Things looked grim at the start of 2009, but the year ended up being great for most assets. So what of 2010? James Ferguson and Tim Price are wary, backing defensive stocks and bonds. Stick with gold too, says Sebastian Lyon. Dominic Frisby reckons the dollar could surprise us. Sven Lorenz has a contrarian property bet. And Paul Hill looks at how to profit from one sure thing the 2010 World Cup.
Why I'm buying up American land
Sven Lorenz
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The most money is made where people least expect it. That's why, last December, I tipped Bank of Georgia (LSE: BGEO). At the time, bank shares were pariahs. And indeed, Bank of Georgia's share price was extremely volatile during the first quarter of 2010, showing just how hard it is to predict short-term market swings. But sanity eventually crept back into the share's valuation. It is now about 80% up on when I tipped it.
For 2010, I'm making a couple of key assumptions. For one, there will be no crash. As a famous Swiss fund manager told me over lunch last week: "All family offices that we know of are sitting on massive amounts of cash, and they are waiting for an opportunity to invest it." With so much cash on the sidelines, a crash just won't happen. But neither will there be a continuation of the huge gains seen since March. What happened then was a tinderbox reaction, possible solely due to the extreme losses experienced at the height of the banking crisis.
What will continue to work are bets on sectors that are more depressed than they deserve to be. A year ago, it was shares in fundamentally sound banks that were unduly punished. Right now, I like US property as an overall theme. In fact, I would have suggested investing in a US mortgage bank. However, I find banks' balance sheets impossible to interpret and I generally prefer to invest in stuff that I understand. One thing I do understand is the favourable demographics of the US. The American population recently broke the 300 million mark. And each year, five to seven million new residents land on its shores. Think what you will of the US, the majority of the world's population would still love to move there. Just check the staggering application numbers for the US Green Card lottery. On top of this, American birth rates are healthy.
I remember going to high school in the US during the awful 1990 recession. There were rows and rows of empty houses. Manhattan was a crime-ridden, no-go area, all but written off by investors. That recession then felt as hopeless as this one feels now. Back then, though, what too many investors forgot is America's ability to pull itself out of a rut. Fast-forward a few years and Florida condos and Manhattan lofts staged a breathtaking recovery.
Having lived in various European countries as well as in the US, I strongly believe that America's ability to reform itself is without equal. In America, the nasty stuff gets exposed and dealt with. In Europe, a lot is swept under the carpet. The willingness to accept unpleasant change, however necessary, is much lower than in the US.
You don't have to take insane risks to bet on a US recovery. The key lies in buying cheap land in some of its most attractive states. There are several, mostly ancient, US-listed firms that do little more than own vast landbanks (and who don't have overly high debt burdens).
Take Florida-based Alico Inc. (Nasdaq: ALCO), a spin-off from the Atlantic Coast Line Railroad Company. Formed in 1960, Alico's primary assets are 135,000 acres of land in the Sunshine State. That's 546 square kilometres, almost twice the size of Malta. Most of it is used for farming, but every now and then the zoning for some of the land changes and it can be developed. Right now, the share price is two-thirds below its all-time peak and is trading at its lowest point for nearly ten years.
A similar operation is run by Tejon Ranch (NYSE: TRC), which owns 270,000 acres roughly 60 miles north of Los Angeles. Much of the land is used for agriculture, but the management team is actively exploring developing opportunities. Tejon shares have lost more than half of their value and are also trading at their lowest point for ten years.
A slightly more speculative option is The St. Joe Company (NYSE: JOE), which has already taken a more active approach towards developing its land. The company owns a staggering 580,000 acres in North-West Florida. Some 41,000 acres have already been earmarked for developing, and the remaining parts are largely used to grow forests for the pulp and paper industry.
As a more active developer, The St. Joe Company has more risk on its balance sheet than Alico or Tejon Ranch. But it makes up for that by having a bigger upside once the markets recover. The firm's shares have also lost two-thirds of their value and are trading at their late 1990s level.
Picking the ideal time to buy isn't easy. However, there's no doubt that land in two of the most desirable US states will one day become a sought-after commodity again. These stocks allow you to pick up a bargain without having to worry about the company surviving or skeletons being pulled out of the closet. Buy and sit tight it will pay off.
Sven Lorenz is CEO of Zurich-based finance firm ARBB AG, as well as an active investor and published author. His blog is at www.undervalued-shares.com .
Back defensive stocks and bonds
Tim Price
The markets confounded just about everyone last year. After plumbing the depths in March, stocks shot back up, led by banking shares and other speculative investments. Pundits decided it was a "rational bubble" which is, with hindsight, what happens when interest rates are driven down to zero and investors scramble to find meaningful returns.
There is a growing consensus that hefty government support has underpinned the banking sector. But it's also becoming clear that in bailing out the banks, governments have badly damaged their own finances. Unless the Anglo-Saxon economies fall back into recession, it's hard to see much value in conventional government bonds.
UK gilts in particular face the threat of an end to quantitative easing in 2010. The market may not take too kindly to the disappearance of the Bank of England as the buyer of last resort for gilts. There is a real risk that yields will spike sharply in 2010 in other words, that gilt prices will collapse. Political risk is also rising. Morgan Stanley recently pointed out that a hung parliament could easily soften the political will to tackle our fiscal deficit.
Indeed, while Dubai was attracting most of the headlines at the end of last year, Moody's was hinting that the AAA-credit ratings of both America and Britain might be sorely tested in 2010. The US and the UK, it reported, have "resilient" AAA ratings, whereas those of France, Canada and Germany are deemed "resistant". But the truth is there are precious few safe havens left, and G7 government debt is hardly among them. For this reason, when it comes to bonds, I continue to favour the sovereign bonds issued by the world's most creditworthy countries.
The events in Dubai are probably a red herring, given the overall assets of the parent United Arab Emirates. Dubai's total sovereign and corporate debt is put at roughly $80bn. At the federal level the UAE is believed to have net foreign assets of around $900bn. Compare the Gulf region to Britain. Kuwait, Qatar and Abu Dhabi have net foreign assets of 468% of GDP, 387% of GDP and 334% of GDP respectively, according to specialist credit managers Stratton Street. Britain, by contrast, has net foreign liabilities amounting to 30% of GDP. Whose debts would you rather hold?
Stratton Street are advisers to the New Capital Wealthy Nations Bond Fund (contact GAM Fund Management on 00 353 1 609 3927; or call Andrew Clark at Stratton Street on 020-7766 0888 be aware that there are minimum investment requirements). This is the only vehicle I have found that invests on the basis of sensible exposure to creditworthy countries unlike ex-growth nations, such as America and Britain, which are groaning under unsupportable debt loads.
As for stocks, in 2009 the riskiest shares did best. It is difficult to see this risk-asset rally lasting. Britain in particular seems set for an extended period of sub-par growth, with government finances fragile, a general election looming, and credit availability thin on the ground. Investors will be a lot more picky about what they buy during 2010. So, as before, I prefer defensive stocks.
And I'm still keen, as I was last year, on the alternative currency known as gold. The rally in the gold price turned exponential in December. Shorter-term sell-offs are to be expected, with gold perhaps testing $1,000 an ounce and even $800. But given the problems facing currencies such as the US dollar and sterling, I will be a continued buyer of gold and silver, and will look forward to building positions on any weakness.
Tim Price is director of investment at PFP Wealth Management. He also edits The Price Report newsletter.
Stockpile gold and debt-free stocks
Sebastian Lyon
The UK market peaked on the eve of the millennium in a wave of technological optimism. Ten years on and 25% lower, the FTSE 100 is stuck in a prolonged bear market. Might we be turning Japanese? A 20-year performance like that of the Nikkei 225 would leave the UK market 75% off its peak by 2020. This can't be ruled out. But we think it unlikely.
There are similarities between the Japanese crisis and ours namely, the banking bail-outs and unwillingness of the banks to recognise their bad debts. But the differences are greater. The Japanese market had further to fall. It was far more overvalued at its peak than the US and UK markets have been.
Then look at savings. In the 1990s, the Japanese savings ratio was 14%. Individuals were happy to buy low-yielding Japanese government bonds. The economy also benefited from a healthy balance of payments surplus. These two factors underpinned the yen and held off inflation, even when the fiscal deficit was ballooning out of control. In Britain and America, savings ratios are low and trade deficits stubborn.
At the same time, loose monetary policy and quantitative easing strategies (which surely compromise the value of our existing money) are likely to lead to further falls in sterling and imported inflation. That's something the Bank of England Pension Fund appeared to recognise when it published its annual report recently. Over the past two years, the trustees have increased their exposure to index-linked gilts from 26% of the fund to a staggering 88%. It's clear where they think future risk lies.
So how do we protect ourselves from the monetary damage yet to come? One possibility is to follow the Bank and buy index-linked gilts. But the purest answer is gold. We started investing in gold shares in 2003 and acquired bullion for the first time in 2005 at a price of $424 per ounce.
The current price is around $1,100. We're constantly being told the conventional reasons for not holding gold: 'it pays no interest'; 'it has no industrial use', and the new favourite, 'it's a bubble'. But none rings true today. It is, at times, useful to have an asset that provides capital gain instead of income, particularly when that income is likely to be taxed at increasing levels. Gold has little industrial use, but how much of that does a UK gilt have?
As for the bubble business: in late 1999 the post boy at Marconi asked me for stock tips that would benefit from the growth in fibre optics. Then in early 2000, I attended a conference of internet and software firms. The companies presenting hardly had any revenues, let alone profits. They were valued on multiples of 'clicks'. Yet here they were, on the cusp of entering our blue-chip index. Huddled at the back, feeling uneasy, I came across one of my peers. "Do you own any of this rubbish?" I asked. He did. "Sebastian," he said, "if you are not in tech, you're dead!"
That was a bubble. This is not. With the exception of the few gold funds, not many investors hold 2%-3% plus of their portfolio in gold. Most still view it as pretty risky. Yet gold has made positive returns every year since 2001 (in US dollar terms). These are the characteristics of a bull market, not a bubble.
Today some of the world's smartest investors hedge-fund managers John Paulson and David Einhorn are advocating the yellow metal's merits, while central banks, sellers of gold for over a decade, have turned buyers. In November, the Reserve Bank of India bought 200 million tonnes of IMF gold. Gold is no longer a contrarian call, but it could go a great deal higher from here.
So, other than index-linked gilts and gold, what else can investors do to preserve the real value of their cash? In the equity markets we suspect the re-pricing of distressed firms has come to an end. Our preference is for firms with strong balance sheets, little or no debt, and with broad international earnings that generate consistent profits outside the UK and the US. Think Nestl (Zurich: NESN), Coca Cola (NYSE: KO) and Colgate Palmolive (NYSE: CL). All make products in demand from an aspiring middle-class worldwide.
These stocks aren't sitting on rock-bottom valuations businesses of this strength and breadth rarely do. If we are right about the tough times ahead, they'll give us dividend certainty, earnings predictability, and some protection from inflation. We're not as optimistic on stockmarkets as we were a year ago. Confidence has already returned and prices are less distressed. But the outlook now is better than it was for the decade following 1999. Valuations are lower, as are expectations. Both are a good starting point.
Sebastian Lyon is chief executive of Troy Asset Management.
The banking crisis isn't over yet
James Ferguson
We don't yet know for sure whether 2008's turbulence was just a close shave, or if there are still serious problems to address. So global stockmarkets have picked the middle course. Share prices have regained roughly half of what they lost from the complacent 2007 peak to the nadir of despair in March 2009. But markets are still largely flying blind.
Here's what we do know. Huge government intervention (financed by huge debt) has stopped the economy from shrinking. Every recovery from recession for at least two and a half generations has been V-shaped. Indeed, the faster and deeper the recession, the faster and stronger the recovery. So no wonder markets have rebounded. With analysts expecting earnings growth of 35%-50% for 2010, and 25% in 2011, you could be forgiven for thinking that markets should have done more.
But there's a problem with this story. When an economic crisis is centred in the banking system, all bets on recovery are off. Why? First, the banking sector has a unique place in the economy. It is the other side of all other economic players' balance sheets; our assets are the banks' liabilities and vice versa. Second, the banking sector is the government's subcontractor, responsible for executing monetary policy.
This is vital because economies, especially those emerging from recession, respond mainly to monetary stimuli. If credit is more easily available at lower rates of interest then big-ticket items bought on credit (ie, durable goods and houses) get moving again. As demand picks up, inventories decline, prices rise and more people need to be employed to make and do stuff. If the stimulation is left in place too long, it can quickly become inflationary.
But this isn't the case when the banks' risk assets are too large for their overly-thin capital bases. In such post-crisis scenarios (such as the 1930s, the Nordic crisis of the early 1990s, Japan for the last decade or more) the central bank thinks it is applying monetary stimulus to the real economy. But unfortunately, the banks themselves are actually tightening monetary policy. That's because the only way they can shrink their risk assets is by making credit less easily available. The only way they can build up their capital is by widening their spreads (ie, increasing rates of interest).
The trouble is, in the early stages, you can't tell the difference between an economy that is responding only to huge (temporary) fiscal intervention and one embarking on the early part of a self-sustaining V-shaped recovery. But if previous banking crises are anything to go by, problems with the V-shaped view will start to become apparent as we go through 2010, though more obviously at the back end of the year than the beginning. While 2009 started miserably but turned more upbeat later in the year, I bet the economy in 2010 will, more like 2008, start well but be swamped by frustrations as the year progresses.
For example, firms have maintained profit margins in the face of a sudden drop in demand by cutting costs, largely labour-related. So where will the recovery in demand come from if the consumer has borne the brunt of the cost-cutting? Also, such a sudden loss of demand meant firms had to react to sharply higher stocks and stuffed distribution channels by cutting production and hours worked.
When demand growth returns in 2010, albeit at a reduced rate, from a lower level and driven mainly by government fiscal stimulation, it's only then that it will make sense for firms to compete on price. The economist Joseph Schumpeter talked of 'creative destruction', when excess capacity is cut from the economy during recession to allow a more efficient reallocation of resources when recovery comes. There's been little excess capacity cut (China has added prodigious amounts) and government fiscal stimulation is the epitome of centrally planned, politically directed and thus inefficient allocation of resources.
And housing? I'm not surprised prices have enjoyed a small fillip. Since interest rates have been cut over the last 14 months from 5% to 0.5%, prices should have more than doubled. Rates can only go up from here. There's nothing more the authorities can do to support, let alone drive up prices. From here on, either nominal interest rates rise as inflation returns (unlikely), which would destroy affordability, or real interest rates rise as the bank crisis grinds on (more likely). This would deflate the economy and asset values, notably those reliant on credit. The house-price recession is still only two years into what in the 1990s was a six-year decline. This time it may last even longer.
In all, history suggests 2010 will look more like 2008 than 2009. The reflation rebound that's driven markets up over the past nine months will be replaced by a more disappointed, cynical, caste. Bonds may temporarily look wobbly over the next quarter, with seemingly strong GDP growth and inflation data (with VAT rebounding to 17.5% from the start of this year), but this should be ideal for defensive, high-yielding stocks. Boring is back.
James Ferguson is chief strategist for Pali International. He also writes the Model Investor newsletter.
Play the World Cup
Paul Hill
I believe there will be a double dip recession towards the end of 2010 as government spending is reined in and the real economy struggles to stand on its own two feet. It's hard to be precise, of course, but assuming that equity markets react six to nine months ahead, a 15%-20% sell-off in the first half seems likely, sending the FTSE 100 back down to around 4,250.
So investors should stick to undervalued companies with sound balance sheets. Vislink (LSE: VLK) is one such firm. This communications firm should benefit from the one cast-iron certainty in 2010 the football World Cup. Its microwave radio and satellite transmission products enable broadcasters (50% of sales), such as Sky and the BBC, to televise sports and news events from remote locations across the world.
And because of the popularity of high definition TV, the World Cup should trigger equipment upgrades by TV stations as they shift from standard to high-definition picture quality. This is just part of the story. Vislink also supplies kit to the off-shore oil and gas industry (35%), and the rapidly-growing homeland security and services (15% revenues) markets.
I expect 2010 turnover and underlying earnings per share to come in at £86m and 2.9p respectively, and £92m and 3.5p in 2011. That puts the stock on low p/e multiples of 7.7 and 6.5 for the next two years. It also pays a 1.25p dividend, giving a 5.5% yield. Another benefit, if you're a sterling bear like me, is that 90% of revenues are derived overseas, protecting shareholders against further pound softness. Meanwhile, net debt is put at a comfortable £1m.
There's a chance that if conditions get very tough and one of its customers goes bust, say, that the dividend could be trimmed. There's also the danger of further contract slippage, delays in the adoption of high definition, and foreign exchange fluctuations. But with good management and state-of-the-art technology, I rate this as a buy for bolder investors. My fair value on the stock is 33p a share.
Paul Hill writes a weekly share-tipping newsletter, Precision Guided Investments
Two heavyweights will win in 2010: the dollar and David Haye
Dominic Frisby
This year, I find it hard to be positive on anything. It feels a little like late 2006 and early 2007, when despite awareness of impending problems in the US housing and debt markets, the stockmarkets just kept rising. It's the same now, only sovereign debt is the issue.
The countries of southern and eastern Europe are in deep trouble, not to mention our good or not so good selves. Everyone seems to know that the economic fundamentals are rotten, that this banking crisis has been postponed rather than properly dealt with, and that there are major debt-related problems lurking. Yet markets have moved on up. For me it's a question of not if, but when they next fall and by how far. At some stage in the next 18 months, I suspect they will re-test the March 2009 lows. It may be that 2008 was not the crisis it was just the warning.
Gold should continue to do well in such an uncertain environment. I'm betting it will finish the year higher than when it started, as it has for each of the last nine years. But 2010 may not be as good for gold as 2009 was. Another liquidity crisis could hurt it, as could a rising dollar, and a falling stockmarket could hurt gold stocks. Whatever happens, we'll see a lot of volatility. Prices could fall as low as $860 an ounce. But they could also go as high as $1,500, though it may be 2011 before we get there.
Other metals also had a spectacular 2009. Silver rose by 50%, lead by more than 100%, palladium by 90%, and platinum by 50%. Common copper and rare earth metals surged too. But I do not see the same gains for any metal in 2010. They had such a good 2009 because they were bouncing off an awful 2008. We may see the reverse in 2010.
If I was to bet on one surprise, it would be the US dollar. Just as metals got bashed in 2008, and were strong in 2009, so the dollar got bashed in 2009 and will be strong in 2010. The US dollar index (which measures the dollar's performance against a basket of its major trading partners) is currently at 77. I think it will rise to 92 this year. If it does, there will be pain elsewhere.
Back home, I expect the bear market in housing to start up again with vigour. Low interest rates and a temporarily forgiving attitude on behalf of lenders have reduced the number of sellers, creating an 'artificial' market. This can't be sustained indefinitely. Sterling could also come under selling pressure from abroad, such are our levels of debt. Any kind of sterling crisis would most likely mean higher interest rates, the consequences of which don't bear thinking about. If taxes keep rising, many foreign-owned businesses, particularly in the world of finance on which we depend so heavily, as well as the super rich, will just up-sticks and leave.
Two non-financial predictions to finish off. First, the Tories will win the general election by an even bigger margin than Tony Blair in 1997. But they will waste their honeymoon first year, when you can pretty much do what you like without the media and public getting on your back, squandering the chance to make tough choices, impose fiscal discipline and implement the reforms that really need making. Second, I was right about David Haye when I said he would become heavyweight world champion in 2009. In 2010, I'm betting he'll unify the belts.
This article was originally published in MoneyWeek magazine issue number 468 on 8 January 2009, and was available exclusively to magazine subscribers. To read more articles like this, ensure you don't miss a thing, and get instant access to all our premium content, subscribe to MoneyWeek magazine now and get your first three issues free.
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