How to profit from China's growth
Roundtable: buy into China, gold, oil stocks and pharmaceuticals, say our experts - at Moneyweek.co.uk - the best of the week's international financial media.
We invited six of the best strategists we know to join us for dinner and tell us what they think looks interesting in global markets. Here they reveal what they would buy today.
Merryn Somerset Webb: A lot of market commentators are very gloomy at the moment, but I know that some of you are making money - where are investing?
Ian McCallum: Corporate restructuring. That's how we've made money in the UK the last couple of years. Companies aren't seeing profits from top-line growth but from cost cutting, closing down businesses, getting rid of people, etc. That's where the earnings expansion has come from and it will continue. As will the takeover story. All conglomerates are is a concoction of individual brands. There isn't much pricing power in the UK - if you can't sell your brands at a higher price then you need more brands; the minnows are going to be eaten. I think both restructuring and supply side consolidation are going to run and run as market themes.
James Ferguson: One of the reasons why big firms are buying out the small guys is that they can see genuine value. Equities that were looking overvalued back at the end of the 1990s, up to early 2000, now look pretty reasonable, if you allow for the very low interest rates. These allow higher multiples on earnings - and you've got very good earnings at the moment.
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IM: I'd say valuations are sky high right now. If you look at market apitalisation as a percentage of GDP - the equivalent of price to sales for the whole market - the US traded between 25% to round about 80% GDP from 1925 to 1997. Suddenly, in 1997, it re-rated around 130%. Why? Because interest rates collapsed and debt went sky high. If you are saying that current levels are cheap, you are saying that current debt levels are sustainable, and I would say that debt levels in the UK are not sustainable.
Jacob Rees-Mogg: The strongest argument for gloom in the near future is that we have had 12 years of continuous growth and that has never happened before, so it is about time we had a recession. It's not a very sophisticated argument but probably as accurate as anything else.
JF: Bad economic growth is not always bad for the stockmarket. I agree, there are huge economic problems looming, but I still don't come to the conclusion that everything is a sell.
IM: You can still buy individual stocks - I'm talking about the overall market.
JF: At first glance, stocks look expensive. But if you factor in interest rates and bond yields being much lower, they look cheap. The issue that it really comes down to is where are interest rates going? If we go to 10%+, then I would agree with you - everything is a sell. But I doubt we will.
MSW: Ian, if you're looking globally at restructuring plays, then where exactly are you seeing them outside of the UK? In Japan perhaps, or in Europe?
IM: There is restructuring in Japan. Continental Europe looks good too. And bits and bobs in the UK, but less so. In the UK now, you tend to be getting pushed more and more towards spivvy, smaller stocks to find value - which is a worry. But Japan, as well as Europe, still looks pretty good.
MSW: Despite there being a technical recession?
IM: I don't really give two hoots about the overall GDP if the stocks look good. I also like energy, coal, gas and oil big time. Utilities are totally baffling - we have sold out of utilities completely. The valuations are crazy - the water companies have good dividend yields, but there is no cash flow to back that until 2009 at the earliest.
JF: Also, these dividend yields look good in the current environment, but they are about the worst they have been for those companies for a long time. That has pushed most of them to the highest p/e multiples they have ever seen, and though you might say that's fair, given the lower interest rates, it still doesn't give you any margin for improvement.
MSW: Sven, you've been looking at some interesting things haven't you?
Sven Lorenz: I'm a stock picker, so I look beyond the market as a whole. At the moment, there are amazing opportunities in Continental Europe, thanks to restructurings, especially of family-owned companies. So often they have been owned by the same people for decades, and hid their earnings in their balance sheets. I think there are some really interesting stories out there that investors should take notice of. People are now finally waking up, cleaning up their balance sheets, buying back their shares, restructuring nicely. Despite the obvious economic problems, continental Europe looks a lot more interesting than the UK.
Tim Price: The UK is a mature capital market, and Europe isn't.
SL: That is a key point. What always amazes me is the lack of transparency and research on the European continent. They have companies with market caps in the billions, yet you cannot find a single analyst's report. Research reveals a lot of overlooked opportunities.
TP: Another positive story: I don't think the commodities bull market is over. The commodities sector has been strong for three or four years now - but it has come off a 20-year base. The reason that I'm intrigued by the story is not purely because it's predicated on a belief in higher prices - although I happen to believe that's also the case - it's because of the fact that fiat currencies are being printed like there's no tomorrow, value is going out of the window, trillions of dollars and pounds and euros are chasing yield and growth indiscriminately. It makes perfect sense just to diversify into real assets.
JRM: And then there is China. Lombard Street Research has just published a report saying China really accelerated at 14%-15% last year, but the official figure showed just 9% growth. And the increase in demand for oil in China was 15%. As long as they carry on demanding oil at that sort of growth rate - even if it goes down to 10% - the oil price is not going to collapse. And this applies to every commodity that they are importing.
JF: China is so big and diversified that it is like 17 countries. But China has always been there in my lifetime and every single time it has disappointed. It disappoints on two fronts. The growth gets eaten up - it is like a shark eating its own entrails. And what you make domestically, you often lose on currency anyway.
Guy Dresser: Lots of companies have gone to China and lost huge sums of money because they don't understand the culture of doing business there.They make basic mistakes because the culture and the tastes of the Chinese are essentially alien to Western companies.
MSW: Jacob, if we wanted to invest in Chinese growth, how would we do it?
JRM: It's very difficult because actually the Chinese do make sure that they make the most of any Chinese investment opportunities. However, there are several oil firms, some listed in Hong Kong, that can be traded relatively easily and can give you exposure to Chinese growth.
IM: There's a problem with China. Companies aren't making any money. Profit margins are getting blown apart because import costs are going through the roof. How you make money in China is by buying the stuff that they need, ie, you're back to commodities. And that, to me, is the China story - they are sucking in foreign investment, knowledge and foreign reserves to buy commodities and become self-sufficient. So you want to be on the right side of the trade - all of which takes us back to commodities.
SL: Commodities are one option, but occasionally you can actually find Western companies that do good business in China. For example, LVMH, the French luxury goods company, went to China in 1993. Very few high-end brands will earn any money because they don't know the market and they have not established their brand. There is so much purchasing power there, so an established brand like LVMH is the exceptional company that I think can actually make real money in China.
MSW: Is there as much purchasing power in China as we think? The middle class still is tiny.
TP: It's exploding though. I know this is a fatuous point, but China is so big that 5% of the Chinese population is equivalent to the whole population of the UK. And 5% of the population is rich.
MSW: Getting back to Tim's point on fiat currencies, what are your thoughts Jacob?
JRM: I think fiat currencies are a great myth - that there is no value to paper issued by governments - it's backed by absolutely nothing other than confidence in the government. The notes you take out of your pocket are worthless. Gold isn't, though: it has rarity and it's a store of value.
JF: I don't agree. It's not a great store of value and it's not that rare.
TP: But gold has kept its value over thousands of years and no other currency has ever lasted so long. Unless there is deflation, I would always hold gold over cash.
JRM: If you think policy makers are fundamentally clever and able people, then you should be in favour of fiat currencies. If you think the market gets things right more often, then you should be in favour of gold. I think the gold standard led to greater economic growth than we've had with policy makers intervening.
JF: I personally think buying gold for the sake of gold is a red herring. I think if you were talking about commodities - gold as one of the commodities -that's fine.
TP: Surely the bottom line here is that we don't have to bet on any single one investment, and that maybe it makes sense to diversify.
MSW: Has anyone got any specific tips?
JRM: Yes: buy gold. I keep a gold stock in all of my portfolios and think that they are still offering attractive value.
MSW: James?
JF: I'm quite bullish on equities and I don't see why one should look any further afield than the UK. I would concentrate on pharmaceuticals and oil. I didn't think pharmaceuticals were attractive a few months ago, but since then people have been selling quite aggressively and I don't think the sector has got any more downside. There is evidence that both AstraZeneca and Glaxo are now breaking to the upside.
Then there's oil. The oil stocks have not nearly done enough to compensate for the new sea-change in where medium to long-term oil prices are - people had responded to the short term. It looks like we are looking at a good 40%-type upsides on BP and Shell. To tip an individual stock, I think the biggest upside stock in the UK is Legal & General - on the basis of how the market has priced it in the past, Legal & General has just dropped off the radar. There are several stocks priced too richly on this basis and several are priced too cheap. Right now, the cheapest on the FTSE100 is Legal & General.
MSW: Tim, you're a fan of oil stocks.
TP: Yep, BP would definitely be there and Billiton is at a new 52-week high, Anglo-American certainly isn't, but Rio Tinto, which is the third-largest mining stock in the FTSE, is also at a 52-week high, so I'd be happy with those.
SL: For a stock tip that combines the European restructuring story and Emerging Markets buyers, take a look at Unique Airport, it's Zurich Airport, listed on the Zurich stockmarket. There has been a mystery buyer for months. One of the hot candidate buyers would be the Dubai government, which is looking for a hub in Europe to fly European tourists over to the attractions they are building. And Zurich is one of the very few large central European airports that actually has spare capacity - because of the aftermath of Swiss Air going bust. But they are still making a profit and the shares are fairly lowly valued as well - they are even below book value.
IM: I would also recommend a continental European company. Karstadt, the German retailer is cash poor, asset rich. It is one of the leading retailers in Germany. It's a restructuring story, they are selling off the crown jewels. This company trades at 0.1 times price to sales, which is very low, even for the supermarket sector. We are expecting that over the next 12-18 months it will go quite heavily into cash positive territory. The stock is a strong buy.
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