedged (Class B) shares have risen 53% over the last year and the TER is 1.7% a year.
Reasons to buy AstraZeneca
AstraZeneca (LSE: AZN) is the result of a 1999 British/Swedish merger. The company is the number two pharmaceutical company in Britain (behind GlaxoSmithKline), and number seven worldwide. Yet it seems to be in secular decline.
In 2012 revenues shrank by 7%. Pre-tax profits fell 38%. The first nine months of 2013 brought no relief, with revenue down another 7% and earnings per share for the whole of 2013 set to fall by about a third. In the past six years the company has laid off 32,800 people.
The trouble is that, of all the big pharma stocks, no other company has quite as big a patent-cliff problem as AstraZeneca. The patent cliff refers to the expiry of patents on blockbuster drugs, which opens up competition from the producers of generics – cheap copy-cat medications.
Counting all recent and upcoming expiries of patented blockbusters, AstraZeneca will lose around 40% of its existing revenue in the space of seven years. No matter how hard it tries, it won’t be able to rejuvenate its ageing product portfolio before 2017, which is when its pipeline is likely to start producing one or more big new drugs.
Yet in the past three months, AstraZeneca’s share price has risen sharply. It’s up by more than 20% for the year. Why? Take a closer look at its product portfolio and balance sheet, and you have to conclude that AstraZeneca is more likely than not to fall victim to a predator.
Much as the expiry of patents is weighing on its figures, there is a lot of life left in those old bones. In 2012, AstraZeneca generated cash flow of $7bn. When generics come along, sales of branded drugs generally don’t fall off a cliff, but go into a gradual decline. That’s because many patients remain loyal to an established brand.
This cash flow has allowed the company to retain a strong dividend policy. At £35.40 a share, it yields 4.7%. Management has stated that it aims to keep dividends stable. And AstraZeneca could become an even more potent cash machine, as long as management takes the right steps.
It currently invests roughly $5bn a year in product development. But you could instead see AstraZeneca’s development portfolio as something to be sold off, or shut down.
So instead of throwing cash at product development in the hope of reaping a reward in the 2020s, shareholders could simply take cash off the table in the coming years. The financials are compelling. The company is currently valued at around $74bn. But a buyer could unlock $26bn to $53bn in extra value, according to an estimate made some a while ago by a UBS analyst.
There are few investment opportunities on the planet where it’s possible to deploy several billion dollars of money and be sure of achieving an attractive return. And this is at a time when other drug companies are awash with cash and desperate to find ways of achieving attractive returns on investments into their core business.
Finding finance for such a deal has also become easier. So I believe that sooner rather than later, something big will happen.
In any case, with the yield where it is, AstraZeneca would be worth having even without anything else happening. So the downside risk is limited, while the potential takeover bid makes for additional, significant upside. The dividend yield is the day-to-day return, and capital gains from a bid would be the gravy thrown in for free.
In all, I expect the company to be taken out, sometime in the next year – combining the dividend yield and the potential bid premium, I reckon you could earn 25%-30% in the next 12-18 months on what is a relatively low-risk stock.
• Swen Lorenz is a private investor, entrepreneur and author.
Precious-metals miners will shine
It’s been an incredibly tough year for gold and silver, as Dominic Frisby notes below, and an even tougher one for precious metals miners. But if you think a recovery is on the cards – as I do – now could be a very good time to buy bombed-out mining stocks.
One I particularly like is Canada-listed silver miner SilverCrest (Toronto: SVL). Like many silver producers, its assets are in Mexico. Its flagship property is the 100%-owned Santa Elena Mine, a high-grade silver and gold producer that has only been in commercial production since July 2011.
To date the company has been mining through an open pit, but after some successful exploration it is about to begin an underground operation, of which much is expected. With an eight-year mine life, it’s well positioned to take advantage of higher future silver prices.
The company has only been producing for a couple of years, but it is already developing a very decent track record. Production from Santa Elena hit a record in the third quarter of 2013, and a three-year expansion project SilverCrest started a couple of years ago is starting to drive production a lot higher.
The latest phase – scheduled for completion at the end of the first quarter of 2014 – should increase capacity to 3,000 to 3,500 tonnes a day.
Funding for this expansion and beyond is expected to be completed through cash flow from operations. So as things stand, there’s higher production on the horizon with no additional debt or shareholder dilution. This could potentially double annual production to about five million ounces of silver equivalent by 2015.
Based on a silver price of $28 and gold price of $1,450, this is forecast to produce an eye-watering internal rate of return of 88%. It’s also worth noting that with an all in cost of $13.45, they’re comfortably below the current silver price, so still making good money – even in these challenging market conditions.
• Simon Popple writes the Metals & Miners newsletter.
Back fracking in Britain
I’ve been writing about natural gas, and the ‘fracking revolution‘, for several years. The ability to access gas (and oil) held in shale formations means the US now sits on an abundant, cheap source of energy.
But in 2013, the biggest headlines on fracking came not from America, but from here in Britain.
From politicians making ill-advised comments about the ‘desolate’ north, to high-profile protests in leafy rural locations, fracking in the UK proved one of the most controversial topics of 2013.
I appreciate that lots of people have concerns about fracking. But the key question is this: can we just leave this stuff in the ground? The world desperately needs a reliable, efficient energy source whose supply is secure. It also needs to be affordable, and to minimise environmental damage.
Britain in particular faces growing risks of blackouts over the next two years if our system comes under pressure from unplanned power station shutdowns, or prolonged cold weather. This will only get worse as old power stations are forced to close by anti-pollution regulations, and more nuclear plants are phased out.
No energy source is perfect – but for now, natural gas is a good option. It is less chemically complex than many other sources, with fewer impurities. It’s colourless, odourless, and nontoxic – the cleanest-burning fossil fuel available. Better yet, there’s loads of it – particularly in Britain.
In June last year, the British Geological Society confirmed that one of the largest gas shale fields on the planet lies beneath British soil, in the Bowland Shale. Our offshore reserves could be even bigger. There is a very real opportunity here for Britain to become energy self-sufficient for decades.
Given the benefits, I believe fracking in Britain will go ahead, with an emphasis on public safety, and proper regulation of shale oil and gas drilling operations. This time last year, I tipped French oil and gas giant Total (Paris: FP) as a good play on the global natural gas story.
It has been stepping up its exposure to gas, and has shown strong interest in UK shale. The shares are up around 20% in sterling terms in the last year, but with a gross dividend yield of around 5% and trading on a single-digit price/earnings ratio, I’m still a buyer.
As for a purer play on UK shale, we’ve been holding IGas (LSE: IGAS) for a long time in The Fleet Street Letter portfolio. IGas has a 300 square mile 100%-owned operating licence in the North West of England. In June a study revealed its potential asset base was much larger than expected.
You should invest in this one with a very long-term view – the drive to get fracking off the ground in the UK could taketime. And the drilling business itself is risky. But if the UK really can get its shale act together, IGas will be a prime beneficiary.
• David Stevenson writes and edits The Fleet Street Letter newsletter.
Another horrible year for gold
What a horrible year for gold – down over 25%. It’s been even more awful for the miners, with the majors down 60%, and smaller miners down even more. Can things get much worse in 2014? I’m sorry to say it, but, yes, they can.
There are all sorts of bullish arguments, of course. There’s unprecedented buying in China: Chinese gold imports from Hong Kong are some ten times higher than three years ago. Each month seems to set a new record. That’s on top of China being the largest producer. So Asian demand alone is likely to exceed global production, even as new mine supply looks set to fall.
All but the lowest-cost mines face closure, or at least ‘high-grading’ (when only the high-quality rock is processed). Development projects are being delayed, if not shelved, due to lack of funding. Exploration budgets have practically vanished, so there will be few new discoveries.
The gold mining industry has atrophied. Western governments still run eye-watering deficits, while their accounting systems mean huge debts and obligations are hidden from view. And sentiment is so overwhelmingly bearish, it’s hard to see how gold can be any more loathed.
So much gold has been sold in the West this last year – over a third of exchange-traded fund holdings, for example – that you have to wonder: at what point will there be no more gold to sell? When will we become net buyers again?
Finally, there’s the fact that in the great gold bull market of the 1970s, the price actually fell by over 40% between 1975 and 1976. Perhaps we’re experiencing something similar now.
But, for now, price is what matters – and the price is trending down. The worst may be over, but I can certainly see gold falling another 15% in 2014 and re-testing the $1,050 mark.
I hope I’m wrong – I still own a lot of gold (a good deal more than the 5% that MoneyWeek recommends you keep in your portfolio as insurance). But that’s what I’m seeing.
• Dominic is the author of Life After the State (£7.19 via Amazon).
The big risks for 2014
What are the stumbling blocks to watch out for in the year ahead? These are our main concerns…
War: Money Morning editor Ed Bowsher’s biggest concern for 2014 is some kind of geopolitical flare-up. “There are so many potential trouble points, the chances of at least one turning into a crisis are worryingly high. I can think of three obvious ones.
“Firstly, there’s a chance that North Korea could attack South Korea. Kim Jong Un seems sufficiently irrational that you can’t rule anything out.
“Second – and perhaps most worrying of all – the tension between Japan and China could get out of hand, which could suck in the US.
“Third, there’s always the chance of a further flare-up in the Middle East, either as a result of the Syrian civil war spiralling out into the wider region, or of Iran and Israel going to war. It’s worth keeping abreast of what’s going on so that you can be ready both for buying opportunities and any potential nasty surprises.”
The euro: senior MoneyWeek writer Matthew Partridge thinks investors have become too relaxed about the euro’s future. “Some countries could still leave the zone – and Italy would be the most disruptive. With unemployment high and growth still non-existent, anti-austerity protests, involving both the far-left and far-right, have been growing.
“If Italy did vote to reject the euro, it would be good news for the nation’s economy in the long run – but it would be disastrous for French and German banks, which are still exposed to the periphery.”
While that seems unlikely for now, with the Federal Reserve starting to taper, and the Bank of England apparently under constant pressure to justify its stance on house prices, the threat that central banks will be more aggressive than anyone expects “cannot be entirely ruled out”.
A wealth grab: our share tipster Phil Oakley worries the government will wage a war on savers. “Annual pension contribution limits fall to £40,000 from April and the lifetime pension fund limit drops to £1.25m. But there are still plenty of generous tax reliefs for the government to get its hands on, or for the Labour party to start complaining about. The 25% tax-free pension lump sum might be pared back, and there has been talk of a lifetime cap on the amount held in an Isa (individual savings account).
“The economy may be growing now, but government borrowing levels remain way too high and wealthy investors are an easy target. It would be bad news – but a government savings raid is a distinct possibility.”
A bond market panic: the most over-priced markets are generally the most vulnerable, says editor John Stepek – and right now that’s the bond market. The Fed might be planning to take the taper slow and steady. However, given that even hinting at tapering caused emerging markets plenty of stress earlier in 2013, actually carrying it out could have unintended consequences.
The end-of-year surge seen in the interest rates that banks charge each other in China is just one possible sign of the unexpected impacts the taper might have. With some commentators also worried about just how liquid the bond market is – given new regulations that make banks less inclined to hold the inventories that allow them easily to make markets in bonds – any panic in one area of the market could spread rapidly.
What the finance gurus predict
You’ve read our experts’ views – what are other financial pundits predicting for the year ahead?
Anthony Bolton, the fallen star of the investing world, is bullish on equity markets worldwide next year. In fact, he expects global valuations to “go well above trend” in this cycle, and markets’ capacity to overshoot means that share prices have a fair way to go yet. Bolton doesn’t think we’re in bubble territory yet – this isn’t “an environment where everyone has capitulated and is doing stupid things”.
As for bond markets, Bill Gross of US bond-fund giant Pimco tells Fortune that we can expect more of the same from the Federal Reserve, the US central bank, this year, despite the tentative start to the tapering of its quantitative easing programme.
Ongoing easy money “may not necessarily be a good thing in the long run, but in the short run for bond investors it probably means a year in 2014 of relative stability” – so while 2013 was quite a tough year, he doesn’t expect a bond bear yet.
Also in Fortune, US wealth manager and commentator Barry Ritholtz argues that, while US stocks are hardly cheap anymore, “if you really want to find the sector that is disliked”, you should be looking at the financial sector, including US banks. He likes the Financial Select Sector (NYSE: XLF) exchange-traded fund as a way to play it.
Via the Zero Hedge blog, Marc Faber of the Gloom, Boom and Doom Report newsletter says that stocks in the US look expensive generally, with returns set to be poor over the next seven to ten years. Social media stocks in particular “are grossly overvalued”, he reckons.
He picks out Twitter and Facebook as good candidates for shorting, along with electric car maker Tesla Motors. On the long side, Faber is sticking with gold as insurance (“given that the total credit as a percentage of advanced economies is now 30% higher than in 2007”), and he also thinks that gold shares “are very inexpensive. A basket of gold shares I think next year could easily appreciate 30%.”
Finally, he’s sticking with Vietnam as one of his favourite stockmarkets – it gained 22% in 2013, but he sees scope for this to continue.