After subprime: what the next big story is

This month's roundtable of expert investors include Patrick Evershed, manager of New Star Select Opportunities Fund; Jim Mellon, chairman, Regent Pacific; and Tim Price, director of Investment,PFP Group.

Merryn Somerset-Webb: It would be nice to start with an upbeat thought. Anyone got one?

Jim Mellon: Overall, the markets haven't fallen that much so far.

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Patrick Evershed: If you take out all the Russian mining firms, the FSTE 100 has probably fallen about 20%-25%.

Tim Price: And Aim has fallen a lot, although it has jumped recently in what looks like the world's biggest example of wishful thinking. It's all very odd. There is a residential property-market collapse in the making in America and we're just on the cusp of the same in Britain. Consumer spending, we know, is a large component of GDP, services are a big factor and the financial sector has contributed to recent growth. I don't think anybody expects finance to be a driver going forward. So why Western markets have been, comparatively, as good as they have in recent weeks is simply baffling to me.

Patrick: I think people are being over-optimistic. In large numbers of sectors, possibly not in mining, nor oil at the moment, there are going to be big squeezes.

Merryn: So what's going to make all these over-optimistic people suddenly pull out of the market?

Patrick: When profit margins really start to crumble. Banks are having a rough time. House-builders have had it tough and I think retailers are going to have an extremely rocky ride. The savings ratio has fallen to about 2% when, given our ageing population, it should be more like 12%. So at some point, people are going to have to save a lot more which means a big squeeze. You might think everyone would know this by now, but people are often surprisingly unaware. Think about the tech boom and how that crashed, or consider the Australian mining boom, or the commercial property boom in London in the late 1980s and 1990s. Some of the most informed people on earth over-expanded and went bust.

Tim: If you were going to be outrageously generous, you could say that the market is now looking 18 months, 24 months down the line and pricing in a recovery then but even that is grasping at straws.

Jim: Still, the smaller end of the market is interesting. Small firms have performed very badly in Britain and if there was still a public to private market if there was financing available I'm sure a lot of these companies would be taken over very quickly. The big firms across the Western world are a different matter. Even in America, where markets aren't, like ours, heavily weighted to oil and gas, the indices are barely off their highs. I think it's down to excess liquidity. There's been a huge amount of money injected into the system by central banks to try and prop the banking system up, and that's kept stocks moving. But what I think it can't do is stop Britain slipping into recession. We're already in recession in the States, where the housing crisis, as Tim says, is only halfway done. And with a housing crisis kicking off here, there is no way that this country is going to grow by the Government forecast of 1.6% this year.

Patrick: Still, while the overall outlook is bad, like Jim, I want to separate out some of the Aim companies. Aim is incredibly depressed and there are a lot of bargains to be seen there, especially some of the growth ones that get less publicity.

Jim: There are bargains, but even so there's nothing compelling to make one want to buy now. The only market that looks really good is Japan it looks like it really wants to burst up.

Tim: And it has a compelling valuation.

Patrick: Japan might look good now, but it's a wonderful example of the way markets can be overvalued and take decades to recover from the subsequent crash. It can often take ten years for a market to recover. People aren't always as wise as one thinks they are, and we should take advantage of that fact hence I've still got lots and lots of cash.

Tim: I've got something positive to say: you will all have heard the numbers being bandied about for the recapitalisation of the banks it's going to be somewhere in the region of $2trn. That's bad news. But offset against that number, we should all look at figures from the International Energy Agency, which strongly suggest that the global infrastructure spend over the course of the next decade or so is going to be of the order of $22trn. In other words, the infrastructure spend is going to be ten times bigger as a story than the subprime disaster we're currently living through.

Bundle that in with Asia it's all part of the emerging-market story and surely energy and energy-support services is the only game in town. Some people have begun to refer to dot oil'. But the truth is that these businesses are much more sensibly priced than profitless dotcoms ever were. There's still plenty of money to be made out of a combination of energy and infrastructure stories.

Patrick: There are also firms in the sector that aren't well followed. I like Aim-listed Velosi (VELO), which does safety checks for all the major oil companies and is growing fast. It is on a p/e of just ten.

Merryn: Do you think the oil price will stay high?

Patrick: Not necessarily but even if it falls, the oil firms are investing so heavily that service companies should continue to do well.

Tim: It strikes me that they are in the perfect sweet spot. Now this sounds a bit crass, but they're a bit like arms dealers: they're selling products to all sides and they don't care who wins. So at this point, it makes no odds whether the oil price goes up or down.

Jim: I think the oil price will come back down. As far as I can see, there's a lot of speculation in there, a lot of stuff about Russia and its problems in production and so forth; and, of course, we are facing weakening economies. So I think the oil price will come down to perhaps $80 or $90. But at that level it is still profitable for oil firms to invest, and it's still very profitable to invest in coal mines and so on. So I agree with Tim and I think it's not just an energy situation, it's also an infrastructure play relating to base metals and other key components of growth in China and India. This is much larger in scale than the Industrial Revolution ever was.

Merryn: So hang on to all the big miners?

Tim: Yes, particularly the diversified ones. There's short-term risk here, but taking the long view, you don't want to be underweight on this stuff. For the last five years, it has been all about industrial metals, industrial engineers, mining, electrical equipment, oil-equipment services, chemicals, and oil and gas producers but this trend will run.

Merryn: What about emerging markets?

Jim: Brazil has got to be the best one. It's got everything although it seems to me that the real has got to come down. It's up 100% plus in three years. But the currency I really want to short is Latvia's, the lat. In Latvia, everything is as expensive as in the most expensive parts of Europe, despite the fact that they have massive personal debt, no industry of any substance and the largest current-account deficit in the world. So short the lat! The euro is grossly overvalued too it is quite clearly a short.

Tim: I think sterling is the biggest short out there, so everything has to be seen relative to that.

Merryn: Jim, you'd hold the pound over the euro?

Jim: I'm neutral on that one.

Patrick: The euro over the dollar?

Jim: No, at the moment I prefer the dollar over the euro. It wasn't that long ago that perfectly rational-seeming people thought the euro was a disaster. Now they think it is almighty. But look at Portugal, Ireland, Greece and Spain the PIGS as people are calling them they're disasters that need to see interest rates cut. I think that will be reflected in a fall in the euro.

Patrick: I also wonder if the next move in US rates might be up in, say, 12 to 18 months' time, given the way inflation is going.

Merryn: Do you think we have to keep worrying about inflation even as we are worrying about recession?

Jim: I think we are in an inflationary period, leading to potentially a deflationary period. What we're seeing in the way of inflation now is the reflection of the end of Chinese exported deflation, the continuation of service inflation in the Western world, and, of course, commodity price inflation. But now we are going into a recessionary period and that's not great for pricing. And so we will have inflation for the rest of this year, and then next year we'll get the opposite.

Patrick: But during the 1970s we had recession and very, very high rates of inflation. It is possible to have both. The possibility that we will soon be importing rising Chinese prices is very important.

Jim: But there are alternative places with lower manufacturing costs: there's Vietnam, and even Africa.

Tim: The bigger picture, at least in the near term, is that neither the Fed nor the Bank of England is going to consider putting up interest rates with the housing market in the state it's in.

Merryn: OK. Enough misery. Where should we put our money?

Jim: Short the lat. Then watch out for our new Aim listing, Emerging Metals Ltd. It's involved with all the metals needed to make solar panels indium, for example. The new generation of solar panels requires a different type of semi-conductive material and the metals that work are in short supply. Very few people appreciate that solar is the only renewable energy source that is subject to Moore's Law panel efficiency rises and prices fall tremendously over every 18-month period. The old photovoltaic cells the devices that convert solar energy into electricity had a silicon-structured base that is hard to manufacture and in relatively short supply. But the new ones are just sputtered with semi-conductive material and that involves copper, indium, gallium selenide, or composites of these, and you just roll them out on your roof, or wherever. So we've been buying up all these key metals in order to benefit from the boom. You know solar in a country such as, say, Spain could generate 50% of all electrical output within ten years' time.

Patrick: But it doesn't work at night!

Jim: Well, the battery technology is also very important. Plus it ticks all the Zeitgeist boxes. It's totally clean, whereas nuclear power comes with lots of nasty waste. Windmills are a blight on the landscape and leave a big carbon foot print owing to the cost of manufacturing them. Yet solar, for all that it's a sector full of hype and charlatans, will nonetheless be a very big industry. There is a solar ETF called Claymore (US:TAN), which is a good one.

Merryn: Patrick?

Patrick: Every time I come here I mention Bioquell (LN:BQE), but it's one of my favourite buys. It has the ability to remove MRSA and Clostridium difficile from hospital wards. It's also putting through phased blind-trial tests a cure for leg ulcers, and that's going well. In fact everything is going well for this firm, bar the share price. Otherwise, a firm I haven't mentioned before is Peru-based gold miner Serabi Mining (LN:SRB). Its shares have collapsed in the wake of some technical production problems last year, but these are now sorted out and profits should recover quite quickly. Serabi's brokers have the shares on a p/e of about four for this year and three for next year.

Tim: In Britain, I'd stick with energy services. I like Weir Group (LN:WEIR) and small cap Lamprell Group (LN:LAM). They're performing nicely and aren't, I think, dependent on the oil price staying where it is (although obviously that would help).

My favourite US pick would be Fluor (US:FLR), America's largest engineer. It just reported its first quarter figures and completely demolished analysts' forecasts. It's an engineering and construction firm that caters to the energy sector, services, governments and industrial infrastructure. It even makes reactors for nuclear power plants. It's probably one to average into, because it's had a great run already. But if you want one stock in the area of infrastructure demand and energy spending, and all the rest of it, this is a good one.

Otherwise, I like the Market Vectors Agribusiness ETF (US:MOO). It has holdings throughout the agricultural sphere, in potash, chemicals and construction. This is not the cheapest of the ETFs it has an annual management fee of 65 basis points. But on the plus side, that is half what an actively-managed fund would cost. And the ticker, rather charmingly, is MOO.