MoneyWeek Roundup: The end of Britain

The week began with the shock news that the chancellor, George Osborne, had appointed Mark Carney as the new governor of the Bank of England. The former head of Canada's central bank had previously stated he wasn't in the running, but clearly Osborne had been busy working behind the scenes to make it happen.

So how does this affect your money? In Wednesday's Money Morning Dominic Frisby investigated whether the new man will change things for investors.

For starters, says Dominic, the markets have given us a pretty muted reaction. "Sterling was pretty much flat on the day of his appointment, while the FTSE 100 was down about 30 points, in line with other stock markets. There was no 'this-is-going-to-save-us!' rally, nor 'this-is-the-end!' falls."

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So what of Carney's record? Some pundits have hailed him as 'the man who saved Canada'. On the face of it that seems fair. After all, Canada emerged from the financial crisis in much better shape than the UK. But dig a little deeper and the story isn't so encouraging, says Dominic.

Carney achieved his 'miracle' by adding liquidity and slashing interest rates "in other words, exactly the same as every other central banker".

Indeed, the real reasons why Canada looks OK now have little to do with Carney, says Dominic.

"First, it's the only one of the G7 countries to have run a budget surplus for the last 14 years. (One reason for which, incidentally, is that with the US next door, it spends very little on its armed forces). So it was in a stronger position going into the crisis."

"Secondly, Canada is extremely rich in natural resources - oil, gas, metal and grain, the prices of which (except gas) recovered very quickly after 2008."

However, the Canadian economy could still tank.

"As a result of his slashed interest rates, the banking system may not be such a paragon for much longer. Carney leaves behind him high house prices in both Toronto and Vancouver, where, not unlike London, locals complain that housing has become unaffordable to them." Both could be bubbles that are about to burst and lay waste to his reputation.

As for your money not much has changed.

"Carney only has the same cards as the last head of the BoE words, and the ability, if in doubt, to print as much money as the Treasury wants. So there's no need to change your investment strategy. There's no big change of policy coming. We're likely to remain mired in this stagflationary bog. Stick with income-paying stocks, cheap markets outside the UK, and, of course, plenty of gold to guard against the ongoing devaluation of sterling."

Has Japan finally hit rock bottom?

If you've been reading MoneyWeek for a while, you'll know that we have backed certain stalwarts, including gold and income-paying stocks. And so far, both have proved pretty sound investments. One long-time favourite with a far less impressive record, however, is Japan: we've long backed it to make a comeback, and so far we've been disappointed.

But in the last fortnight or so, Japan's main stockmarket has risen almost 9%. So in Tuesday's Money Morning, John Stepek investigated whether Japan is finally about to come good.

"There are plenty of reasons to fret about Japan", admits John. "The spat with China over a group of islands in the East China Sea has dented demand for Japanese goods in China. It doesn't help that China's economy was already slowing down anyway.

"But the key issue for Japan is its ludicrously strong currency. This has been a mixed blessing for overseas investors. On the one hand, it has protected them from the worst of the Japanese bear market.

"However, the yen is now becoming a serious problem It's quite simple. Japan exports a lot of stuff, and a strong currency makes exports expensive. There's only so much that people will pay, even for good quality exports."

As a result, investors have started to shy away from Japanese stocks. "Global fund managers now have their lowest net exposure to Japan in ten years", notes John.

"It's not that fund managers are stupid. But they have a tendency to herd If almost no one is investing in a specific area, then the only way is up. If there's hardly any money being allocated to Japan, then even if there's more bad news up ahead, it can't have much impact. And if things start to improve just a little bit, then even a relatively small amount of added investment could have a big impact on stock prices."

As John points out, most fund managers can't sit around waiting for long-term bets like this to come off - many are under pressure to show good results every quarter. At the very least they don't want to be way below their benchmark. And that means that most stick to following the crowd.

Private investors, however, have the luxury of looking longer term. So what could send prices heading upwards? Two obvious catalysts are the forthcoming election (on 16 December) and mounting pressure of the Bank of Japan to do something about the strong yen.

"I hate to second-guess politicians or the results of elections", says John. "The good news is that in this case I don't have to. Japan is cheap. Whether the catalyst that persuades markets to recognise this comes tomorrow or in a year's time is by-the-by."

Britain is about to bomb

Our optimism over Japan stands in stark contrast to our view about Britain. Indeed this week we sent out our latest report on the state of the nation's economy. It makes for pretty grim reading for those of us who live and work in the UK.

Unsurprisingly the report created a storm this week in the media. Some, such as Russia Today presenter Max Keiser, and MP Douglas Carswell came out in support of the findings. Meanwhile others, including Economist reporter Daniel Knowles, vehemently contested them. I'll let you make your own mind up read the controversial End Of Britain report in full.

Now's the time to buy Argentina

Another country that's going through a tough time at the moment is Argentina. I've spent several spells working there and it's a beautiful country. However, the current government's management of the economy is a mess.

In this week's edition of The New World newsletter I used Argentina's travails to distinguish between the 'old Latin America' and the 'new' one.

"The story begins in 2001/2002 when Argentina made history with the biggest sovereign default ever seen. With its economy in crisis Argentina was forced to devalue its currency and defaulted on almost $100bn of bonds. Over the years, Argentina managed to cut a deal with most bondholders, agreeing to return about 30% of their money.

But it has refused to pay a cent to one set of investors the vulture funds. These funds swooped on the debt in the aftermath of the crisis, buying up the debt for a tiny fraction of its nominal value. And, as a result, the Argentinian government sees them as financial opportunists rather than legitimate bondholders."

And now Argentina is embroiled in a lengthy legal battle with the so-called vultures. If judges eventually decide that Argentina should pay the vultures, and Argentina refuses, then it could even end it defaulting on its debt.

But, as I explain, all of this is actually good for investors in Latin America.

"Argentina isn't the only Latin American country facing the wrath of foreign investors. Bolivia and Venezuela have both enjoyed their fair share of expropriations and nationalisations over the years. These actions generate plenty of dramatic headlines here in the West, and do a good job of scaring investors away from Latin America."

Why? "Because while those three nations might be living up to a lot of Westerners' expectations of Latin American economies, elsewhere in the region things have been quietly changing. Over the last decade a new breed of open, investor-friendly, well-managed economies has started to emerge."

My four favourite economies in Latin America are Mexico, Colombia, Peru and Chile. They've all made important reforms, have fast growing economies, and, conveniently, have come together in a new grouping The Pacific Alliance.

The group has a lot going for it. Low debt levels, friendly investment environment and lots of commodities.

But their standout characteristic is their attitude to international trade. "They are all incredibly open economies and have free trade agreements with vast swathes of the globe. These agreements aren't just about securing export markets. They also help local consumers enjoy cheap imports from around the world and ensure that local companies are competitive."

I don't have space here to detail all the bull points read the piece in full for that but I'll finish with my favourite observation about the Alliance. "The group has a population of 215 million, but a GDP of only $2trn. That's a smaller GDP than the UK, but with three and a half times the population. I know who I'd bet on to enjoy the best growth over the next few decades."

Moneyweek's wine club is up and running

No matter how hard things get, one thing you can never imagine the Argentinians losing is their great red wine. I'm no connoisseur, but even to my untrained palate Argentinian wine, especially Malbec, is excellent. If you're a big wine drinker, or keen to learn more, you may want to join the MoneyWeek wine club.

I was lucky enough to attend the launch last week a quality tasting with dozens of fine wines, hosted by one of Britain's premier wine experts, Matthew Jukes. If you missed it, don't worry. You can see a short video of the evening, including Matthew's excellent presentation, right here.

Some key penny share pitfalls

Before I go, a quick nod to an article from Tom Bulford that really caught my eye. Twice a week Tom sends out his Penny Sleuth investment newsletter. As you can probably guess from the title, it's all about finding tiny companies 'penny shares' with big potential.

But it doesn't always turn out that way. In Tuesday's Penny Sleuth Tom explained the pitfalls that can waylay even the most promising penny shares.

Last year Tom highlighted Ceres Media (CMI) an innovative British company that has developed an environmentally friendly plant-based oil to replace oil made from plastic. Tom didn't tip the share, but he did say it was one to watch. Well, thank goodness he didn't recommend that anyone buy it, because the stock has tanked. "In little more than a year since Ceres came onto AIM, its share price has fallen from 18p to 1p", says Tom. And that makes Ceres an interesting case study of what can go wrong for small caps.

What's happened to Ceres is fairly typical when small companies debut on the stockmarket, says Tom. "While City advisers are happy to encourage companies on to the stock market with promises of keen investor interest and the prospect of a rising share price, they don't mention the downside."

So when, "within three months of coming on to the market, Ceres admitted that sales were not as buoyant as hoped, the finance director resigned, the City threw up its collective hands in horror and the share price went into free fall".

The fact is, says Tom, the share price of a small company is a lot more susceptible to bad news.

So why were results worse than expected? Well, again, Ceres is suffering from some pretty typical small-cap problems.

"The first is that the product does not have an obvious price advantage over the incumbent. The type of advertising banners that are seen in supermarket car parks or shop windows are made of polyethylene. This can be imported at low cost from China and it does what is required so why change it?"

Instead, Ceres needs to trade on other advantages. Such as the fact it's better for the environment and it also shows up better in certain light conditions.

The other problem Ceres Media faces is that it's trying to disrupt a market where it's a small fish in a big pool.

"Ceres has to try and persuade companies that are much bigger than it is, and have established supply chains, to change their ways. Simply getting hold of the decision maker in a large organisation can take months of trying.

And in the case of the supermarket hoardings, the material from which these are made is not really the decision of the supermarket itself but of its suppliers the printer of the banners and of the distributor who sells plastic film to the printers. Ceres has to convince not just a single customer, but a whole supply chain that sees little reason to change its established ways."

Ceres hasn't given up the fight. But, observes Tom, "the share price may take a lot longer to move from 1p to 18p than it took to complete the opposite journey".

If you want to hear more about small-cap investing from Tom, you can sign up to The Penny Sleuth here.

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