At this month's Roundtable, our experts predict whether the current rally can continue and tell us where they are putting their money now.
John Stepek: The FTSE 100 is well above 5,000 now will this rally ever end?
Anthony Cross: My big fear is that it will continue for longer than I think it should. Money is being printed and injected into the gilt markets, and it's getting into equity markets. But it's not getting into the 'real' economy yet. If that continues, then at some point companies will say: "We've rebuilt inventories, things are more stable, but we're not actually seeing a big pick-up in demand." That's when valuations, particularly of cyclical stocks that have run up very, very fast, will come under a lot of pressure. But that might be a few months away.
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James Ferguson: I agree. A bear-market rally is designed to suck in everybody before it peaks. People think the rising market is giving them information, so the market moves start to feed on themselves. But the fundamentals underpinning the market are starting to unwind at a frightening rate. In America in the last quarter bank, lending has fallen at an annualised rate of more than 15%. That's taken US broad money growth in the last quarter to a negative 5% annualised rate. That's still very much in 1930s territory. The markets think we're back to business as usual. That's not the experience from past banking crises.
But when will the equity market get it? That's anyone's guess. Traditionally, people start taking profits in October, so late September or early October may be the point when everybody is as bullish as they can be. But it won't necessarily happen according to the script.
Mark Asquith: Markets always climb a wall of worry and this is the biggest wall of worry any of us have ever seen. But that's one reason why markets could run quite a lot further, because there will continue to be money on the side for as long we have these major concerns out there. I agree that we are seeing some worrying trends in bank lending in the US, and that maybe some Western economies are still in trouble. But in Asia, where we focus, some of the economic data is pretty strong and confidence is incredibly high too.
Middle-class people in most countries actually expect employment to rise. And this is based not just on government stimulus, but on decent economic growth. So I would say this market is going to go further because we are all still so scared. I don't know when reality is going to kick in in the West, but I think there is a case for a shift to the East, and a possible dollar crisis.
Max King: By the end of this year there will be two sorts of people those who get it and those who don't. The ones who get it will be looking back on what was probably the best investment year of their lives. Those who don't get it will look back and say, I missed the best investment opportunity for one hundred years. The market may have gone far enough for now it might even have a bit of a setback. But I think it could be significantly higher by summer next year. And my experience of bull markets is that trying to trade in and out is a waste of time and money.
We face a long period of relatively slow growth led by emerging markets. That's fine slow growth involving a retrenchment of government spending in the developed world, and led by the emerging markets, is very healthy and will enable company profits to rise. Companies are cautious in their guidance, but are upgrading their forecasts. Very fast earnings growth is expected next year and on that basis the market is cheap. So stay in there and keep investing it's far too early to sell.
Anthony: What makes you think there will be strong earnings growth next year?
Max: Consensus forecasts say plus 28%. That puts the global market on a p/e for next year of a bit over 13. We think fair value is 15.5 to 16. That's a nice upside.
Anthony: I disagree. I can see how you can get the earnings uplift for the next 12 months through inventory rebuilding and cost cutting. It's what comes after that I can't see that 25%-30% earnings upgrade. I think investors here will get burnt when the guys who are seeing a light at the end of the tunnel realise that actually there's another tunnel after that. When end demand doesn't come through strongly, and consumers are still saving, then cyclical stocks in particular, which have risen to quite dizzy multiples on the hope of strong recovery, will come under pressure again.
Mark: In emerging markets I can see a two-stage path to growth. Firstly, companies are starting to see some of the benefit of lower commodity prices and input costs in the last quarter or so. So falling costs lead to earnings growth in the second half of this year. Then at the beginning of next year you've got growth from domestic demand. The most obvious countries to see this are Brazil and Turkey, where interest rates have fallen from over 20% to single-digit figures. In the West, we've also got that, but we've been bingeing for 50 years on social security and consumerism. The emerging economies have only just got this and I think it will be like the beginning of the 1980s for them. You're going to see runaway consumer growth there it's happening already.
John: James, you used to work in Japan there were similarly strong rallies over there throughout their bear market. Could the same happen here?
James: It looks like it to me. I don't think the market is climbing a wall of worry at all quite the opposite. Everyone is thinking: "That was a close shave I thought the whole banking system was gone." Now they're celebrating because they think it's all over.
But they're wrong. Right now companies are all slashing costs. Then they're saying: "We've cut all these costs, so assuming that sales are flat to slightly higher next year, we're going to have a nice surge in profits". But the trouble is, they are all either cutting capital spending (so they're not expanding), or they're cutting labour costs. Labour costs in the US are now falling at the fastest rate seen since World War II. We now have five million people in America who have been out of work for at least six months, so these are the genuine long-term unemployed. In other words, through all this cost cutting, companies have effectively cut their own customer base. That means sales will disappoint, which will then put the squeeze back on their margins.
Mark: Macroeconomics is all very well, but I would rather fall back on company valuations, especially in stronger economies. I frankly don't understand everything that Ben Bernanke is doing with the Federal Reserve's balance sheet. All I know is there are still some cheap companies out there who are doing good business. There's an obvious case for emerging markets, but I am sure there's one for developed markets as well. There are almost no decent patents being churned out in Asia or emerging markets. The West has a massive edge in terms of technology. Whatever the next bubble is in nanotech, biotech, or perhaps IT our economies have growth areas that they can explore and possibly market to the East.
John: The other big news is gold hitting $1,000 an ounce. Any thoughts?
Max: It went from a bit below $1,000 to a bit above $1,000. It wasn't that big a move, frankly.
James: In any case, the peak it has to beat is more like $1,030, or even more.
Mark: I think it should only matter in rupees anyway, the Indians being the only ones who actually buy it. They make up 23% of that market and they're not buying at the moment.
Anthony: To me gold is a classic example of the kind of confused, high-octane market we're having to deal with just now. Whatever the price is, there is a bullish argument for a higher price but also a bearish argument for a higher price.
Max: We have allocations of gold funds in all our funds. We are somewhat in the 'don't know' camp at present we've done very well out of it, but we're not quite sure which way it's going to go.
James: I argued some time ago against gold going to new highs because everyone was buying it as an inflation hedge and I don't believe inflation is going to be a concern. Sure enough, gold has done absolutely nothing although against some assets that's quite a good performance.
Max: On inflation, HSBC pointed out today that the UK inflation numbers have been higher than expected in 13 of the last 17 months. People are being very complacent about inflation but it's quite clearly a mounting problem in Britain.
James: But don't forget that less than two years ago UK inflation was hitting 16-year highs. The only reason British inflation has stayed so high relative to other countries is because of the big hit to sterling. Unless sterling has another large drop in the next 12 months, deflationary pressures will catch up with us.
Max: I'm not sure. We've seen devaluation of the currency, interest rates slashed, and a huge government budget deficit. They say it's all in response to the credit crunch. Maybe that's true but this is also a classic pre-election boom and the consequences are already coming through in terms of higher inflation. I think we'll see a short-lived recovery, but as inflation starts to be a problem and government spending is cut, it'll stifle the upturn. I'm not worried about a double dip globally, but I think Britain is the one place where you're likely to see a slide back into recession. The UK is in a mess all of its own.
John: What about our property market?
Anthony: On property I feel you can't have it both ways. Currently, low interest rates are allowing people to pay mortgages they wouldn't be able to pay with higher interest rates. But if stronger growth comes through, then at some point interest rates will go up. That's when the property market will start to crack again. I think it's got a bigger correction to come.
Max: The International Monetary Fund reckons that UK house prices are still something like 12% or 13% overvalued. US house prices are cheap, but relative to trend and relative to earnings UK prices are still expensive. I think what has happened is that a small amount of demand has met zero supply and that's caused this short-term market rally. But I think mortgage rates are going up, I think Britain's economic problems will continue, and I don't think value is great. So I am certainly not a bull of residential housing in Britain.
James: Yes, in the UK affordability is still absolutely rubbish. The dramatic drop in interest rates, which the government has forced the banks to hand on to existing mortgage holders, has cushioned the fall. But because of that, banks basically pulled out of writing new mortgages because they decided that if they were going to have to have narrower margins than they'd like for their existing mortgage books, then they certainly wouldn't be rushing to write new home loans in a deteriorating environment. Which is why, even after this much-lauded recovery in mortgage approvals, approvals are still well below the worst single month of the last housing downturn.
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Our Roundtable tips
John: Let's look at specific share tips. Anthony, where would you invest now?
Anthony: I would go for businesses with contracted strong recurring income. By that I mean at least 80% of their annual revenue is recurring. I also want businesses with strong intellectual property (IP) and distribution. My first pick is Craneware (LSE: CRW). It provides accounting software to hospitals in America to help them track their spending. This is currently a big growth area with all the reforms going through. If you're bringing more people into an insured system, there is going to be a greater need for hospitals to be accountable for spending. It's a lovely business. They have very long-term contracts, high recurring income they know what next year's numbers are and 75% of the year after that and strong IP.
My next tip is StatPro (LSE: SOG), which is a performance measurement business for fund managers. Again, 90% plus of its income is recurring. I like it because much of its distribution is electronic and its products are increasingly becoming embedded in customers' systems and servers, which means StatPro is very hard for competitors to get rid of. I also like NCC Group (LSE: NCC). If you take software from a big company and you want to make sure you retain the rights to the software if that company goes bust, then NCC effectively acts like an insurance provider. It takes the software from the large company and backs it up on servers on other sites. Again, NCC benefits from very high recurring income.
John: Do these all pay dividends?
Anthony: Yes. You don't get a huge initial yield, but they are massive cash generators, and they'll suddenly hike the dividend by 30% because profits have gone up, for example.
Mark: One area I like a lot is South Africa, which has been overlooked in favour of China and India. There is a very good company there called Cashbuild (Jo'burg: CSB), which sells construction and DIY equipment into both urban and rural South Africa. It's had strong free cash-flow growth, hasn't been free cash-flow negative in its history, and has about 15%-20% sales growth per year. The other theme I like is healthcare. Sino Biopharmaceutical (HK: 1177) in China just reported sales growth of 40% on the back of the government's fiscal stimulus towards the healthcare sector. The company supplies a lot of efficacious traditional Chinese medicines, 45% of which are related to hepatitis treatment and are proven to have an effect.
John: Max?
Max: One area that we have been cautious about, which I am much more positive about now, is energy equities. Although I think the oil price is probably going to come back a bit further, stocks have underperformed since March and they look quite attractive now. A price around current levels is a very good environment for energy companies and they can raise profits or increase cash flow and make good returns for investors. I do think it is better to buy energy funds than individual stocks.Dare I say it Investec Global Energy Fund (020-7597 1800) is the obvious buy, although we have a healthy respect for BlackRock Energy and Resources (NYSE: BGR) too.
It does look as though cyclicals have gone too far relative to defensives for the time being. The guys at Invesco Perpetual Neil Woodford and Mark Barnett had a great time until the market turned and then they had a pretty soggy time, so you can buy, for example, the Perpetual Income & Growth Investment Trust (LSE: PLI) at a nice discount now [currently 4.5%], and that's worth doing.
Our panel's FTSE forecasts Mark Asquith
Fund manager, Somerset Capital Management
Forecast: n/a
Anthony Cross
Director, Liontrust
Forecast: 4,650 by year-end
James Ferguson
Chief strategist, Pali International
Forecast: down 20-30% by summer 2010
Max King
Portfolio manager, Investec Asset Management
Forecast: 5,300 year-end; 6,000 mid 2010
Our Roundtable tips InvestmentTickerPrice
CranewareLSE: CRW 295p
StatProLSE: SOG99p
NCC GroupLSE: NCC395p
CashbuildJo'burg: CSB R7,835
Sino BiopharmaHK: 1177HKD1.92
Investec Global n/an/a
BlackRock Energy NYSE: BGR$22.65
Perpetual Income LSE: PLI205p
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