Fund managers have faced a trying six months as last year’s gloom over the European debt crisis evaporated, to be replaced by surging confidence that the global economy is once again poised for growth.
In an interview with Business Spectator, veteran investor Kerr Neilson from Platinum Asset Management (which oversees a $15 billion portfolio of international equities) outlines his view of global markets, and his approach to investing during turbulent times.
First of all, Kerr, what’s your view of markets at present?
The thing we saw late last year was that, although there was great uncertainty in Europe, valuations were becoming extremely attractive. Markets were building in very modest expectations of what reasonable companies could do in the future.
If you study market activity over the long term, you know that there are always parts that are in decay or death and others in birth or rebirth.
Some private investors get terribly caught up in looking at whether the market’s bloom is over, or whether it’s continuing. But there is always creative destruction in markets: there are always new winners taking the place of those that are. So if you only look at the market’s surface, it may appear flat, but there’s always huge turbulence taking place within. There are always good companies that are exploiting the new thing, for example, the huge rise of internet shopping, or the take-off in mobile technology.
So even if the overall view of the world is fairly unhelpful and, it appears that things are going nowhere, one should always be looking for the companies that are doing new and interesting things, or older companies that are doing things in a different way. This approach explains why our performance has kicked up nicely in the last three months.
My other view is that China is not the growth engine it once was. We think it’s very clear that China does not want to have a very powerful rentier class of property owners. So although they might give some support to the lower end of the property market, they clearly want to squeeze speculators out of the upper end, and to see prices adjust downwards. At the same time, there is the uncertainty created by the leadership change later this year.
I think China could have a slight setback if the authorities end up being a little tardy in adjusting their policy settings. And investors could see the Chinese economy slow more than what they’re currently projecting.
Where this could be a problem is that provincial governments in China typically depend for at least half their income from property sales. As the market has deteriorated, so have the levels of property prices and transaction activity. As a result, their revenues are being squeezed quite considerably.
The end result is likely to be that the central government provides the provincial governments with more funding, and maybe one or two of them are given permission to raise funds by selling bonds themselves. But this will be deficit spending, and it will entail a rise in government spending as a share of the economy.
So there’s a reasonable chance that in the next six months people could start worrying about how much growth to expect from China at a time when hopefully the global economy is looking a bit better.
And so you’re expecting a pick-up in the US economy?
Quantitative easing, where the US government has acted as a backstop to anyone who wanted to borrow, has worked better than I would have thought.
We can’t know the full long-term costs of QE, but in the short term at least it prevented people from going into a complete funk. The huge deleveraging process will therefore take place over a much longer period, instead of happening very quickly (and alarmingly).
I think that in the US three things are changing. Firstly, the central bank is making it easier for people to borrow. Secondly, there’s new investment going into developing the country’s shale gas and oil reserves with all its associated downstream ramifications. And thirdly, while accelerated depreciation provisions ceased last December, the housing market is gradually improving. In the middle of last year new starts at under 600,000 units barely replaced the loss of housing to natural disaster and demolition etc. Housing starts have a long way to get back to the low end of trend.
As a result, I expect that the US economy will now gradually wend its way higher. And the US market was starting out at valuations that were quite interesting.
What about other major markets?
What’s interesting to me is that Japan is trading at, or slightly below, book value while Europe is trading at, say 1.3 times book value. (I find book value is an interesting measure because it represents the very lowest cost of reconstructing a company.)
And although there has been something of a revival of interest in the Japanese stock market, most investors have very little money invested in that market (Platinum has 16 per cent of its funds invested in Japan).
One company we like is Toyota. It had the combination of the tsunami and the earthquake and the power cuts to contend with, and its price got down to a silly level for what is essentially a very good company. Also, Toyota made the mistake of trying to become the biggest car company in the world, rather than one of the most profitable.
We think Toyota is now at a turning point. It will be releasing about 18 new models in the next 18 months, and we think people will be surprised.
Values there just got silly. (Platinum has about 24 per cent of its funds invested in Europe.)
I think that the European Central Bank decision to finance the banks through the LTRO program has taken away the concern that banks might actually go bust. And it gives European banks three years in which they can rebuild their equity bases quite significantly. At some point, I expect that the European banks will hit the market with new equity raisings, but they are going to be reluctant to do that at values that are below book.
In the heart of all the disruption last year, we started buying into the Dutch fast delivery company TNT. The insight was that even if the earnings were below our expectations, the fallback was a takeover by one of the American freight giants. Both Fedex and UPS had invested heavily to try to break into the European market, why wouldn’t they spend $5 or $6 billion to buy the biggest fast freight operator in Europe? Last month, UPS made a $6.4 billion takeover bid for TNT up 90 per cent on our entry price!
I also think that European luxury goods will continue to perform strongly. In the second- and third-level Chinese cities, it’s clear that people want to show off how glamorous they’ve become by spending on this stuff. Meanwhile in Shanghai and Beijing, people are discarding their Louis Vuitton and going one step up. So there are some very interesting changes taking place in that market.
And how about investing in China?
We’ve been buying the microblog site Sina – which is a bit like Twitter, although with some elements of Facebook. It’s subject to fairly tight government regulation, like entries being deleted if people say the "wrong thing". But I think last year’s major Chinese rail crash showed how important social media has become. The Chinese Communist Party goes through phases of tightening controls over social media, but there are always factions within the party who want these sites to keep operating, so I don’t think social blogging is likely to be banned but it might become more bland. Anyway, it’s hard to see how they can extinguish the internet.
Another interesting Chinese internet company is Sohu, which has a very large game playing subsidiary and a well followed portal. It’s also building its content library to deliver popular TV shows and movies on demand over the internet.
What one often finds is that Chinese internet firms appropriate some great ideas from the United States. On the one hand they are governed with a steel fist in terms of regulation but on the other, the government prevents foreign firms from gaining access to the Chinese domestic market – ie foreign competitors are locked out. So the system is not without benefits for the entrenched Chinese players.
We have about 8 per cent of our funds invested in China, just under 2 per cent in India, as well as other investments around Asia. It’s been quite a fertile area.
Finally, I know Platinum does not invest locally, but how do you see the Australian economy?
There’s been this most wonderful development – the Australian public has taken to saving again, even though there’s been a huge 20-year boom.
Property in Australia is ridiculously expensive by world standards, although no one wants to hear this because of vested interests. Property in Australia was like it was in China – it became a lubricant in itself. Now the game is over. You’re seeing some price creep now, but it’s below the inflation rate. The whole explosiveness has gone out of property.
Generally speaking, there’s a growing realisation that shares are not a one-way bet. It’s not like the 1980s and 1990s, where you were able to make large returns as a result of strong profit growth super-charged by the re-rating of equities due to falling bond yields. That whole process stopped around the time of the GFC, and then reversed.
It is unlikely that we’re going back to a period of upward re-rating of equities because we’re in a world that is deleveraging. We don’t have the same aggregate demand that we had when everyone was taking on debt.