Our roundtable members
John Stepek: What surprised you most and what surprised you least in what’s been a very weird year?
Simon Edelsten: I totally agree it’s been “weird”. The main thing that everyone had feared would happen – inflation – happened. But according to the economics textbooks, bond yields were supposed to go up, and they haven’t. That confuses everyone. It causes issues for savers and I think it should cause some caution for us. It wouldn’t take much of a move in bond yields towards the inflation we’ve already seen for markets to struggle quite a bit. And yet everyone seems to be dead bullish. Global equities are up 20% this year and they went up even more than that the year before, from the lows. So the equity market is behaving as if it’s party time.
Max King: I agree that the big surprise has been that despite inflation bond yields haven’t gone up – and if they haven’t gone up now, it’s very unlikely that they’re going to. It seems to me that the world is populated by Christmas Grinches who spend all their time trying to convince people that the market is about to crash. We are in a golden age of property and stockmarket investment, and despite grumbles about valuations, I don’t see markets as particularly expensive in most of the world. So “don’t worry, be happy” is my message.
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Steve Russell: I think I have to come in there and do my best to be a Christmas Grinch. We’ve been predicting inflation for ages, but when it actually came along and stayed, we were surprised – we didn’t expect US inflation to now be nearly 7%. But we did absolutely expect bond yields and interest rates to stay nailed to the floor. The problem is that markets have decided that real interest rates are the discount rate, and this is just wrong. Say interest rates remain at 0% and inflation is at 10% – you’ve got a minus 10% real rate. But you still have to discount future cash flows by 10% inflation to get the current valuation [when the discount rate rises, current valuations should fall, all else being equal]. So I think markets face a painful re-rating that will kill the bull market, once there’s a realisation that inflation is persistent, but that central banks aren’t raising rates and that bond yields are just a false market.
Until that happens – next year, maybe the year after? – equities will be attractive because we’re getting quite good growth. Equities are better than conventional bonds because they are at least real assets. So there is no reason why the TINA (“there is no alternative”) trade shouldn’t continue until there is this realisation of the damage that inflation and negative real rates can do.
Jim Mellon: But is it really the case that markets are up 20% this year in a conventional way? There’s been a high concentration of return in about ten US stocks. I read the other day that there are more stocks down this year than there are up in the major markets, which I think is probably true. I think we’re setting up for quite a big fall. In fact, I can’t see any way out of it.
John: Yes, Cathie Wood’s ARK Innovation fund has tanked this year – it peaked in February. That holds all the “longest duration” equities in the market. Is that a canary in the coal mine?
Simon: The big tech stocks – the FAANGs – have done very well and have been a big contributor to Wall Street going up 28% in sterling terms. But the MSCI World index is up 20% and Europe is up 13%. So, it’s not all one place. The ARK portfolio is not FAANGs – it’s Tesla and a load of things that don’t make a profit – a very concentrated, rather small part of the overall market. What’s interesting is that the Googles of this world – old-fashioned, established tech, if you like – are now behaving like staples whereas the speculative and unprofitable stocks have sold off very aggressively. That could well carry on.
Inflation: how much more will we see?
Matt Tonge: We own a software business called Kainos, which employs about 2,000 software engineers, so it’s seeing very high wage inflation, for example. But the key is that Kainos has pricing power, so it can pass those costs on. To take another example, we invest in James Cropper, which is a paper mill, founded in 1845. It makes the paper for poppies; it has a technical fibre-products division that makes non-woven carbon-fibre veils; it’s in aviation, hydrogen fuel cells, automotive – so it has lots of intellectual property. Now the price of pulp has been going up and other companies in the sector have struggled to pass on those costs and have had to issue profit warnings. Cropper, however, has been able to put its prices up and so hasn’t had to warn on profits. But this is a problem that each business is going to have to negotiate.
John: Isn’t there a risk that inflation goes even higher? A lot of this stuff already seems embedded in the system, particularly wages.
Simon: There are some aspects to the inflation we’re seeing that have probably been pumped up by the size and speed of the global recovery, such as oil and the price of petrol. But others seem more stubborn. Take shipping costs. The main Chinese ports have been putting their rates up by 10%-20% in the last week. So if you’re selling products you’re making in China, the cost of your product has just gone up and you’ll soon see whether the public is prepared to buy it or not. That hasn’t even started getting into the system yet.
As for wage inflation, that will take longer to work through. I remember one week reading five different articles from five different countries about port congestion and the lack of truck drivers, and each gave a local reason for the shortages. A Hong Kong port was bunged up because of China’s zero-Covid-19 policy. Los Angeles ports were bunged up, which the Republicans said was because Joe Biden had given everyone $3,000 to sit on their sofas. The bunging up of the British ports was, of course, all about Brexit. And the German ports were bunged up even as the Poles were saying that the Germans had hired all their drivers for more money.
As a London taxi driver explained to me, the reality is very simple. If you have to pay an annual fee to be part of a driving club – such as a London taxi driver or a trucker – and you’ve had two years of Covid-19 and no money, and you’re in your 60s and you thought you were going to retire in three years anyway, you just drop out. That’s all that happened, and they weren’t training any new drivers. That will take longer to work through.
But it’s about time the lowest-paid saw some wage inflation. It’s a healthy sign. We could very easily see 3% or 4% inflation for the next few years, but that’s fine for the equity market. The adjustment can be tricky, but when you’ve got companies growing this quickly, they can cope. It allows government debt levels to fall, which is what governments and central banks want.
Max: One aspect that has been a bit ignored is the revolution in the payment systems. Cashless payments have made pubs and small shops far more efficient. Many businesses that we would have assumed would be dead in the water because of cost increases are actually thriving because there have been enough beneficial changes to compensate.
Jim: But why couldn’t inflation go much higher? The world is more indebted than ever – and the percentage of that debt which is index-linked is at an all-time high. What is the fundamental difference between the current situation in developed economies – where we all seem to think that central banks will get their hand on the tiller in just the right way – and, barring the idiotic governance, Turkey?
Simon: Turkey has done the opposite of every conventional macroeconomic policy for the last five years, whereas over the last year central banks in Britain, Europe and America have done a very good job. As soon as the virus turned up, they stuck a proper amount of money in the system and prevented massive unemployment.
Steve: Yes, but on Jim’s point there will be different reactions to high inflation from different central banks. Some countries – and the UK unfortunately could be one of them – might be seen as a bit too weak or too behind the curve. So I think you could get more currency fluctuations – which have been pretty much missing for the last ten years – which could exacerbate inflation for individual nations.
Simon: That’s an important point on geographic differences. US inflation just came in at 6.8%, but there are still people buying ten-year bonds at 1.5% – Americans are fairly used to inflation and the UK’s similar. But you also have 6% in Germany, which they’re not used to. German savers may well get very upset if their cost of living keeps going up at that rate. Yet it wouldn’t suit Europe at all to put up interest rates.
John: Given that France has a big election next year, do you see the eurozone coming under pressure again?
Simon: A lot of inflation in Europe is likely to come through fuel prices and if you apply the German process for carbon-costing electricity across Europe, you could see 20%-25% increases in domestic electricity bills in Italy and Spain. That gets people upset.
The energy transition
John: Given rising energy bills, do you think the environmental, social and governance investing (ESG) bubble might burst this year?
Jim: I don’t think ESG is going to go away, but its composition may change. There’s a growing recognition that nuclear is the interim solution. We need more, especially in the UK where we’ve been running down our capacity in contrast to France, leaving us very tight on electricity supplies.
Simon: Do you think COP26 supported nuclear, or do you think they still just don’t want to think about it?
Jim: I think the first thing you’ll see is the taxonomy of various sources of energy from the European Union. That’ll incorporate nuclear as a green factor, which might allow the Germans to reopen some of their nuclear power stations. Uranium, a very volatile commodity, might be one way to play it in the next few years and there are much safer ways of doing nuclear power now than in the past, such as these mini-reactors.
Steve: Jim’s probably right about having an interim transition via nuclear. The problem is we stopped spending on oil and gas five to ten years ago and we need it for at least another ten, maybe 20 years. I’d be wary of oil explorers because I can’t see why we need to find more – we just need to keep producing what we’ve got. But the market has priced them as if they’ll be dead in five years’ time and I think they may only die in 15 years – that’s a big difference in cash flows.
Max: Energy is going to be the biggest bottleneck in the global economy for the next 20 years, as it has been for the last 50 years. That means periodic steep rises in energy prices and it means money going from successful, efficient countries to corrupt, unsuccessful ones. If there is one cloud hanging over the global economy for the next 20 years, it is the constraint of the energy sector.
John: What about hydrogen? Will that help?
Simon: Hydrogen is not a fuel – it’s a storage device. It costs a lot of fuel to make and then you get a little bit less fuel out. So the question is: can you make clean hydrogen at an economic cost? And there are some fantastic advances here. One or two North Sea wind farms already have small electrolysers. When they produce power that we don’t need, because we’re asleep, they produce a little bit of hydrogen that can then be picked up by ship. So it’s already happening, but it will need government subsidies to scale it up. It’s a 15-20 year project, but its applications could be enormous.
The trouble with a battery is if you have a surge in demand – when everyone turns their kettle on at halftime in the FA Cup final – then it can’t cope, whereas you can burn hydrogen very quickly when you have a surge in demand for the grid. But the idea that anyone could plan to change the world’s energy supplies in a stable, sensible way – even if it’s very pricey – over anything other than 20 or 30 years is just ludicrous.
UK stocks are still “ridiculously cheap”
John: Let’s move on to tips. Steve, what are you thinking this year?
Steve: Despite everything, I do think the UK is ridiculously cheap and that a lot of firms are likely to attract serious private equity interest if stockmarkets don’t do something about it. Any sterling weakness will just exacerbate that. So here are four UK names that everyone has heard of: BT (LSE: BT.A), Currys (LSE: CURY), ITV (LSE: ITV) and M&S (LSE: MKS). They’re all on about eight times next year’s price/earnings. Most have sorted out their balance sheets, and I think there’s real upside. We’re also still keen on the oil majors, BP (LSE: BP) and Shell (LSE: RDSB).
I’m also really fascinated about the rise in demand for cars and the need to restock inventories across the world, so I’m going to go with VW (Xetra: VOW) again, which I think is soon going to be Europe’s largest electric-car manufacturer. Car rental is fascinating too. We made a small but very rapid fortune in Avis recently, helped by a short squeeze – the first time I’ve ever been an actual beneficiary from such an event, in terms of owning a stock that went up threefold on the day. But Hertz (Nasdaq: HTZ) is probably a better pick now. If anyone has tried to rent a car recently, you’ll know it’s costing double what it was. This also seems to be one of the industries Covid-19 has restructured via bankruptcy and the loss of competition. On top of that, the car manufacturers won’t be stuffing car-rental companies with excess stock anymore. In fact, their 18-month-old cars are now worth more than they paid for them. So Hertz is a very interesting recovery play.
John: Jim, what do you like just now?
Jim: In the banking sector, I think Lloyds (LSE: LLOY) remains an outstanding buy. Its prospective yield is 7%, it’s on eight times earnings and it trades at a discount to book value. On Steve’s private equity point, I see no reason why Tesco (LSE: TSCO) wouldn’t be taken over. It’s not a national treasure and it’s well within the bounds of the big private-equity firms. It’s on 11 times very dependable earnings – especially with the acquisition of Booker – and a prospective yield of 4.5%. In cars, I’ll go for General Motors (NYSE: GM), which has the autonomous driving division. It’s on roughly eight times earnings and is very well run. Lastly, in uranium, Cameco (NYSE: CCJ) would be my pick.
Matt: These are micro caps, not the most liquid stocks, so just be careful of that. The first is Crawley-based Inspiration Healthcare (LSE: IHC). It makes warming mats and ventilators for babies born prematurely, helping save their lives. Although Inspiration has competition, its relationships with the doctors actually saving these lives enables constant innovation of the products and hopefully improved outcomes for more families in the future. The ventilators are quite complicated to make – over 2,000 parts – so that’s a big barrier to entry, and it’s not expensive – around 1.8 times sales when comparable businesses are typically on four times. It also has the potential to expand into the US.
The second is Vianet (LSE: VNET). It provides monitoring equipment to pubs, which pay a monthly subscription for a bit of technology between the barrel and the pump that makes sure what comes out of the barrel goes into the till. This cuts down on wastage. The division has been in decline for probably ten years because pub numbers in the UK has been falling. But Covid-19 has pretty much cleared out that sector and its customer base seems to have stabilised now at around 10,000 pubs, with about 85% recurring income. Another division puts contactless-payments technology into vending machines. If you do that, sales go up by about 40%, because no one has cash on them anymore. That division has 42,000 machines paying weekly subscriptions and there’s leeway for another 42,000 from a couple of contracts they’ve got. I reckon in two years’ time Vianet will be producing £3m-£4m free cash flow; its current market cap is about £25m. It is geared because it had to borrow some money because all the pubs were shut due to the virus, but I think that will be paid off. So that’s really cheap, although another full-scale pub lockdown would be unhelpful.
Third is AdEPT Technology Group (LSE: ADT), based in Tunbridge Wells. It does cloud services for small firms. For example, it has a big contract to do the London Grid for Learning, which is 33 London boroughs providing fibre to schools. It used to be involved in providing telephone lines, but it’s bought loads of cloud-services businesses and that’s helped it to become what is probably now a growing company, from one that wasn’t. The issue is that it’s really quite small and the old management team was quite happy to run it at around three times gearing. The market hates that, even though it’s got very strong cash flows to support it. But if it can just stop buying things and pay down its debt, which new management indicated in the last statement was the plan, the market will like it again. There again, it’s on five to six times earnings and it’s in a sector enjoying high demand.
The world’s best chips
Simon: Taiwan Semiconductor (NYSE: TSM) is the world’s biggest and best maker of the best chips in the world. Every developing technology you see relies on fast, efficient chips – when people talk about the “metaverse”, or artificial intelligence, or machine learning, somebody somewhere is having to ring up either Taiwan Semi or Samsung. So the company has never been busier – it just put up its sales forecast again. It is extremely profitable and has been for the last ten years. People think it’s cyclical, but it’s less so than it used to be – its technological lead on others in terms of the speed and efficiency of the chips it makes, and how small they are, is unsurpassed. This is why both China and America have national programmes trying to build chip plants anywhere near as good as these.
John: Are you at all concerned about the political situation in Taiwan?
Simon: Yes. But all the best chips in the world are made in either South Korea or Taiwan. None are made in China and none in America. If you want your cruise missile to be given facial recognition so it can hit someone on the nose, you need one of those chips. So, this isn’t just about inventing a driverless car, this is about security. China may want to re-invade Taiwan, but in a way, Taiwan has been rather sensible building the world’s most important semiconductor plant there, because the Americans have a not-quite-equal, but certainly opposite, interest in defending them. But you’ve got to take these things into account, of course.
My next recommendation is boring – Google, otherwise known as Alphabet (Nasdaq: GOOGL). It’s massive, it’s growing like a weed, it’s never been more expensive and keeps going up. It has incredibly fast conversion of income to cash flow – and cash flow is what drives shares up – and it can cope with any sort of inflation, any variant of the virus. Nothing seems to knock it. The bear case? Biden and his new regime having a go at tech firms, changing regulation. But the way in which we do our valuations, we pretend that Google pays full tax. It can well afford it and it would be politically sensible to show that it’s a good corporate citizen – but Google doesn’t ask my opinion on that.
So, that’s two quite solid world-leading growth stocks. I’ll throw in one in the UK. I have problems investing in the UK because there aren’t many long-term growth stocks. But, I found one recently, AVEVA (LSE: AVV). It came out of Cambridge Science Park. It has information technology that makes oil companies more efficient in terms of their wells, chemical plants and refineries. If you look at what came out of COP26, everyone is being asked to cut methane emissions. AVEVA happens to make IT systems that will model your refinery using sensors, then tell you what you need to do to comply with rising regulations in this area. We’ve been selling our wind-farm stocks because they’ve gone up a lot, but there are lots of other firms like this one that will contribute to a low-carbon world, which aren’t necessarily so well-known. It’s not the cheapest stock in the world, but it’s a British leader with top-class software and lots of repeat business.
Finally, there’s Yaskawa Electric (JP: 6506), the world’s second-biggest robot maker. It’s underexposed to the part of the industry that supplies car makers, which has been saturated, but it’s the main player on the semiconductor side, which is where more plant capacity is being put in. Automation is extending into a large range of new sectors such as textiles, agriculture, food manufacturing and even surgery. For example, there is now a robot that will weed your rice paddy overnight. This is the most interesting thing for us in robotics – it’s not the big, heavy metal-bashing that robots have done for 20 years, it’s how robotics is getting into new sectors and improving productivity in a range of industries – key during a period of cost inflation. It’s a huge growth area long-term and Yaskawa is one of the best ways of investing in it.
The best investment trusts to buy now
Max: I think the outlook is pretty good, so it’s a good time to top up on the global trusts, which are generally growth-orientated (see page 24 for Max’s views on these). But those won’t give you much exposure to the UK and I rather like Steve’s focus on reviving growth stories such as ITV and Marks & Spencer. So you can capture that quite well with Lowland (LSE: LWI) or Temple Bar (LSE: TMPL). Small cap looks attractive, particularly in the US. JP Morgan US Smaller Companies Trust (LSE: JUSC) has been a very good long-term performer, but Brown Advisory Smaller Companies (LSE: BASC) also looks really good.
Listed private equity is rather neglected in the UK because it tends to be high-cost, and wealth managers and charity managers don’t like disclosing high costs, so they tend to have very low allocations to it. Yet as a result, it’s a fantastic area for both value and growth. It’s not just obvious ones such as 3i (LSE: III) and HG Capital Trust (LSE: HGT), but also HarbourVest Global Private Equity (LSE: HVPE), ICG Enterprise Trust (LSE: ICGT), Pantheon Int. (LSE: PIN) – all these have done really well in the last year and I’m confident that’ll continue for the next year or two.
Finally, for an out-and-out punt, something in emerging markets, like the BlackRock Latin America Fund (LSE: BRLA). Energy prices are strong and the economies are doing well. Covid-19 is diminishing in these countries fast and those with loony governments like Peru have already realised what a mistake they’ve made. So I think this could be a very attractive modest punt on the side.
John: I meant to ask if anyone thought emerging markets would make a comeback this year.
Max: I think so, but Latin America, Eastern Europe and Russia are probably the most interesting areas – maybe some of the frontiers. I’m still wary of China.
John: A quick-fire round before we go… this time next year will Boris Johnson will still be prime minister?
Max: I wonder if he’ll be PM this time next week.
John: But how will they get rid of him?
Simon: There’s a way. Look at what happened with Thatcher. He’ll be taken into a room and told to go. They’re a vicious bunch, the Conservatives.
Steve: They’re a lot better than Labour at doing this.
Simon: Yes, they’re very efficient at it.
John: And if you had to put a figure on inflation this time next year? US or UK, your choice.
Steve: 6% in the UK.
Max: 4% UK.
Simon: US, 3%.
Jim: I’d say US 10%.
John: That’s what I like to see, a good spread! Thanks everyone and have a great Christmas.
|Our roundtable tips (20/12/21)|
|Marks & Spencer||(LSE: MKS)||225.6p|
|Inspiration Healthcare||(LSE: IHC)||112p|
|Adept Technology||(LSE: ADT)||200p|
|Taiwan Semiconductor||(NYSE: TSM)||$114.94|
|Yaskawa Electric||(JP: 6506)||¥5,700|
|Temple Bar||(LSE: TMPL)||1,068p|
|JP Morgan US Smaller Companies||(LSE: JUSC)||445p|
|Brown Advisory US Smaller Cos||(LSE: BASC)||1,402p|
|HG Capital Trust||(LSE: HGT)||419.5p|
|HarbourVest Global Private Equity||(LSE: HVPE)||2,730p|
|ICG Enterprise Trust||(LSE: ICGT)||1,278p|
|Pantheon International||(LSE: PIN)||332.5p|
|BlackRock Latin America||(LSE: BRLA)||332p|
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