How is the tapering of quantitative easing affecting emerging markets? And where should investors look for profits? John Stepek talks to our Roundtable panel of experts to find out what they're buying.
How will the tapering of quantitative easing affect emerging markets? And where should investors look for profits? John Stepek chairs our Roundtable.
John Stepek: The big news is Britain's apparently rampant recovery. But does it spell trouble for Bank of England boss Mark Carney and his quest to keep interest rates low?
Rupert Welchman: I think we've got ahead of ourselves. We're still at a really early stage in any recovery GDP is still 3% below its peak. If we can achieve escape velocity', we will probably have to put up with a bit of turbulence. But we'd take advantage of any dips in the market because, if the economy is improving, that's good news for companies. They've been through terrible times, so they've had to get their balance sheets and cost bases in order, which means they've now got great operational leverage for when better times arrive.
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Marcus Ashworth: Europe is finally showing signs that its economy may not just go straight down all the time. That's important for Britain, because that's really what's holding us back. As for Carney, I'm not convinced by forward guidance. I don't think it's a replacement for active bond buying (quantitative easing, QE). But his biggest problem is that he's at the mercy of the Federal Reserve's actions, like the rest of us.
Robert Jukes: We've seen Asia and Latin America lose momentum, and Carney talking about interest rates being lower for longer. If you boil that down to an investment view, it suggests that the FTSE 100 index, and all the big commodity and resource plays it's stuffed with, will struggle for the foreseeable future, while domestic, consumer-orientated businesses should continue to do well. Crudely put, it's a UK mid-cap versus large-cap story.
Rupert: Yes, two or three years ago stocks that generated 40% or 50% of revenues from emerging markets were all the rage. But now we're asking: how little do you have in emerging markets?
Gene Salerno: Actually, I think we're near a point where the gloomy sentiment towards emerging markets is all played out. During the first six months of the year, emerging markets were hammered. However, the trend of developing markets outperforming emerging ones has broken in the last two months. We may now be past that spiral downward in sentiment.
I think it really is all about sentiment. Most investors would struggle to explain in any technical detail how the end of QE or a slowdown in China would actually affect emerging markets.
Marcus: It's US money coming home. US money propelled these things to ridiculous heights now it's coming back.
Gene: Exactly. But the sucking of funds out of these markets has actually subsided as well. I think it's an opportunity now.
Robert: My fear is that these capital outflows are rather more permanent. The infrastructure spending that has powered recent growth in China, for example, is now a thing of the past. It's part of this bigger rebalancing of less government-led investment and more consumer-orientated economy.
Rupert: Yes, China might eventually become more consumer-orientated.
Robert: Well, that's the aim. Japan never really made it.
Rupert: Yes, but in any case it can't immediately replace the growth from those government-funded capital projects. That's a problem. It's one reason why we feel that global trend growth for the ten years post-crisis will be around half of what it was for the 20 years pre-crisis. There's some serious rebalancing to do. And it can't be debt-fuelled, it has to be productivity-related.
John: But we all need to rebalance, Britain isn't rebalancing either.
Marcus: Short term it doesn't need to. The Fed is tapering for a good reason. The US economy has done incredibly well in the last year, given the spending cuts that arose out of the fiscal cliff. It is now at the point where the Fed has to stop pumping money in because the economy is recovering. For emerging markets, the short-term impact of that might be pretty horrific. But that is not the Fed's problem. So you've got to be very selective with emerging markets.
Gene: I'm a big fan of demographics. It's a longer-term factor, but it drives everything. China has been singled out on this basis because since 2012 the number of economically active people there has been in decline. But demographics isn't just about absolute numbers, it's also about productivity and the scope for productivity gains in China remains enormous. So global demographics are still quite positive, even for China.
Marcus: Interesting. I would think that China, like Russia, has a much bigger problem with a rapidly ageing population than even Japan had. Japan's over the hardest knocks its population is already declining. Actually, on Japan, I think it's looking good just now. I didn't expect it to win the Olympics and it seems no one else did some stocks in the relevant sectors jumped by 15% or 20% on the news. Maybe this is a catalyst to help Japan a bit more.
John: Is Japan now less reliant on the weak yen than it was?
Marcus: It's never been about the weak yen. It's nothing to do with exporters. It's the construction companies, banks, real-estate plays, consumer-finance plays all the local-market, domestic-reflation plays that's what has moved first. I think Japan could go a lot higher, although it might not be quite as easy as it was during the first leg up. Prime Minister Shinzo Abe has got three years now without any form of interference on the electoral side.
His main battle now is with the employers' federation to get them to agree to up the minimum wage. Disposable income that's what counts for Japan, not GDP, unemployment thresholds, or anything else. The employers need Abe to release them from hiring and firing restrictions ease up on regulation, cut the corporation tax, and then things will start falling into line.
Robert: For me, the jury's out on Japan. It's one of the most xenophobic countries in the world. That makes it a curiosity for tourists, but not a massive tourist destination. I think exoskeletons have more chance of raising productivity and stopping the demographics problem than any realistic programme of importing labour from neighbouring countries.
John: What about bonds? Are there any buyers just now?
Marcus: There's probably selective value in emerging markets if you have a manager who knows what he's doing. And we may see a short-term correction lower in bond yields because there's been a very big move there. But QE has created such ridiculous distortions that yields are still only back to where they were two years ago they can go a lot higher from here. Overall, I've hated bonds for a long while, and I still hate them now. I'm sure most of us here would agree that in the longer term, we'll probably see much better upside in equities than bonds.
John: So have we now embarked on the long, slow road to higher interest rates? Are we missing anything?
Rupert: It does feel like we're at a point where public markets take over from the government. But in the long run it's great news if we can exit from QE. Yes, we'll get a lot more volatility, but we're only returning to what we were used to before QE came along. QE dampened volatility in both equities and bonds because every time bad news appeared, it just meant more money printing. As long as the market is strong enough to digest this return to normal, then we'll keep moving on. Probably the first reaction will be the strongest and we'll just get ripples thereafter.
John: Would anyone still be buying gold?
Robert: No. It's a good time to sell.
Rupert: People struggle with valuing gold and I do too. But if the US, the main economy in the world, is improving, the US consumer continues to get better, unemployment keeps falling, house prices continue to rise, and bank share prices continue to rise, gold is less interesting.
John: American housebuilders have fallen hard recently.
Marcus: But the sector was up 96% last year. It's only fallen because the 30-year mortgage rate has jumped recently.
John: But if a lot of the recovery is built on cheap money, and money isn't getting cheaper anymore, surely that's going to be an issue?
Marcus: Economies have grown successfully with higher rates in the past.
John: Well yes, but it depends on where they start from, surely.
Robert: This is the fundamental problem with QE. QE has held interest rates too low for a very long time. Central banks have under-written risk assets, but no one knows what they've done for real growth. Price/earnings (p/e) ratios have expanded the p' has gone up. But we're still waiting for the e'. That's why I'm not overweight equities right now.
Marcus: It's more of a concern for Britain than for America, though. Britain is very dependent on housing, where we haven't seen proper deflation yet, and so everyone is being propped up by super-low interest rates. In America they've had a huge clear out and you've got fantastic affordability, even assuming a rise in mortgage rates.
Robert: US householders were certainly able to deleverage by handing their keys back to the lenders, whereas British consumers weren't able to play that trick. But I think describing the UK housing market as being robust due to low rates is not quite right. It's actually down to devaluation of the currency, which made London more attractive to international buyers. And one thing to remember about the taper is that we're only talking a slower rate of money-printing it's not stopping.
I think the shock of tapering has already been digested. So bonds still have a place in a multi-asset portfolio as one of the best ways to diversify away equity risk. It's very rare to have a year of negative total returns in fixed income.
Rupert: We like British recovery plays. One sector that hasn't done much on that front yet is food retail. Take electrical retail.
Dixons has had a great year, and quite right too you just need to look at what it's done since its restructuring, plus the fact that it's pretty much the only electrical retailer left in Britain. But food retailers haven't done much at all. So if you think the British consumer is improving, and you consider that a lot of non-food items are sold by food retailers, then a stock such as Sainsbury (LSE: SBRY) looks interesting.
The valuation for 2014 is about 11.5 times earnings, and its trend valuation since 1998 is about 16 times. So you're already buying at a big discount to history. You're also getting a 4.5% dividend yield forecast for next year.
It's been very well run by Justin King there's always one retailer in the supermarket sector grabbing market share from the others, and he's put Sainsbury's in that position for now.
Robert: But how long before we are getting our groceries through Amazon?
Rupert: I think it's a while. If Sainsbury's can do what it should in market share terms, then it's nothing to be feared. Yes, the sector is competitive, but Sainsbury's valuation is quite compelling now. And food retail stands out as a sector that hasn't really been picked up on by investors yet.
My second tip is Finland's Sampo (Helsinki: SAMAS), which invests in financial services. It has its own insurance business, with market positions in Norway, Sweden, Finland and Denmark. It's headed by Bjrn Wahlroos, the rock star of Scandinavian financial services. It also has a big stake in Norwegian bank Nordea, which has a huge capital ratio, like most Scandinavian banks.
Although the Scandinavians have extremely severe regulators compared to further south in Europe, they've all got great dividend-paying capability, so Sampo has a 5% dividend yield. In terms of financial services, it's the most stable area in Europe you can find.
My last stock is at the other extreme. I was recently at a conference sponsored by the Hellenic Stock Exchange, seeing Greek companies. We all know Greece is a mess. GDP is 25% below peak. They don't collect any taxes. Everybody works for the public sector, and on it goes. But within that there are several companies that have had to survive these conditions.
This time last year, Greek telecoms company Hellenic Telecommunications (Athens: HTO) was to all intents and purposes bankrupt because it couldn't refinance a load of debt that was coming up for maturity. It had no access to debt markets because Greece didn't either. It's 40% owned by Deutsche Telekom, so you'd have thought that there'd be some kind of a support network there, but there wasn't really. The bonds had just collapsed.
Yet these guys have 60% market share in Greek fixed-phone lines, 40% market share in broadband, and 40% in mobile. Compared to anyone else in Europe, that's dominant. The company has free cash flow of around €0.5bn a year, and it's only planning to pay down debt with it, not even paying much more than a piecemeal dividend. As a result, it will be debt free from the end of 2015.
It's not the way telecoms companies are normally run because of the recurrent nature of their income there aren't any others I know of that are debt free. There are a number of such companies in Greece very, very good operators in extremely tough environments that can actually start to recover now that the foot is off their throats. If Hellenic Telecommunications is too fruity, then there are a few Greek exchange-traded funds (ETFs) that you can buy. One is the Lyxor ETF FTSE Athex 20 (Paris: GRE).
John: Greece has already bounced a lot.
Rupert: But there's more to go. So far it's just those with very high risk appetite who have gone in, but now you're getting those who are prepared to back companies for the longer term.
John: Marcus?
Marcus: An interesting recovery play is Mirror newspaper publisher Trinity Mirror (LSE: TNI). If you're playing the stockmarket over the next three months to a year, and you want some bang for your buck, you'll have to be in a few lively stocks. Trinity Mirror trades on about four times earnings now, which is extremely cheap. It's also going to be debt free in 18 months' time. Management has transformed the business. They've finally got the internet product right but, more importantly, the business is very geared to local areas, which is good news if the UK consumer picks up. It's extremely cheap and stocks like this can double and more not that I'm saying it will, of course.
I also looked at logistics services group Wincanton (LSE: WIN) on a similar basis. Again, it's only on about four times earnings. It's another diamond in the rough that will benefit if local and regional economies pick up.
The third company is similar TUI Travel (LSE: TT). It's been trampled by Egypt and then Syria hitting bookings. But there's not much more bad news that can come out. It's got a decent business in France and in Germany, and very few analysts are bullish on it, so it's relatively unloved. Thomas Cook is a similar story, but I think TUI's probably the better bet of the two.
Robert: Isn't TUI Travel dis-intermediated by the internet in the same way as Sainsbury's?
Rupert: Actually, TUI Travel has a good online business it has an online bed bank, one of only two in the world. The other is owned by Kuoni. These are massive aggregator sites that just sit there, and other sites use them to check for spare bed capacity.
Marcus: Well, if TUI Travel has survived so far, it's only going to do better from here. Also, I think that as people get a little bit wealthier, they don't necessarily want to scrabble around online organising their own travel they might prefer just to walk into a travel agent and get someone to do it for them with a bit more of a personal touch.
I'm not saying these firms are buy-and-hold forever jobs, but in the short term they could do well with just a small improvement in underlying performance. And I like Japan too. You want to be short the yen and long the Nikkei. That trade's back on again until the end of the year I think.
John: Gene?
Gene: I have three British names. One is engineering group GKN (LSE: GKN). We expect it to have some of the highest earnings per share (EPS) growth in the industrial sector over the next year or so. European car sales are down about 20% from the peak, but we think that has stabilised, even if we haven't necessarily turned the corner. The recent Volvo Aero acquisition looks good too we think civil aviation is a sound sector for the foreseeable future.
Another firm is global satellite operator Inmarsat (LSE: ISAT). There are only so many players in this sector, but the key thing is that now, after three years of heavy investment in its satellites, they are expected to start generating substantial cash flows. Its end-customers are maritime, military and land-based corporate users. Obviously, the military side is a bit of a concern with government budget cuts, but that's been known for a while. The reality is that users are going to have ever-more sophisticated data requirements. So we think Inmarsat has a good organic growth profile.
Perhaps my most boring pick is Marks & Spencer (LSE: MKS). We like it as a play on British consumers, because it's not in the squeezed middle' of general food retailers such as Sainsbury's or Tesco. It has 11% of the retail clothing market, so it's still a player. Yet on the sentiment side, people have just forgotten about it. We like unloved names and arguably it become an unloved name. Marks & Spencer has been investing in IT, and at the end of the day either chief executive Marc Bolland is going to get it right, or he's not either way, that's a catalyst for the share price to get moving.
John: Robert?
Robert: I have three fracking plays Technip (Paris: TEC), Honeywell (NYSE: HON) and Flowserve (NYSE: FLS). Cheap gas from fracking has already been transformational. It's led to on-shoring in the US (firms returning to America, rather than going overseas) and this story has a lot further to go. Technip has considerable downstream engineering capability keyed into US chemicals (the sector is a beneficiary of fracking via the cost of energy and ethane-derived raw materials). Honeywell and Flowserve make the valves and components required for fracking. So that's one theme.
As I've already mentioned, I favour UK mid-caps over large-caps. If the pound is stronger, and the British consumer comes to the fore again, domestic stocks should do better than commodities exporters. So bet on the FTSE 250 over the FTSE 100 the iShares FTSE 250 (LSE: MIDD) tracks the mid-caps, for example.
And I still like infrastructure such as HICL Infrastructure (LSE: HICL), or International Public Partnerships (LSE: INPP). It offers fixed-income-like cash flows, and bond-type risk. The British government has already committed to building infrastructure. I think these stocks are really interesting, in that they profit from the austerity debate what do you want to leave your children: lots of debt, or a bridge, or a hospital? Infrastructure building generates jobs and gets us out of recession. These firms are a good way to invest in that.
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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.
He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.
His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.
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