One of Britain’s best-known investors, Jim Mellon, talks to Merryn Somerset Webb about how Silicon Valley is set to turn all of our lives upside down, and picks the very best company to buy to benefit from this huge wave of disruption.
• If you missed any of Merryn’s past interviews, see them all here.
Merryn Somerset Webb: I’m here today with Jim Mellon, investor – very good investor – and author. His new book, Fast Forward is just out, and we’ve written about it in the magazine, I think many of you may have it already, but today we’re going to talk a little bit more about some of the themes inside it.
Before we do that, Jim, I just want to talk a little bit about the markets in general. We’re talking just as the rouble has really, really collapsed and you have some experience in Russia. I know that last month you told your readers to not invest in Russia, in fact not to touch it with a bargepole. Have you views changed at all, now that it’s really collapsed?
Jim Mellon: It’s like catching a falling knife, isn’t it. A lot of people have been wallpapered in the last couple of days with Russian paper, but I think it’s getting very close to a climactic moment, but they’ll impose capital controls in Russia, I’m absolutely certain of that. So that may stabilise the rouble but it means that if you buy the rouble, are you going to be able to trade it freely? I don’t know.
In fact one of my recommendations as a sort of bonus Lotto recommendation is to buy Gazprom ADRs, because Gazprom is producing three times more gas than it did in 2003. The price is twice as high as it was in 2003, despite everything, and the share price is exactly the same as it was in 2003. So it’s two times earnings, it’s got a dividend yield of about 5-6%, so it might just be worth a punt.
Merryn: It’s so cheap that you just might as well?
Jim Mellon: Exactly, and it’s the world’s biggest producer of gas. Russia is basically a petrol station with everyone else living off the proceeds, which is its problem, basically. I think the danger is that the general population in Russia is now really scared and it reminds me of 1998 when I lost an absolute fortune in Russia.
Merryn: That’s why I thought you might have something interesting to say on Russia.
Jim Mellon: So anything I do will be very cautious. I don’t want to lose all my money all again, basically, and get margin calls in the middle of the night.
Merryn: The capital controls issue is a tricky one because if you do invest in Russia – not just in the currency but in the stock market – once you’re in you may not be able to get out.
Jim Mellon: Except the ADR is traded with the US, and if I remember rightly, it’s about $7 an ADR. So it’s very cheap relative to where it’s been at. I think it’s been as high as $30 or something. So it might be interesting.
Merryn: Moving away from the misery of Russia for a minute, when we last talked, your favourite market was Japan.
Jim Mellon: Yes.
Merryn: Still there?
Jim Mellon: I don’t actually have anything in the Nikkei at the moment but I still think it’s going to go up. For some reason it’s really stalled in the last couple of days but I think that the Nikkei has got 20,000 written all over it, and 16,500 today so why wouldn’t you buy it.
Merryn: That’s purely as a result of the falling yen? QE and the result of that on the currency.
Jim Mellon: You mean the yen is now going back up, basically? Today it was back up.
Jim Mellon: I think that’s partly it but I guess there is a lot of uncertainty in Japan post the election; the second, the most recent election. The economy has still not got traction but I’ve just been in Japan. I know you go to Japan quite often, I felt that it’s not nearly as dire as people might like to portray it.
Merryn: No, but I never feel it’s as dire as people might portray it but all the way through the Great Depression, Japan has felt absolutely fine when you’ve gone there and now it feels even more than fine, it feels great, but then of course we tend to go the big cities, don’t we, so we don’t necessarily get the feel outside that.
Jim Mellon: Yes, that’s true, but I don’t think the yen needs to go any lower because 30% of Japanese production is outside of Japan. Their price elasticity on their exports is not very high because they’re highly sophisticated manufactured goods. So I don’t think the yen needs to go any lower for the Japanese to be very competitive in export markets. So I wouldn’t necessarily hedge the yen anymore, I’d leave that unhedged but I’d buy the Nikkei.
I was looking at Honda today which is having problems because of this airbag issue in America, and it’s nine times earnings, it’s stuffed full of cash, it’s making four million cars a year, it’s a very good company, why wouldn’t you buy it. It’s got a 3% dividend yield and the Japanese government bonds are yielding 0.3%. So if you’re a Japanese investor, wouldn’t you want to trade government bonds – which are uncertain I would have thought, given the lack of credit suitability of Japan – and buy the stocks, when everything is going for stocks. My general view is, buy Japan.
Merryn: Buy Japan, buy Europe.
Jim Mellon: Much more than buy the US.
Merryn: Much more than buy Russia.
Jim Mellon: Well, Russia is a speculative punt and I’m actually thinking about putting some money into Russia, but I’m still thinking. I’ll let you know if I do it.
Merryn: Let us know when you actually do it, and let us know when you go back into Japan properly as well.
Jim Mellon: Yes. It will be very soon.
Merryn: Europe, you’ve been very bearish on the euro for ages?
Jim Mellon: Yes. I can’t see any upside to the euro, I don’t know about you but if they do have a huge QE, which is most unlikely… The current attempt to add a trillion dollars to the ECP balance sheet is pathetic, it’s actually gone nowhere, it’s like $200 million, it’s nothing. Unless they go into buying sovereign bonds directly then they’re not going to do an effective QE.
Merryn: You think they won’t do that?
Jim Mellon: I don’t think they will because the Germans just won’t let them do it. So if they don’t do that, then it’s even more disaster for the peripheral European countries, and by periphery I include France in that now because France is such a lemming like rush to the cliff.
If they do do it, then you’re going to have all the consequences of massive QE, which is a depreciating currency. As a trader, I sense that the euro is about to have a little bounce to maybe 1.26 or 1.27 but my bet is it will be 1.10 by the end of next year.
Merryn: So the trend is down whatever happens?
Jim Mellon: Yes, so it’s 8.5% down so far this year, as of today, and I think another 10% down next year. It’s a great bet, if you’re a foreign exchange trader. It’s the only one really that I see total clarity on.
Merryn: So it’s a brilliant trade on economic misery and deflation?
Jim Mellon: Yes. I don’t see what the solution is. The only reason that you’re getting current account surpluses in the peripheral countries is because domestic demand has collapsed. I don’t think their bank balance sheets have been properly repaired. This latest asset quality review showed asset impairment on €48bn out of I think €2 trillion of liabilities, or bank assets rather, which is pathetic really. As our friend James Ferguson keeps on pointing out, you need 10-15% impairment to get the balance sheets right, and they’ve done about 2%. So nothing really looks good in Europe.
But if the euro goes down to 1.10 then the exports become viable and they’re now cheap, the European stocks are cheap relative to other international markets. You might want to watch Germany.
Merryn: So it’s reasonable to expect the euro to go down and as a result to buy cheap exporters in Germany?
Jim Mellon: It’s the Japanese argument really, isn’t it?
Merryn: Very simple. Same as the Japanese market. Of course, they’re competing with each other, the German exporters and the Japanese exporters.
Jim Mellon: Well, to a certain extent, but only on cars and machinery, that’s true. Actually that’s the other thing, is that the Chinese economy is definitely slowing faster than most people are saying.
Merryn: Why do you think that? We would agree with you but why do you think that?
Jim Mellon: I don’t think it’s just a thought. If you look at all the components of the Chinese economy, none of them seem to be growing but they’re still saying that they’re growing at 7% a year and I don’t see how that’s possible when the property market and construction, which is one third of the economy, is in a dire recession, when the banks have got a lot of impaired loans, when the consumer is not spending. You can see luxury goods going down, especially with the corruption crackdown, and exports are not really growing fast. So where is this growth coming from, is the government spending a lot of money, it doesn’t seem to be. So the figures are fictitious. What’s the true growth in China, maybe 4-5% but that’s not enough to…
Merryn: To keep the global growth show on the road.
Jim Mellon: Exactly. So JP Morgan is saying that global growth this year is 2.5% in real terms – that’s global growth – and next year will be 3% but all brokering houses are going to say that it’s going to be better next year, but my general impression is it’ll be worse next year.
Merryn: Yes, because you’ve added all that, where’s it coming from.
Jim Mellon: Where’s it coming from, and even the US, it’s growing but it’s not Gangbusters. In Europe it’s zero growth, the emerging markets are really feeling the pain from the rising dollar and falling commodity prices. China is not great, Japan is still flatlining. Where is this growth?
Merryn: We looked at some of the cheap markets but that would make the US market on your estimation, hugely overpriced, I’m guessing?
Jim Mellon: I think we all agree on that.
Merryn: I’m always looking for someone who might disagree. Someone must disagree because someone keeps buying it.
Jim Mellon: In my recommendations today – they weren’t very good last year but hopefully it’ll be better this year – I’ve got a US stock, Hewlett Packard, which looks cheap to me for a variety of reasons, and it’s a sort of old dinosaur. But everything that’s growth orientated is ridiculously overpriced, 100 times earnings or not, even earnings, basically, and I do not think those valuations under any circumstances can be justified.
Merryn: Let’s move away from the misery and go to the good stuff. Let’s move on to the book, Fast Forward, and what it was that prompted you to write that?
Jim Mellon: Originally I was going to write about human redundancy, which is the age of automation is going to make a whole load of people redundant. That’s still a thesis but there was a couple of authors in the US that wrote exactly that book called The Second Machine Age so I was somewhat pre-empted on that.
Merryn: It’s very good, by the way.
Jim Mellon: It’s very good.
Merryn: Yours, I’m sure, would have been just as good if not better.
Jim Mellon: Theirs is not an investment book, so what we wanted to do was to show the positive aspects of technology and how you can actually make money out of it. That’s a difficulty because the investment in technology is very cartelised at the moment. In the Silicon Valley area, 40% of all the great companies that are called Unicorns, which become £1bn valuations and normally they do it in seven years, and normally the founders are not in their 20s but in their 30s, they come out of Silicon Valley, that’s globally. So that’s one tenth of 1% of the world’s population is producing 40% of the… and that’s because all the venture capital companies are the same, they’re the ones who see these companies and you’ve not got these large scale, basically, technology trusts like Google or Facebook or Amazon, or Ali Baba in China, which any time there is anything good, buy it up for $1-2bn.
Merryn: You refer to these big companies now as technology trusts because they’re effectively buying up all the small companies with the good technology before anyone else gets a look in?
Jim Mellon: Exactly and then the only time you see the opportunity for the retail investor or even the institutional investor is when they out at fruity evaluations in Ali Baba type IPOs. I’ll give you an example, in the ‘Fast Forward’ book – which is now available in hardback because the publishing industry is so dinosaur it takes a long time to come out, as you know having published books yourself – I wrote about this company called Lift which makes a spoon for Parkinson’s disease people. If you’ve got Parkinson’s disease, your hands in later stages go like this and you can’t eat because you can’t get the food into your mouth. So they make a spoon that’s got a gyroscope, basically a very sophisticated spoon that allows people to eat with Parkinson’s disease. So I wrote about this in the book, and guess who buys that company just a few weeks ago; Google. What’s Google got to do with Parkinson’s disease?
Merryn: They’ve bought this before we even get the book.
Jim Mellon: You can get it on Kindle of course. So in other words, anything that’s interesting has been snapped up. That’s not the case so much in life sciences, although I think it will become the case because Google is getting into it and no doubt the rest of them will follow.
Merryn: But does that make Google a buy?
Jim Mellon: I think if you want a very long term fund, admittedly it’s not cheap; Google probably is the best buy. It’s slightly scary but they’ve got the smartest people and they have huge cash flow from their advertising business. I can’t see that being interrupted any time very soon. Apart from Fujitsu FANUC, or FANUC as it’s now called in Japan, they are the leaders in robotics. There is no other company that’s really investible in robotics apart from them, KUKA and FANUC in Japan. So the range of opportunity…
Merryn: People just do not think of Google as a robotics company.
Jim Mellon: They’ve bought Boston Dynamics, which is probably the best robot company in the world. They are the leader in drone technology, they’re doing all sorts of stuff in medicine, they’ve got the contact lens that measures your blood sugar, they’re doing bioinformatics. They’re not making any money off this stuff but I think they start out with the premise that they don’t really care if they make any money because they’re making so much money elsewhere, they’ll just find something that they can monetise in the future.
Then the others are doing exactly the same. So the best virtual reality company – and virtual reality, by the way, will be a very big thing – is owned by Facebook.
Merryn: Why will virtual reality be a very big thing? I can’t really think of it beyond games.
Jim Mellon: Because for instance, let’s say you’re buying a house, you’ll be in an immersive experience inside the house at a remote distance through virtual reality. Not wearing one of these big, clunky headsets, it’s all going to become much, much more compact.
Merryn: Are you saying that estate agents are going to become redundant; we’re no longer going to have to…
Jim Mellon: They are redundant, aren’t they?
Merryn: We still have to walk around houses with them when we go and look at them, don’t we. Is this going to end the man showing you rooms and saying, “There is great potential here for a side return”?
Jim Mellon: Don’t you think it’s going to basically cut down the number of houses you actually go and see, so when you’re buying a house, instead of seeing 100 you might just see 100 virtually and then go to the top three, basically. So it’s going to expedite the process. But that’s just one example of it. Films will become immersive, learning will become immersive. So it’s going to be a much bigger industry. For instance, doing operations will be done in virtual reality as well. I’m talking about surgical operations.
Merryn: Going back to education, it’ll become immersive because what, because you will do it from home but you will be virtual reality-ed into a lecture hall?
Jim Mellon: Well no, I think you’ll do it in a classroom but you’ll be in a virtual realty space and you’ll be presented with various alternatives which will be a way of challenging you, basically. I don’t know because I’m not in the education business, but it will become embedded in almost everything in the relatively near future, and most people don’t even think about it. They think it’s a sort of 1984 or Brave New World type thing. But it’s here and Facebook own it. Where is the opportunity for the rest of us, basically.
So the same venture capitalists, the same companies, the same brokerage firms control a very large part of the future market. So what I was trying to do in this book is to write one that obviates or helps the retail guy to get around this maze of cartelisation that’s producing very little opportunity for them.
Merryn: You did find some good companies that are available?
Jim Mellon: Yes, we have a portfolio at the back which I think will be a good one longer term, but some of the old dinosaurs like Hewlett Packard may have something in them that could completely transform their growth prospects.
Merryn: What does Hewlett Packard have?
Jim Mellon: It has this thing called ‘memristor’. If you take my iPhone here, this is 128gigs, which is the most that you can get I think in an iPhone, but if I could put 100 terabytes onto that phone I could record every moment of your life from the beginning of it to the end of it and still have space to spare.
Merryn: It would be very boring for you.
Jim Mellon: It would, but just to show that the memristor gives the capability of compressing vast amounts of data in portable format, and Hewlett Packard is the leader in that. They’re going to commercialise that in the next couple of years, I think it’ll be enormous. So it’s basically like flash memory but an infinitely large amount. So instead of having a PC that you have in your office, you’ll just have a little effectively USB stick that will carry everything – everything.
The other thing that’s really interesting at the moment is the internet of things, which I know you’ve written about before, but internet protocol that’s just come into play will allow every single atom to have its own IP address, so that almost everything will be able to talk to everything else. So supply chains in industry… It’s going to have a much bigger industrial application than consumer application to begin with. Everything in the retail space will communicate somehow or other with very, very powerful computers to make it more efficient.
Merryn: How is that going to change my life?
Jim Mellon: I guess it’ll reduce the costs of goods because they’ll just become a much more efficiency supply chain, basically.
Merryn: So it’s very deflationary, what you’re talking about here?
Jim Mellon: Yes, but it’s good deflation. I don’t think deflation is entirely bad. The idea that it’s got to be terrible is just not true. I was reading today that between 1830 – you know this already – and 1939, there were 50 years in which prices fell and only seven of those were recessionary years. So why does deflation have to be so terrible. In fact we’ve been experiencing deflation in many of our… You know that services go up in price every year but the reason that prices overall don’t go up a lot is because the price of this comes down or the price of foodstuffs come down because of manufacturing efficiency. That’s deflation, but it’s positive deflation. I don’t think it’s necessarily a terrible thing.
Merryn: Unless you’re very deeply in debt and you quite wanted to inflate all that debt away. In which case it suddenly becomes a very bad thing.
Jim Mellon: We get back to Russia and this is the big problem for Russia, is they’ve got $600bn of imminently debt that needs to refinanced and how are they going to do it, because it’s in dollars. Basically the country is bust and it’s much worse than it was in 1998. So maybe there will be some political solution, maybe Vladimir Putin will be forced to come to an accommodation. That’s the opportunity but it’s also the risk, that maybe these companies will just go bankrupt. The Kremlin can’t support them.
Merryn: We were trying to get away from the bad news, we were heading for the good news.
Jim Mellon: The good news is that basically, despite the luddites in the world who are saying that everyone is going to be out of a job… And by the way, it will be very disruptive, and I think the generation born in the 1980s are going to find it particularly hard because they’re a little bit too old to really embrace the modern technology and the changes that are happening.
Merryn: Too young to have got out ahead with a final salary pension.
Jim Mellon: Exactly, and not just pension but to get in… I’m sure you know lots of people who are in their 20s and 30s who find it really hard to get on a proper career ladder. Also there is this horrible thing that every day in the newspaper, there is someone who has just become a billionaire at the age of 20 or 30. When we were that sort of… well you being much younger than me but even in your time, the only way you could get rich was by being a rock star when you were in your 20s and now the role model is the Silicon Valley thing but there are very few of them. They’re very, very few.
Merryn: They’re very public.
Jim Mellon: Very public and it must make people in their 20s really frustrated about the fact that they’re in dead end jobs working in Pret A Manger or whatever. I think that generation, to a large extent, is lost.
But my real worry is in emerging markets because this automation is going to take over every single task that can be done by human beings in a repetitive sense. That’s not just in factories, it’s also in cleaning, it’s in hospitals, it’s in some caring industries, it’s in fast food. That’s what’s going to happen and even in fund management now they’re talking about basically this is going to be an automated process, and why not. Active managers don’t make any money, or only one in five makes any alpha.
So what happens in the emerging markets, because the old story was you left the farm and you went to the factory and you made the cheap goods and they got sold to the West or to Japan. Today, manufacturing in this era of capital abundance is going to be localised. You can make the product much more cheaply with robots near the consumer, you don’t have to have it made in China with long supply lines and quality issues and all that sort of stuff.
Merryn: This is nice for developed nations because it’s reshoring, it brings some of the jobs back, or certainly the knowledge jobs back.
Jim Mellon: It does but then think about Africa. How are they going to support what will be 4.5 billion people in 2100, up from one billion today, at the current rates of population growth. Nigeria, which is in 1960 had 48 million at independence, is going to a billion people on its own in 2100. So what’s going to happen, how are they going to have jobs, because the old model is broken and we in the West, yes I think we’re in a strong position because first of all we have a very low fertility rate and therefore populations are not expanding. We can probably find jobs for the people in our societies, or even quasi non-jobs, and we are the most advanced in terms of automation.
But it is an absolute fact that almost everything… there is a thing called Amelia, which is being developed by PSI Soft, Amelia will replace all PAs in the next 10 or 15 years because she learns from all her mistakes, she works 24 hours a day, she doesn’t need to be paid, once you’ve paid the licence.
Merryn: Finally, those of us who don’t have a PA, will have a PA.
Jim Mellon: In a way you already have one, it’s this, isn’t it.
Merryn: It doesn’t work very well.
Jim Mellon: Amelia will just organise everything. Already in the US in the last 10 years there has been 600,000 secretarial or PA jobs that have been lost. So if you ask me what are the industries that are going to be job productive, I would say the artisanal industries. I’m not talking about you’re making baskets and stuff like that, but where you’re making highly crafted stuff using technology. So maybe for instance personalised knife sets. I was reading about this company in the US that makes these really amazing knifes and they’re made to specification and to order. So the artisanal industries are growing in the United States, which is the model for everything really.
The caring industries I think will be enormous as the population ages and we don’t want to be cared for, necessarily, by robots for the rest of our lives, although there will be an element of robotic stuff.
Then you’ve got the IT industry, which is if you are actually a young person… This book is really designed for parents to give to their teenagers to think about what’s happening in the world.
Merryn: So what do we teach our children? What’s the most important thing for my children to learn at school so they can survive in this new world of automation? Not just survive but prosper.
Jim Mellon: I think you don’t do what mummy and daddy did. So the old model of going into accounting, the law, being a doctor, having that sort of professional job is broken. I think you have to be IT savvy. I’m not talking about internet savvy but IT savvy is really important, and be very flexible in your approach. Everything is changing so quickly, I don’t know what’s going to be big in five years’ time but you just have to be very opportunistic in what you’re going to do.
Merryn: Languages, do I have to bother teaching the children Mandarin?
Jim Mellon: No, they can do it all on Duolingo basically if they want to, or Google Translation.
Merryn: So no need for second language. Coding, or will most of the coding be done by computer too?
Jim Mellon: Exactly. People are doing these coding schools and sending their kids to it, but actually that’s like sending kids to clerical school 50 years ago. Do you want them to be a clerk, sitting there doing coding, no. Use the coders to get where you want.
So what are going to be the future industries? Well, I try and lay them out but the energy industry in its various forms is going to be a big one. The transportation industry is really reforming very quickly, and I’m not just talking about driverless cars, I’m talking about railways, space travel is very interesting. New materials, so graphene you’ve written about many times, but there are many other new materials that are of very great interest. Payment systems, what’s going to happen to the banks, I don’t know, but they’re not going to be where they are today.
Merryn: Nothing good.
Jim Mellon: Nothing good. So there’s lots of opportunity there and what I was basically trying to do is to distil all of the stuff that we already know in vague terms into something that’s both condensed, hopefully readable and also has some investment portion to it, because if you invest in the status quo today, as we all know, you’re going to be toast.
Merryn: There is a portfolio in the back of the book?
Jim Mellon: There is, yes.
Merryn: Give us your favourite tip in it? Number one stock, for the punters out there.
Jim Mellon: I think basically you just buy Google as a long term investment. I hate to say it because it’s already a huge company and it’s probably only going to grow by 10-15% but if you want all the key components it’s in that.
Merryn: That’s the one to get?
Jim Mellon: Yes, at least at the moment.
Merryn: Brilliant, thank you, Jim.
Jim Mellon: Pleasure, thanks for having me.