Will we live long enough to see Brexit? Is the US dollar heading for a bear market? Will wages take off in 2019? John Stepek asks the experts at our Christmas Roundtable.
John Stepek: How will Brexit affect markets next year?
Jim Leaviss: Since the 2016 referendum, sterling has already weakened substantially. On the Big Mac index, it’s one of the world’s cheaper currencies. And we don’t have that doom loop that existed in the US in 2008 after the Lehman Brothers crash, whereby falling asset prices created more panic. Now if sterling falls a bit…
Tim Price: …it just boosts FTSE 100 earnings.
Jim L: Exactly. If anything, weaker sterling helps. So I don’t think we have that to worry about. Even so, I think next year will be very difficult for sterling assets. Bank of England governor Mark Carney’s worst-case scenario for commercial property was the one that
I thought was the most worrying – down 48%.
Jim Mellon: Yes, but how good has his forecasting been in the past? British assets and property were overpriced well before the referendum. So it’s not surprising they’re coming off, and maybe Brexit’s adding a bit of impetus to that. But I’m selling property in Germany at the moment because I think it’s overcooked, and I’m looking very closely at UK real estate investment trusts. They’re well managed, selling at discounts (which will probably expand further), pay sustainable dividends, and have relatively low fees. It’s not there yet. It’ll be another 10% or 20% down – but I disagree with doom-mongers who think the UK is toast.
Alastair Mundy: What’s striking among investors is this sense of: “I wouldn’t touch UK stocks with my mate’s bargepole”.
John: “Uninvestable”, as the Financial Times puts it.
Alastair: “Uninvestable” – typically spelt “B–U–Y”!
John: So have you been taking advantage of this idea that Britain is “uninvestable”?
Alastair: We’ve been building exposure to Britain for a couple of years. Banks have been the biggest part of that, because it’s been the pariah sector for ten years now. I just sense we’re at a point where there are not many people left to sell banks. For me, Lloyds (LSE: LLOY), RBS (LSE: RBS) and Barclays (LSE: BARC) all look cheap – they have repaired their balance sheets (with encouragement from the regulator) and loan growth has been modest over the last five years, which suggests bad debts shouldn’t be a big issue. There is some competition from challenger banks, but the high-street players have large, fairly inert, deposit bases. That gives them a competitive advantage.
The management is new and the corporate memory is great – if you’ve only just screwed up within the last decade, you’re probably not going to be first in the queue for screwing up next time. And my ambition is very simple for them. I just want them to be dull and boring. So unless the outlook for the UK significantly deteriorates, then I think they will see pretty decent returns via the dividends and re-ratings.
John: This time last year we talked about inflation and interest rates rising and how that would boost banks’ profit margins. So when do the shares take off?
Alastair: Personally, I’m all out of catalysts. I thought value was going to bounce when bond yields started going up two years ago, and nothing’s happened. Then again, I still don’t know what the catalyst was for the market falling in 1999.
Charlie Morris: But banks have done much better in America, where bond yields have been rising; and they’ve done a bit better in Britain, where bonds yields are a bit higher, than in Europe and Japan, where banks have been terrible. So there does seem to be a link there.
Max King: The problem with UK banks now is that they need more capital than before, and with interest rates so low, it’s hard to make a decent profit margin and, in turn, a decent return on capital. But within those constraints, if you can find a bank trading on or below book value, it’s going to be interesting.
UK house prices and interest rates
John: The UK housing market has slowed a lot – what impact might that have on the banks?
Alastair: I’m not that bothered – if you look at the average loan-to-value for Lloyds, say, it’s around 45%.
Jim L: Another point on interest rates is that the UK savings rate is about 0% now. So people effectively have no money left at the end of the month, which suggests that there is very little scope to raise rates. Consumption accounts for about two thirds of UK activity. Say the average mortgage rate is about 3% and people pay about £600 a month. If the Bank of England put rates up by 1% in response to Brexit, or higher wage growth, that’s £200 a month on your mortgage. At a savings rate of zero, that either comes out of consumption or means even more borrowing.
Tim: Talking about rates – I was speaking to a headhunter recently, and he told me: “We’re looking for senior traders – at least six years’ experience”. Six years? That’s 2012. It brought it home to me that there are dealing rooms now where nobody has seen a bear market in interest rates. I think that’s… interesting.
John: Well, the yield on the ten-year US Treasury bond finally broke above 3% this year, which was seen as a line in the sand, but it’s fallen back as markets have taken fright in recent months. Now Federal Reserve boss Jerome Powell seems to be a bit more cautious on raising rates. Do you think that might trigger a rally?
Charlie: It might. You’ve had this surge into the US dollar and US assets. If the Fed stops hiking rates, then it may just be the turn of the rest of the world. And there are a lot of oversold emerging markets. They could all surge quite a lot, because they’re all under-owned. I was telling the youngsters in the office today, you’ve no idea how much fun a dollar bear market is.
Just to clarify, I do think that global stocks have entered a bear market, after a ten-year rally. But that doesn’t mean everything will crash. In the late 1990s we had an emerging market crash in 1998, well before the big tech bear market. So when the tech bust arrived, lots of value stocks sailed through – not necessarily storming, but doing okay. Gold miners, for example, were highly speculative companies that went up during that bear market. In the credit crisis we got used to the idea of everything going down, but perhaps that’s an abnormal bear market – in a normal bear market, you can buy assets that are out of favour at the start.
Will wages surge in 2019?
John: What about wages? I saw a Deutsche Bank tweet the other day, saying that if the Fed doesn’t pay attention to wage inflation, then we could end up in a 1970s situation. Is that realistic?
Jim M: There’s a lot of wage pressure in the full employment economies, with big companies such as Amazon or Walmart unilaterally raising wages. Labour is getting better organised, even those who are not unionised. And when you can’t hire anyone, you have to pay more. It’s the same in the UK.
Charlie: Rising purchasing power is good, isn’t it?
Jim L: Yes, we should be thankful if wages grow, because we’ve had this lengthy stagnation where all the spoils of capitalism have gone to owners of capital. If we want people to carry on buying stuff, and keep the economy going, they’re going to have to earn more – it’s the Henry Ford argument: you have to pay workers more so they’ll buy your cars.
Alastair: That’s right, but that also plays into deteriorating margins, doesn’t it? Profit margins have been too big, and the wage part of the pie too small.
Max: But it depends on productivity. If productivity keeps rising, you can afford to pay higher wages.
Jim L: My concern is that wages won’t carry on rising because US companies in particular have huge cash stockpiles. If human workers are no longer cheap, they will go and invest in machines
Charlie: But that’s not a bad thing. To improve productivity is what we’re here for, isn’t it?
Jim L: But it would be bad for workers, if suddenly you decide that, rather than build a factory, we’ll buy a load of robots.
Tim: It depends on whether you believe in human ingenuity or not. If you don’t, then you succumb to the idea that we’re all going to be replaced by androids. But humanity finds a way, we’re very creative.
Max: I do think that having some exposure to inflation-linked government securities is not a bad idea. Peter Spiller’s Capital Gearing Trust (LSE: CGT), and Sebastian Lyon’s Personal Assets Trust (LSE: PNL) have large holdings of index-linkers. In a mixed portfolio, I think that makes a lot of sense.
John: You’re a bond guy, Jim – it must worry you.
Jim L: Yes, inflation’s what keeps you awake at night as a bond investor. But it looks as though US inflation peaked earlier this year. The Fed’s core measure is below 2%, and core European inflation is 1%. It’s a false dawn for now. But wages are the thing to watch.
Jim M: What about the US federal deficit?
Jim L: Yes the US is spending billions a day on interest payments alone. Meanwhile, we’ve gone from a world where bonds are scarce under quantitative easing (QE) to one with potentially too many bonds under quantitative tightening (QT), just as we see deficits stretching out forever in the US. That’s the reason that 90% of asset classes are down this year. I think everyone would agree that QE boosted growth and inflation; reduced gilt yields, Treasury yields, and corporate bond yields; and boosted risk assets as everyone moved up the risk spectrum.
Your investment-grade corporate bonds guy bought high-yield bonds instead. High-yield guy bought emerging markets. Emerging markets investors, I don’t know where they went – bitcoin maybe. But as QE turns into QT, all of those things go into reverse. So growth is going to be lower, inflation is going to be lower, and government bond yields higher, as everyone moves back down the risk spectrum. Why own fine wine when you can own high-yield emerging markets? And why own that, if you can own Walmart bonds? You end up moving back down in safety, and I think that’s what’s happened this year.
The outlook for China
John: China has been in a bear market for a long time now. How will that pan out?
Jim M: Two things: firstly, every Chinese person with money wants to get it out of China. Secondly, China doesn’t have a current-account surplus with the rest of the world any more. So there is tremendous capital flight, and that will continue, because the society feels repressed. The children are living in terrible polluted conditions, and the government’s not addressing that fast enough. On the other hand, the Chinese market’s very cheap – it trades on about seven times earnings if you strip out the financials.
Tim: The trouble is, you can’t trust the corporate governance. It’s off-the-scale bad. But what I do find interesting is that China has the biggest gold reserves, mines the most gold, and doesn’t allow an ounce of that gold for export – and has recommended all of its citizens own gold. I think this is entirely consistent with moving from a mono-polar world into a multi-polar one – the dollar’s slowly losing its place as the centre of gravity. But it won’t be replaced by one thing. It’s going to be replaced by a multitude of things.
John: But how long would it take the renminbi seriously to challenge the US dollar?
Charlie: Financial historian Russell Napier’s thesis is that with the current account in or on its way to deficit, we’ll see a devaluation of the renminbi. That will result in a global deflationary shock, but not as bad as in 2008. Then we get the same sort of policy response as we saw then – lots of money printing – because everyone panics. And then we get inflation.
Max: The trouble with the devaluation thesis is that it doesn’t really work for China. China is trying to make the renminbi a reserve currency, owned around the world. But if it floats and devalues against the dollar, people across the world – Latin America, Africa, Asia – are not going to say “I want some of those renminbi”. They’re going to say: “I’m sticking with the dollar”. That’s the secret behind the dollar – people massively underestimate the demand for it.
Charlie: Napier’s thesis is that it will become a reserve currency, but much later.
Jim M: China can’t afford a recession, that’s for sure, because otherwise the public will rise up against the Communist party. So it’ll keep on printing.
Max: The Chinese know that there’s a long history of authoritarian governments, interspersed with bloodthirsty insurrections, so yes, I think China will do whatever it takes to stop any unrest.
Living long enough to see Brexit
John: Let’s turn to investment opportunities. Jim, you’ve been focusing on longevity – what’s the latest?
Jim M: I think it’s going to be a stockmarket mania. Everyone wants to live longer, in a robust condition, and science is catching up with that aspiration. We own half of a company out of the University of Pittsburgh, which has worked on a way of taking a dead person’s liver, dividing it into roughly 100 pieces, and putting each of those into 100 patients with failing livers, in a lymph node. How many lymph nodes do you think you have?
Charlie: No idea.
Jim M: Between 500 and 600, so there’s plenty of them, and they don’t rupture when the blastocysts are put in there. Within six months, there’s a brand new, fully vascularised, fully functioning alternative liver. It’s been done in hundreds of animals, and while it hasn’t happened in humans yet, it’s going into patients with failing livers at the end of next year, or the first quarter of 2020, But here’s the really exciting thing: where do your T-cells come from?
John: I don’t know.
Jim M: Your thymus – that’s why they’re called T-cells. Your B cells come from your bone marrow, then go to the thymus to be matured, and those T- and B-cells comprise your immune system. When you get really old, you end up with no thymus – it involutes to nothing. By using this technique to regrow a thymus, you could possibly regenerate the immune system within old people. So organ regeneration – science fiction 20 years ago – is now happening, and it’s just one of many strategies out there.
This area is very similar to the internet in 1992 – there’s a lot going on, because the prize is the biggest in the history of the world. You can now remove senescent cells from mice, for example, and see a 95-year-old mouse return to being a 50-year-old mouse, in a matter of weeks. And there’s a whole load of other stuff being done to influence the pathways of ageing, some of it in human trials now. There are a couple of interesting listed companies in the US.
One is a senolytic drug company, Unity Biotechnology (Nasdaq: UBX). The other, ResTORbio Inc (Nasdaq: TORC), is using rapamycin to boost the immune system in elderly people. That’s why I’m not overly concerned about Brexit and the like. If we live to 110 or 120, all this stuff is irrelevant.
Tim: Unless we never leave!
Jim M: But it’ll change everything. Look at the finance world – pension promises go out of the window.
Pensions, cruises and longevity
Tim: Do you have a view on the viability of insurance companies and pension providers?
Jim M: It depends on their book. If you’ve promised someone a fixed rate of return over a very long period of time, or based on them living to 85, and they live to 120, then you lose money. But if they carry on paying their premiums, and it’s a non-fixed rate of return, then that’s very good. And patterns in consumption will change. For example, cruise lines, such as Carnival (NYSE: CCL) are an outstanding buy. Seriously, just put Mum and Dad on a cruise liner for a couple of years and wave them goodbye. They’ll live to 120, just going round and round and round.
John: How has the science moved on since last year?
Jim M: It’s unbelievable. Six years ago I wrote a book called Cracking the Code, and recently I wrote Juvenescence. In that six-year period, a cure has been developed for hepatitis C. Cancer immunotherapy didn’t exist six years ago – it will hit $100bn in sales next year. CRISPR-Cas9, the gene-editing system, didn’t exist six years ago, and now it’s sweeping the scientific world. Or take the use of artificial intelligence to design novel compounds – in our own company’s lab, we can now do in about six weeks what would once have taken three years. It didn’t exist six years ago. So what’s going to happen in the next six years is going to be good, and real money is going to be made. And it’s amazing how quickly a sector can turn into an established investment theme – just think about marijuana. A year ago I was involved in a marijuana business, but I would never have believed we’d be at the stage where the likes of Constellation Brands were paying billions to buy into the sector.
Marijuana and gold mining
John: Does anyone think marijuana will be legalised in the UK in the foreseeable future?
Charlie: Parliament is a bit busy just now.
Tim: True, but we’re in an environment where anything’s possible, so in the longer run, absolutely.
Max: I think cannabis in America will be a success and the UK will follow suit. I agree that medicine continues to be a good place to invest. Another interesting story is Alzheimer’s, where massive progress is being made. You can invest directly in BioGen (Nasdaq: BIIB), or in healthcare funds such as Worldwide Healthcare Trust (LSE: WWH), or BB Healthcare (LSE: BBH).
Alastair: Patient Capital Trust?
Max: I’ve been negative on Patient Capital Trust for a long time. It has been an absolute dog, and I think that will continue. I would just get out – it’s not too late. But a fund I would go for is JP Morgan Emerging Markets (LSE: JMG). I think emerging markets are coming right, and this fund has done very well in a tough year. And I think you have to go for UK stocks. I was going to mention Temple Bar (LSE: TMPL), but since you’re here Alastair, I’m not going to flatter you! So perhaps a small-cap fund – BlackRock Smaller Companies (LSE: BRSC) has fallen back recently.
Alastair: Another stock I like is Tesco (LSE: TSCO), which appears to have recovered its mojo, at least in terms of operating activity, having been roundly hated a few years back. Life has been made harder for the discounters and Tesco continues to cut costs and improve its offer to customers. The balance sheet is much stronger than it was and it looks decent value.
And how about a bit of gold and silver? They’re very small asset classes, and if just a few people decide they want to lighten up on bonds a bit, you don’t need much of a switch to get these things going.
Max: Physical gold, or gold miners?
Alastair: Gold miners are a nightmare. I said to someone the other day, my career ambition is to make money out of an option, but I also wouldn’t mind making some money out of a gold miner before I die. So let’s just stick with the bullion.
John: Tim, what are you thinking this year?
Tim: We seem to be in an environment of even greater uncertainty than usual, so I think there’s merit in precious metals, particularly gold and silver. But I brought along two stocks this year, to ring the changes. The first is Tokyo-based property company Tosei Corporation (JP: 8923). It buys and refurbishes old, mid-sized office buildings. The market value is about $460m, but it’s worth about a billion, so it’s trading at about half tangible book value. Since the financial crisis, it has more than doubled its top line, grown its operating margins sixfold, and its net profits 56-fold. It’s on eight times current earnings and seven times next year’s. It doesn’t really get much better. The other thing that gives me some comfort is that the CEO owns 26% of the business and his daughter owns 12%, so it’s effectively a family run business. Japan’s our favourite market – there are loads of extremely cheap but very profitable businesses there.
The other is a US stock, Seaboard Corporation (NYSE: SEB). It’s a diversified agribusiness – its background is in milling, but it’s now the biggest producer of turkey in the US, and also does pork and chicken. Its cash-on-cash return is now over 10%. It’s also run by a family – in this case the Boston-based Bresky family. It has a $4.5bn market cap but no Wall Street coverage whatsoever. It’s a very profitable business, and we love it. We own it in our fund, and own Tosei indirectly through funds we own.
John: You mentioned Japan – do you think it’ll have a good year next year?
Tim: Japan can expect perhaps another two years of complete political calm and stability relative to the rest of the world, which has clearly gone nuts. So I think for the near-to-medium term, you have to love that market, not least because it’s not the UK, it’s not Europe, and it’s not the US.
Argentina, bonds and bitcoin
John: Charlie – where do you see opportunities?
Charlie: The whole growth-to-value switch. It’s very much like 1999 – lots of stuff has been left behind: from Argentina, to oil, to UK banks. I don’t think the whole world is going to collapse like it did in 2008. Instead, we’ll see a bear market where the hot areas will be in a lot of trouble and the cold areas will just carry on. Argentina especially is cheap and under-owned – inflation looks like it’s coming under control. If it stays that way, that will be good for the banks.
John: How can readers buy Argentina?
Charlie: There’s an exchange-traded fund, Global X MSCI Argentina ETF (LSE: 0IWO).
Max: The BlackRock Frontiers Investment Trust (LSE: BRFI) has some exposure to Argentina too.
John: So it’s “sell the FAANGs, buy cheap stocks?”
Charlie: Not just the FAANGs – I’d go much further. Anyone involved in buybacks is guilty. Lots of debt on the balance sheet? Guilty. Popular theme? Guilty. Your profit and loss looks too good to be true; your cash flow looks better than it really is; all those artificial ways to make your company look good – guilty.
John: Jim, how about bond markets?
Jim L: Bond markets have seen some damage this year. We’ve seen credit spreads widen, partly as QE comes to an end. So that’s created opportunities. US investment-grade credit is starting to look good. Emerging markets bond yields have risen sharply, while currencies are off by 30% or 40% in some cases. M&G’s emerging market manager is called Claudia Calich. Her fund goes everywhere in emerging markets and I think that kind of flexibility will be good for next year. We’ve also just launched our first credit investment trust – the M&G Credit Income Investment Trust (LSE: MGCI). It’s small, £100m, but it’s tied-up capital, which makes sense in credit, where things trade by appointment rather than on an exchange. You want to be able to own the illiquid stuff forever, and the investment trust structure allows that.
John: Bitcoin was a big topic last year, and everyone was bearish, but some suggested that if it fell by 80% it’d be worth a look. We’re almost there now…
Jim M: The total market capitalisation of all the cryptocurrencies was about $850bn at the start of 2018. Now it’s about $200bn. But bitcoin has seen 20% rallies during this slide, and it might go up another 50%, but it’s not something to stay around in.
Charlie: Cryptos are probably going to see a rerun of what we saw in the internet. So I think the next bit will be real. Bitcoin has suffered four “85%-down” bear markets so far. The bottom on the last one was $200. We’re now at about $4,000 – so it’s gone up twentyfold since the bottom of the last bear market, about three years ago. So that’s pretty good really.
Jim M: But the problem is, most people who cottoned on to bitcoin bought at $15,000 or more. They will be a perpetual wall of worry – selling even as it goes up.
Charlie: How many years did it take Amazon to make a new high?
Jim M: Yes, but Amazon’s a disruptive business with lots of utility.
Charlie: Bitcoin is a network – it’s simple. The correlation between price and network size is 80%. The number of people trading bitcoin now is roughly the same as in November last year, and the price then was approximately $5,000. So it’s about where it should be. The altcoins themselves are worthless, because the bitcoin code itself is not worth much – anyone can get it off the internet for free. It’s the network that has the value, and in the crash, all users in the network came back to the most liquid cryptocurrency – that’s all that’s happened. You’ve got one survivor, and as the market dynamics recover, it will carry on. The broader sector is going to be enormous. Tokenisation of everyday assets, from diamonds to gold to art to buildings, it’s all coming. This sector goes way beyond the price of bitcoin.
John: Everyone else has left the room, Charlie.
Charlie: I’ll take that as a good sign!