VALUE OR GROWTH? A Tale Of Two Scottish Funds

There are two Scottish funds listed on the London Stock Exchange, which I would like to focus on in this article. They both have similar names, yet their investment strategies differ considerably. The first of these two funds, The Scottish Investment Trust, is a contrarian value fund. Whilst the second fund, the Scottish Mortgage Investment Trust, is a growth fund.

The Scottish Investment Trust (SCIN) is over 130 years old and was first established in Edinburgh in 1887. Since 2015, the fund has been managed by Alasdair McKinnon with a focus on blue chip dividend paying companies that are out of favour. McKinnon takes a contrarian view to investing avoiding sectors that are hot and investing in companies that are undervalued and where sentiment is poor. The rationale being that when sentiment turns, the value of the companies increase as investors begin to pile in. To be clear, contrarian and value investing don’t mean simply investing in any old company that is down and out and going through a turbulant period. It is important that the company has a margin of safety to ride out any difficult period thus protecting it from having to raise emergency cash and/or ceasing to remain a going concern. It is also equally important that the company has healthy cash flows and a decent track record of this. The amount of cash that a company generates from its operations is a crucial metric and sometimes overlooked. A low P/E (Price To Earnings) ratio is one thing and a significant metric in indicating whether or not a company is overvalued, yet it doesn’t tell the whole story. The level of cashflow generation indicates how much cash a company is generating and the more cash it generates, the more of a financial buffer it has, especially if it’s total operating margins are not very high. It is also important to monitor a company’s total liabilities and how manageable and sustainable they are.

As of 30th April 2020, the largest holdings in SCIN’s portfolio included large gold mining companies such as Barrick Gold and Newmont Mining, large pharmaceutical companies such as Roche, Pfizer and Gilead Sciences and other assorted value blue chips such as United Utilities, Japan Tobacco, BT and Chevron. The gold mining companies have been in the portfolio for sometime. Recently gold has performed very strongly and it’s likely to continue. McKinnon, like myself, is of the view that major fiat currencies run the risk of being debased. Since the last financial crisis in 2008, we have been living through a period of very low interest rates and easy money. The present COVID-19 crisis has only exacerbated this as central banks have reduced interest rates even more and printed unprecedented amounts of money to prop up national economies in the wake of this crisis. Add to this the staggering levels of global government, corporate and household debt and you have a rather fragile situation. McKinnon’s thesis for having exposure to gold is as a form of insurance against this extraordinary macro environment and the real future risks and consequences it carries. He is also no fool by investing only in the biggest and most geographically spread global mining companies with low production costs. Whilst it is true that gold may not currently be unloved, I would still consider it a contrarian investment as it represents, to a degree, a lack of faith and trust in central banks and governments. It is also considered unfashionable. I would argue that newer supply-capped digital cryptocurrencies such a Bitcoin are more fashionable and hotter than gold. Especially amongst younger investors who generally overlook gold and other precious metals as a store of value.

McKinnon deliberately stays away from sectors that are hot and fashionable such as the technology sector. SCIN has absolutely no exposure to FANG (Facebook, Amazon, Netflix, Google) stocks or any other hot tech/startup stocks. The closest thing to tech in the portfolio are it’s holdings in boring and undervalued blue chip communication service companies such as BT, China Mobile, Verizon and Deutsche Telekom. McKinnon believes that the tide will turn regarding the high valuation of many technology companies, as unlikely as this may currently seem, and that value stocks, for a long time overlooked and underperforming compared with their growth counterparts, will prevail in due course.

The Scottish Mortgage Investment Trust (SMT) is currently the most valuable investment trust by market capitalization listed on the London Stock Exchange. As of today, it has a total market cap in excess of £10bn and over the last decade has performed extremely well. The primary reason for its impressive performance has been it’s exposure to all the FANG companies plus a number of other tech investments that have recently done exceptionally well. For example, the fund has a substantial holding in Tesla, whose share price has more than doubled since the beginning of this year. Generally speaking, tech shares have done very well since the COVID-19 induced lockdown measures were put in place over the last few months and the share price of SMT is trading at all time highs.

SMT, like SCIN, is also a very old investment trust with a hundred year plus history having first been established in 1909. It is currently jointly managed by James Anderson and Tom Slater. Anderson has been managing the trust for 20 years with Slater joining him in 2010. Their focus is purely on growth and investing in companies of the future. SMT is everything that SCIN is not. SCIN adopts a Benjamin Graham style value investing strategy. SMT does not embrace this type of strategy and even questions it. This is highlighted in a series of interesting essays written by Anderson and published on the fund’s parent Ballie Gifford website entitled Graham Or Growth?. I highly recommend giving them a read as it provides one with unique insights into Anderson’s way of thinking and by extension the investment philosophy and strategies of SMT.

It is true that growth investing has greatly outperformed value investing since the last financial crisis more than a decade ago. At the very start of 2009 the Russell 1000 Growth Index (RLG) was around 360 points. Today it is almost 1820 points. In this time the RLG index has grown more than 500%. That is highly impressive. By comparison the Russell 1000 Value Index (RLV) was around 446 points on 1st January 2009. Back then the RLV index was higher than the RLG index. The same cannot be said today with the RLV index almost 1,105 points. The RLV index has grown less than 250% during this period. Whilst this is certainly not a poor return, it doesn’t hold a candle to the RLG index’s 500% plus return.

Regardless of which side of the fence I am on regarding value or growth investing, it cannot be denied that both Anderson and Slater are highly skilled and visionary managers with a highly impressive track record for picking winners. It is much harder to quantify growth stocks than value stocks via traditional metrics and methods of fundamental analysis. If one were to just use just those methods when investing, one would have passed on investing in Amazon, Alphabet or Tesla in the early stages of their listings in the public markets. It takes more than just the tried and tested strategies of the past to value these companies and Anderson’s essays make this very clear.

However, it is just simply not the case that all new and exciting tech companies are ‘crushing it’. There have already been some casualties. The one that springs most to my mind has been the downfall of workspace company WeWork. Before the issues of the company came to the fore, it had a valuation of $47bn even though it had vast amounts of debt. Today, it’s worth far less at around $3-4bn. One of the largest investors in the company is SoftBank whose Vision Fund took a massive hit. Fortunately, SMT and its parent company Baillie Gifford, never built up a stake in WeWork over the years, but it could have easily happened here.

The recent WeWork debacle is one of a number reasons that make me nervous about having too much exposure to SMT right now irrespective of its stellar performance. As much as I respect the vision and foresight of Anderson and Slater, I worry that their fund could come a cropper some time down the line if a number of the holdings in the SMT portfolio underwent similar write-offs in value like WeWork. One of the fund’s holdings, Tesla, is probably the most polarised and hyped publicly traded stock in the world today. I have a great respect for its founder Elon Musk, who is a highly driven and exponentially thinking visionary. There is no doubt in my mind that he is special. However, the company could very easily experience a similar WeWork style crisis. No matter how highly I rate Elon, the financial fundamentals of Tesla are fragile and the share price could dive spectacularly in the event of a major existential crisis. This would create a huge dent in the value of SMT, as its Tesla holding currently represents a chunky 10% of the entire portfolio. Together with Amazon (which also represents 10% of the total holdings), it is one of the largest holdings in the SMT portfolio.

McKinnon is very wary of the present high valuations of tech companies and has citied the WeWork situation as a clear and present danger. In a post from December 2019 entitled Peak Unicorn?, he refers to the overvaluation of these exciting multi-billion dollar valued unicorn story stocks as a ‘disruption’ bubble, which has been propped up by an environment of cheap money and will not end well.

The last ten years have been very good for growth and technology stocks, yet it remains to be seen whether the next ten years will be equally magnanimous.

By Nicholas Peart 

Published on 27th May 2020

(c)All Rights Reserved

CITED ARTICLES:

https://resoluteoptimism.bailliegifford.com/will-the-mean-revert/

Peak Unicorn?

Image: tripsavvy.com

The Future Of Tech, Work, Education and Living Post COVID-19

This year’s COVID-19 pandemic has been highly disruptive in many areas of our lives. As I type this article, there have been statistically nearly 5.5 million cases and almost 350,000 deaths from this pandemic around the world. In addition to the toll this virus has taken on peoples’ lives, there have been grave economic ramifications. Many businesses and industries have been hit hard and as a consequence millions of people have either lost their jobs or have had to take a pay cut.

The unstoppable growth of the internet over the last 20 years has had a profound effect on our lives. It could already be said that we live in both the physical world and the virtual world. Yet during the lockdown period of the last several weeks, we have been spending considerably more time in the latter world. The growth of the internet has already had a noticeable effect on the physical high street as more people do their shopping online. Yet, the lockdown restrictions, at times, have given people no choice, but to buy almost all their groceries online thus increasing greatly the rate of e-commerce transactions. We have also been interacting much more with other people virtually, both for work and pleasure. And as educational institutions remain shut, or at least severely restricted, we have been doing a lot more learning online.

In an article I wrote back in 2017, I discussed new and emerging technologies such as Virtual Reality (VR) and Augmented Reality (AR) and how they could change people lives, especially in the areas of education. As students are still currently unable to physically go to university and attend lectures, much of their courses and lectures are now online. In my 2017 article, I discussed how via VR technology one could be completely immersed in a setting and interact with it from anywhere with an internet connection. The education industry has long needed such a change. One of the biggest current problems facing young people is the unbelievably high costs of going to university. By the time they have graduated, they are saddled with staggering sums of debt. Yet I have long felt that it doesn’t always have to be that way and that given time, technology would soon provide a much needed solution to this issue. Even though I went to university and got my degree many years ago, I find that a lot of all the most recent knowledge I have gained has been via content online. I, of course, also supplement this knowledge with books in both physical and digital form. There is so much free and good quality educational content out there on the web. And I am also happy to pay for exceptional online resources too. Yet the total amount of money I pay is still far less than what I would pay going to universities, where tuition fees in the UK are currently still over £9k per year.

In an earlier article from 2016, I discuss how VR could potentially change all aspects of our lives, not just within the realms of education. During the lockdown period, the video communications app Zoom has taken off in a big way. Zoom has been the default option for not just video calls between family and friends, but also for remote working and playing. By the latter, I mean having a kind of ‘virtual night out’. Rather than physically going out to a bar or club with friends, Zoom has been used as a virtual platform for replicating a physical night out. VR and AR are both powerful emerging technologies and now is the perfect time for them to be harnessed to a greater level. Interacting via Zoom is still a 2D experience, yet VR and AR have the potential to make this a more immersive 3D experience. This would reduce the chasm greatly between the physical and virtual worlds.

There is no question that remote work will continue to grow and these new and emerging technologies will accelerate this growth. Yet will traditional office spaces be made completely redundant? It is tempting to go down this route and its currently all the rage to have the belief that this virus will make the traditional office space obsolete as an increasing number of workers find the option of remote work to be more appealing and perfectly feasible. To be clear, as I already stated, there is no doubt in my mind that remote/virtual work will grow, yet I think it’s at this stage too premature to say that the traditional physical office environment is dead. Even if technology develops exponentially, we are still, fundamentally, organic human beings and creatures of emotion more than logic. As long as we remain 100% organic human beings, we will still long for that human touch and physical interaction. I think to completely 100% forsake the physical world for the virtual world, we will need to physically merge with technology. I am with the futurist and inventor Ray Kurzweil on his prediction for the coming Singularity in 2045 when Artificial Intelligence (AI) will be at the same level as human intelligence. This will be, arguably, the most significant event in human history and I will never bet against the infinite potential of AI. If software is currently eating the world, soon it will be AI. Yet as AI becomes further developed, the options for us to merge with technology will also arrive. AI, rather than posing an existential threat, I believe, will make our lives easier and more comfortable. What’s more, it will also enhance our lives and enable us to reach our fullest potential.

Going back to the topic of post COVID living, could the development of cities/urban spaces be affected? What if there was a growing trend whereby there was an increasing migration from cities to more rural areas? For some time, as technology improved – more specifically; internet speeds and bandwidth improved further – there has been already to a small degree such a trend. You can go and live in the remotest part of the country, but if you have access to a high speed internet connection over there, then you have full sophisticated access to the virtual world no different to that in a big city no matter how remote the physical environment may be. Yet will there ever be a complete deurbanisation type of migration where the physical location of people is much more fragmented? If such a migration were to happen in the near future and we are still 100% organic beings, we will be incredibly reliant on the virtual world and by extension the cell towers connected to our internet providers. Even if SpaceX, via its Starlink project, intends to beam super-fast satellite internet on all corners of the world in the next few years, for now we are still reliant on onshore cell towers as the source of the internet. This is quite a fragile situation, as any disruption to these cell towers disrupts the internet itself and thus a great chunk of our lives. We become instantly irritated with slow internet speeds let alone having no internet. It is amazing how dependent on the internet most of the world is. The cells towers providing the internet are powered by electricity and electricity is powered by energy from both renewable and non-renewable sources. In spite of all the technological advances since the first Industrial Revolution, we have still not found a permanent and workable solution to the long standing energy problem, that is, how do we generate an abundant and unlimited supply of energy for every corner of the world without having to tap into any non-renewable sources?

I sometimes feel that I overestimate the speed of technological development. Earlier in the last decade,  I thought that within the next few years (now), every household would have a 3D printer and the smartphone would be replaced by some form of smart-glasses with fully integrated and advanced VR and AR technologies. This has simply not happened. Even if these technologies may be available in some shape or form, we still use smartphones. The smartphones of today may be more sophisticated than the smartphones of just a few years ago, but they are still smartphones. Our interaction with the virtual world remains a 2-D experience. This is why I feel that in order for us to live completely in the virtual world with little to no living in the physical world, we have to adopt some form of transhumanism where our minds and bodies are fully integrated with technology.

Going back to the economic ramifications of the current COVID-19 pandemic, I wonder whether, at least in the short to medium term, the concept of a Universal Basic Income (UBI) may become more widely adopted? Already technology has been automating many menial and repetitive jobs that has resulted not only in vast swathes of people losing their jobs, but also in these same people being ‘left behind’ as technology marches on. This is a serious concern as such people become naturally angry and turn to political parties and figures who echo and amplify their frustrations rather than turn to transformative solutions. The virus has hit hard industries requiring a constant physical presence. Some of these industries that have been hit hard such as, for example, the physical high street retail industry, has long already been affected by the growth of the internet. This virus has almost been like the final nail in the coffin.

Technology never stands still and the number of people using the internet will only keep growing. If you look at the S&P 500 (the top 500 companies) you will see that the biggest companies today are all technology companies. My concern however is with the demise of all these low skilled repetitive jobs. Although I personally think that a lot of these jobs are time wasting jobs (and time is an increasingly scarce and valuable asset), which offer no spiritual or intellectual nourishment, many people are employed in such jobs and depend on the income for their survival. If such jobs disappeared on an even greater scale and the people employed in these jobs had little or few alternative skills for other jobs, how will they survive? I hear a lot of emphasis on ‘learning to code’. Whilst computer programming is very useful and currently provides a lot of employment opportunities, who’s to say that such jobs also won’t get disrupted? Furthermore, why would anyone want to learn something purely for the ’employment opportunities’ it will bring? Surely one would learn computer programming, because there are interested and fascinated by it? Learning it just purely to make money seems very flawed and short sighted to me. If we want to continue to live in a capitalist economy then a Universal Basic Income may have to become more widely adopted. Otherwise the alternative is a socialist economy. I do in the long run, however, believe that we will enter a brand new kind of post-scarcity and post-work environment of abundance created by exponential technological innovations. This would transcend any economic model of the past. I wrote about this in greater depth in my article from last year entitled ‘THE TRUE SINGULARITY: A Universe Of Unlimited Abundance And Eternal Harmony’. This kind of vision for the future is also outlined very clearly in the excellent 2011 book by Peter Diamandis and Steven Kotler ‘Abundance’. Yet in order for this to become a closer reality, we also cannot take technological development for granted. One of the early internet pioneers and entrepreneurs, Marc Andreessen, wrote a recent article entitled ‘Its Time To Build’ talking about this. We cannot take innovation for granted and rest on the laurels of the technological advancements of the past. When the virus hit the world, we were unprepared. There was no available vaccine to protect us. Thus we had to adopt measures that have been very disruptive to our daily living. Several companies may currently be working on a cure and it could still be several more months before one is in place, but the point is there was no available permanent remedy at the time. Technology may have provided many vital solutions to long standing limitations, yet, as is currently clear, there are so many more limitations that require solutions. And it is only via continuing to innovate and build that we can ensure that these other limitations begging to be solved are solved.

 

By Nicholas Peart 

Published on 24th May 2020

(c)All Rights Reserved

 

Image: qimono

Nick’s Chocolate, Banana and Pumpkin Brownies

There are several different ways to make brownies. Before establishing my own recipe, I wanted to create a brownie recipe that wasn’t too butter heavy and I wanted the creative variation of incorporating other whole foods. I use banana a lot in baking, but I have never experimented with pumpkin before. In this recipe, I find that mashed pumpkin blends very well with raw cane sugar and is great when combined with mashed bananas. The banana and pumpkin combo also gives these brownies a delightful gooey-like texture and is a much more healthy substitute to using large quantities of butter.

 

INGREDIENTS

A good wedge of pumpkin (peeled and cut into cubes)
2 old bananas
1 cup of raw cane sugar
3 eggs
1-1.5 cups of plain flour
2 teaspoons of baking powder
2 small slivers of butter
Cocoa Powder (about one third of a cup)
100 grams of dark chocolate
Rapeseed oil

 

Instructions:

1) Wash the pumpkin cubes and boil in a pan of water until soft.

2) Drain the water from the pan and then mash the pumpkin.

3) Pour one quarter of a cup of raw cane sugar into the pan and mix well with the pumpkin.

4) In a bowl, mash the two bananas.

5) Then crack and apply the 3 eggs to the mashed bananas.

6) Whisk the eggs and mashed bananas thoroughly until smooth and finely blended.

7) Add the pumpkin mixture to the banana and egg mixture and blend well.

8) Add and stir in the remaining three quarters of the cup of raw cane sugar to the mixture in the bowl.

9) Sieve the flour and baking powder into a separate larger bowl.

10) Add one of the two small slivers of butter to the flour and mix well with your hands until the butter is fully integrated into the flour.

11) Next, mix in the cocoa powder to the flour.

12) Apply the banana, pumpkin and egg mixture to the flour and cocoa and stir in thoroughly

13) Add drizzles of rapeseed oil to the mixture, which will further moisten it and aid in getting all the remaining flour and cocoa at the bottom of the bowl properly blended in.

14) Break the dark chocolate into small pieces and put in a small bowl.

15) Add boiling water to a small saucepan and cook on a reasonably high heat.

16) Put the bowl over the saucepan. The chocolate should slowly melt.

17) Once the chocolate has melted, apply and stir it into the mixture in the large bowl.

18) Use the second small sliver of butter to sufficiently grease a rectangular baking tray. Then line the tray with parchment paper.

19) Preheat an oven at 180 degrees Celsius.

20) Apply all the brownie mixture to the tray and put the tray in the oven to cook for 20 minutes.

21) Take the brownies out of the oven and with a small knife or food stick, prick the deepest part of the cooked brownie mixture. At this stage it is very important that it retains at least a modest layer of goey-ness. However we don’t want the mixture too dry and cake-like. If the mixture is too goey and liquid-like return to the oven for a further 5-10 minutes.

 

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Recipe and photo by Nicholas Peart

(c)All Rights Reserved 

Nick’s Rustic Vegan Moussaka

During the last two months of the COVID related lockdown period, I have been spending some time in the kitchen. I enjoy cooking and find it a theraputic and healing outlet. One of my favourite dishes is the famous Eastern Mediterranean dish moussaka. Making moussaka is a veritable treat and worth the effort. It is one of my favourite foods and my plant-based version of this dish is very filling and healthy. When I first made the original meat version of this dish, I followed a recipe on YouTube by the Greek chef Akis Petretzikis. I like his recipe since I find it rather easy to follow. What’s more, he bakes the aubergines, rather than fries them in oil, which I think is a much healthier alternative. I have incorporated some methods and elements of his recipe to this recipe and of course I have brought my own twist to this delicious dish.

In the original classic moussaka recipe, ground beef is used for the mince. Instead of ground beef, I use lentils. I also add some additional flavours to the mince by using cumin seeds and ground paprika.

The béchamel sauce is normally made using butter, milk and egg yolk. For my recipe, the béchamel sauce is completely plant-based and doesn’t include any dairy products or eggs. My version of the sauce is made simply by using extra virgin olive oil, plain flour and soya milk plus ground nutmeg, salt and ground black pepper for taste and flavours.

Lastly, for the first layer of the dish, I have added sweet sliced potatoes to go with the standard sliced potatoes.

 

INGREDIENTS 

1 large potato
1 large sweet potato
1 red onion
1 large aubergine
2 medium sized courgettes
Fresh or dried thyme
Extra virgin olive oil
Ground black pepper
Salt

For the mince:

2 cans of lentils (or cooked lentils)
1 can of diced tomatoes
2 generous tablespoons of tomato paste
1 red onion (chopped)
3 cloves of garlic (chopped)
Vegetable oil
Cumin seeds
Ground paprika
Salt and ground black pepper to taste

For the creamy béchamel sauce:

1 litre of soya milk
Plain Flour
Extra virgin olive oil
Ground nutmeg
Salt and ground black pepper to taste

 

Instructions:

1) Grease well a normal sized baking dish with oil.

2) Peel and thinly slice 1 large ordinary potato and 1 large sweet potato. Then peel and chop one red onion. Next put the sliced potatoes and chopped red onion into a bowl and drizzle them in extra virgin olive oil and add salt, ground black pepper and fresh or dried thyme.

3) Transfer the potatoes and onion mixture into the baking dish and evenly spread out.

 

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The first layer of sliced potatoes and chopped onions before entering the oven 

 

4) Preheat an oven to 200 degrees Celsius and put the baking dish inside for 20 minutes.

5) Whilst the potatoes and onions are cooking, finely and thinly slice the aubergine. Then put the cut slices into the bowl and generously drizzle with extra virgin olive oil and add salt, ground black pepper and fresh or dried thyme.

6) During the remainder of the time, as the potatoes and onions continue to cook, proceed to finely slice the two courgettes.

7) After 20 minutes remove the baking dish from the oven.

8) Then add to the dish, over the cooked potatoes and onions, the second layer of the sliced aubergines.

 

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The second layer of the sliced aubergines

 

9) Return the baking dish to the oven and cook for another 20 minutes at 200 degrees Celsius.

10) Whilst that is cooking, transfer the sliced courgettes into the bowl and drizzle with extra virgin olive oil and add salt, pepper and thyme before mixing well.

11) Then for the rest of the time, before taking out the dish again, heat some vegetable oil in a wide and deep pan. Add a sprinkling of cumin seeds to the cooking oil. Then proceed to add the chopped red onion and garlic cloves  to the pan and cook on a reasonably high heat for a few minutes.

12) Turn down the heat and add a generous tablespoon of paprika and mix well.

13) Next, add the lentils and two generous tablespoons of tomato paste and mix it thoroughly into the lentils.

14) Then add and stir in the chopped tomatoes.

 

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The lentil mince mix of the dish

 

15) Add salt and ground black pepper to taste. Keep the lentil mince mix on a very low flame stirring occasionally.

15) By now, the potatoes, onions and aubergines should be ready to take out of the oven.

16) Once the baking dish is out of the oven, add the sliced courgettes over the aubergines and then return the baking dish to the oven and cook for 10 minutes at 200 degrees Celsius.

 

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The third layer comprising of the sliced courgettes

 

17) As the courgettes and other vegetables cook, heat a good amount of extra virgin olive oil in a saucepan. As the oil cooks, slowly add small teespoons of plain flour to the oil and mix well and thoroughly with a wooden spoon. Once the mixture becomes like a ball of sticky dough, slowly add a little of the soya milk to the mixture and mix well. Keep repeating this until you end up with a silky textured and creamy-like sauce.

18) Next, add salt and pepper to taste followed by a generous sprinkling of ground nutmeg to further enhance the flavour.

 

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The béchamel should have a silky and creamy texture

 

19) Once the béchamel sauce is ready, add a couple of generous tablespoons of the sauce to the lentil mince mix and stir in well.

20) When the courgettes are ready, take the baking dish out of the oven.

21) Transfer the whole lentil mix from the pan and smother over the courgettes in the dish.

 

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The fourth layer is made up of the lentil mince mix

 

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The plant based béchamel sauce makes up the final layer 

 

22) Next, scoop all the béchamel from the saucepan and cover over the lentils in the dish.

23) Finally return the baking dish to the oven and cook for 30 minutes at 200 degrees Celsius. Once the 30 minutes have elapsed, the moussaka should be ready to serve.

 

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Recipe and photos by Nicholas Peart

(c)All Rights Reserved

Don’t Fight The Trend…

the trend

But don’t be off your guard either.

A lot of the time, stocks are priced at a value quite debased from their fundamentals. Thus they are either overvalued or undervalued. This is true since markets are, for the most part, driven by sentiment. In the most extreme circumstances, total greed or fear takes over.

I have been rather baffled by the stock market rally over the last few weeks after having witnessed some of the most spectacular series of crashes over the brief one month period from the end of February towards the end of March. This rally far from reflects the economic reality on the ground. Many people have lost their jobs and are struggling financially. Yes, there have been huge stimulus packages to soften the blow, but these are artificial and only increase an already substantial debt load.

Yet markets can behave irrationally for a very long period of time. Far longer than one can stay solvent, to quote the economist John Maynard Keynes. Instead of trying to be right, sometimes it can pay to just go with the trend. That often quoted adage, the trend is your friend, is very true. Rather than fighting it, it can be less painful to simply ride with it in whichever direction it may blow.

But don’t get carried away. Always be on your guard. As the tide can abruptly change without warning.

By Nicholas Peart

(c)All Rights Reserved 

 

Image: Peggy_Marco

CREATOR/DESTROYER: A Journey Through The Roots Of Tragedy

AssinationGianniV

The TV drama The Assassination Of Gianni Versace: American Crime Story, which first aired in 2017, is one of the most notable TV series I have watched in the last five years. Although spanning over nine episodes, there is only one episode in this series, which truly stands out. Episode 8 entitled Creator/Destroyer is probably the most riveting and powerful one hour of television I have ever watched.

I was just 14 at the time, but I remember very clearly the day when the iconic Italian fashion designer was murdered. One would think, judging by the title of the series, that the series would focus on Versace. In fact, it puts the spotlight more on his killer Andrew Cunanan played by the actor Darren Criss. Much of the series follows Cunanan as he prays on his victims and murders them in the most shocking ways. Yet the jam in the donut of this series only arrives at the penultimate episode.

The Creator/Destroyer episode is about the early lives of both Versace and Cunanan and how they took vastly different turns. In the case of Versace, we see him grow up in a poor town in Calabria, yet he is brought up by a loving mother who recognises his talents early on and encourages him to develop them. Yet she is also very wise stressing that in order to achieve success he will have to work hard. At times it won’t be easy, but that’s ok if you are doing something you love and are passionate about.

The early life of Andrew Cunanan could not be more different. The figure who has the most influence on his early development is his Filipino father Modesto who is played by the actor Jon Jon Briones. Unlike Gianni’s mother, Modesto is an extremely deceitful and delusional individual with no moral compass. Throughout his childhood, Modesto never ceases to remind his child that he is special and that by merely believing that he is special he will be able to achieve anything he wants. He is never instilled with any grounded or true wisdom. Witnessing this had a profound effect on me as it signalled to me that any child who is exposed to such falsehoods or delusions of grandeur from an early age is doomed. They will soon find life incredibly frustrating and unfair with potentially tragic consequences.

Furthermore, Andrew is spoiled rotten by his father. In this episode we see him treated like royalty. His siblings refer to him as Prince Andrew. When the Cunanan family move to a larger home when Andrew is around 10 or 11, Andrew is immediately assigned the master bedroom. In this particular clip, we see the rest of the family, Andrew’s mother and siblings, look exhausted as they move sofas and other bits of heavy furniture. Andrew, however, doesn’t lift a finger.

Modesto buys Andrew a sports car even though he is too young to drive it. Andrew’s eldest sibling Chris is old enough, but Modesto denies him this privilege and gives it instead to Andrew even though it will be a few years before he is legally old enough to drive it. When Andrew’s mother challenges Modesto on this, he violently pushes her to the ground. It becomes increasingly clear that Modesto has an unhealthy obsession with his youngest child and favours him over his other children, which creates a rift and a lot of tension.

One of the clearest contrasts between Gianni’s mother and Modesto, is when Modesto is with Andrew in his room teaching him the codes of social conduct from a book by Amy Vanderbilt entitled The Complete Book of Etiquette. Whereas Gianni’s mother brings out the best in Gianni’s creativity, Modesto discourages it from his youngest son. When Andrew tells Modesto that he would like to be a writer, Modesto instantly dismisses it and says that unless someone offered him a lot of money to write a book, he should forget about it. Interestingly, in another episode and one of the few occasions where Andrew meets Gianni, Gianni encourages Andrew to write his book and tells him how aspiring for success just for the sake of success is a futile and hollow endeavour.

In Modesto’s world, nurturing superficiality such as how one looks, what one says, how one behaves, is of more importance than nurturing talent or aspiring to any notions of truth and beauty. From this, one can make comparisons with the character Willy Loman from the Arthur Miller play Death Of A Salesman. Like Modesto, Loman is also a person drowning in his own delusions valuing etiquette, presentation and current social mores over developing talent and instilling healthy values in his children. Being a ‘social success’ is what reigns supreme in the world of Modesto and Willy. As Loman says to one of his sons, ‘Be well liked and you will never want’ as if by being well liked great wealth and status will automatically follow. By that same token, Modesto relentlessly conveys to Andrew, ‘to remember that you’re special, and when you feel special, success will follow’.

Via the infectious influence of Modesto on his life, Andrew is already displaying signs of brattish and entitled behaviour from an early age. In one clip when he opens the door to the postman, he snatches the mail from his hand and duly slams the door on him rather than offering as much as a ‘hello’, ‘thank you’ and ‘goodbye’. In another clip, a young Andrew is in his room reading a book by an electric fan. When he leaves the room, he forgets to turn off the fan.

Andrew’s behaviour manifests itself into abnormally high levels of self confidence by the time he’s a late teenager. By this point, he is driving his sports car and wearing high end designer clothes. He is already a shining example of all the Amy Vanderbilt etiquette drummed into him every evening by his father. He looks and feels invincible and many of his high school peers are in awe of him even if its all merely a façade.

Yet things soon take a turn when Modesto unexpectedly flees the country for Manila. Just a few years earlier, he managed to hustle his way into a stockbroker job at Merrill Lynch beating over 500 applicants. Despite not having the conventional academic qualifications or any previous work experience in the financial services sector, Modesto goes into turbo charge mode with the Vanderbilt playbook in the interview stage weaving a powerful story and promising to ‘cross oceans’ and create unimaginable levels of growth for the company. His patter works. Yet with his lack of financial experience cracks occur. He makes dubious trades, engages in fraudulent activity, and, in one case, swindles an elderly lady out of all her savings. In an attempt to reduce his chances of getting caught, he frequently changes firms. With each change, he opts to work for a firm lower down in the ranks from the last. It is deliciously ironic how someone who gives a lot of weight to status and prestige, decides to demote themselves in such a way.

Modesto’s luck soon runs out when the FBI are called into the firm he is currently working for to arrest him. When he is tipped off about their arrival by his secretary, he immediately tries to destroy all the evidence of any dodgy trades and proceeds to call his travel agent to confirm his same day flight to Manilla. An epic chase ensues. On the way he crosses path with Andrew in his sports car who is oblivious to what is going on. Modesto gets into Andrew’s car and drives off to the airport. When Andrew gets home, he finds his mum distraught. In her despair, she tells him that Modesto has fled ‘like a rat’ back to Manilla and left them with no money. What’s more, their home will be repossessed in the coming days. Andrew, though, doesn’t believe any of this and is indignant that his mother is wrong about his father. He also refuses to believe that his father could leave them with no money. Such a notion is simply inconceivable in his world.

Andrew travels to Manila to try and track his father down. When he does finally arrive at his father’s residence located in a down at heel area in the deep outskirts of Manilla, he is shocked to discover how his father, whom he always looked up to, could live in such an impoverished and threadbare dwelling. Afterall, wasn’t his father supposed to be this high-flying stockbroker whom he boasted about to all his friends? Instead he meets his father in a basic room in a rickety old wooden house – the kind of room that a seasoned backpacker on an ultra-tight budget would shell out $3 a night for – where he greets his son and serves him a plate of chicharron or pork skins. Andrew is clearly shocked but continues to tread carefully with his father only meekly asking him if there is any money. His father, acting like a bent second-hand car salesman, tells him there are ‘millions’ yet is vague regarding the whereabouts of this money.

It is only during the middle of the night, when Andrew is unable to sleep, that he wakes up his father and broaches the money issue with him again. When his father admits that there is no money the ice finally breaks. For the first time in his life, Andrew properly confronts his father. The floodgates open: ‘My father is a liar and a thief’ ‘You were everything to me dad but it’s a lie and I can’t be a lie’.

This scene is reminiscent of the scene in Apocalypse Now with Marlon Brando where he quotes T.S Eliot’s poem The Hollow Men. It is Oscar winning material. This particular scene is akin to an initiation or the end of innocence. Adam and Eve thrown out of the garden of Eden. The end of a prolonged smoky dream. For the first time, the wool is removed from Andrew’s eyes revealing the real Modesto and not the distorted and artificial version of him he grew up with. Where once Modesto would put him on the highest of pedestals, this time he throws his own son under a bus with taunts calling him ‘weak, just like your mother’, ‘my special sissy boy’ or a ‘sissy kid with a sissy mind’. Modesto has been challenged and he doesn’t like it. Yet Andrew has finally seen the light regarding his relationship with his father and vows to never be like him.

When Andrew returns from the Philippines to the family home, which is already in the process of being repossessed, he flies into a blind rage grabbing the Amy Vanderbilt book his father used to read to him every evening, and starts ripping all the pages out of the book to shreds. What is interesting is that this moment in his life now marks a turning point, which can go either way. This is highlighted whilst he is applying for a job in a local convenience store. Everything is going fine until the owner asks him what his father does? Instead of telling the truth and being cordial with the owner, he embellishes a fantastical story about how his father is an owner of multiple plantations in the Philippines ‘further than the eye can see’. It is clear from now on that rather from vowing never to be like his father, he is prepared to inherit his traits by dealing in the currencies of lies and deception. He had an opportunity to turn his life around but decided not to.

This episode is a masterclass of human psychology. I often wonder how different Andrew’s life would have been if he had a parental figure who, like Gianni’s mother, brought him up well. How different things would have been. Yet one can equally speculate with Gianni how he would have turned out had he been brought up by a Modesto father figure who would have knocked out of him any creative inhibitions.

Another interesting point to note is the growth of reality TV and social media stars in the years since both Versace and Cunanan died in 1997. The reason I make this point is because many of these reality TV and social media stars are famous just for the sake of being famous. There’s a rampant narcissism, entitlement, insecurity and perpetual feeling of lack that drives them. These are exactly the traits that Andrew demonstrated and I sometimes wonder had he grown up in the age of the internet, reality TV and social media what his chances would have been of being one of those insipid reality TV bores? I think he would have lapped up this vacuous culture and taken it to his bosom.

One of the most apt comparisons one can make between Gianni and Andrew is from the biblical story of Cain and Abel. The quintessential creator and destroyer story. Andrew wanted to be rewarded without having to properly earn it through honest hard work and putting his all into it. Gianni worked hard, tirelessly and diligently, and against all odds was rewarded and became a fashion icon. Andrew was jealous of Gianni. He wanted everything that Gianni had, but without having to endure any struggle or battles to get there. So like Cain he murdered Gianni.

By Nicholas Peart

(c)All Rights Reserved

Fishing For Bargains In The Market Carnage (UK MARKETS)

deep sea fish

Disclaimer: All financial recommendations in the article are those of the author and should not be taken as financial advice. It is best to do your own research before investing in any security or to speak with a financial advisor. 

The market crash since February has been painful for all long term investors. Yet at the same time it has presented opportunities to buy several good quality stocks and securities at a lower price than normal. In this article I will focus on some of those, which I think may be worth a look at.

Travel Industry

Lots of the big multi billion pound FTSE 100 blue chip companies are currently trading at much lower valuations than before the crash. One of the industries most affected by the current coronavirus pandemic has been the travel industry, which includes airline and cruise ship stocks.

On the FTSE 100, three companies springs to mind; International Airlines (IAG), EasyJet (EZJ) and Carnival (CCL). The share prices of all three companies have been heavily impacted and currently look very cheap. However, as cheap as they may be, they now carry a lot of risk as there’s no guarantee that, despite their size, they will have enough cash to see them through this difficult period before they are back to operating at normal capacity again.

International Airlines group owns multiple airlines in its portfolio including British Airways, Iberia, Aer Lingus and the low cost airline Vueling. Out of the three companies, this one is in my view the safest bet if I had to chose, which one I would invest in. The principle reason for this is, because of the fact that it owns multiple airlines rather than just one. Furthermore, it also employs the greatest number of people (over 60,000) and it is likely, although not guaranteed, that it would be at the receiving end of a government bailout should it really struggle to remain a going concern in the coming weeks and months. Allowing the firm to go bust, would result in a lot of people out of work.

Easyjet carries more risk than International Airlines. Although it has decent cash reserves, it has entered into an agreement with Airbus for £4.5bn to purchase 107 aircrafts. Considering that Easyjet’s current market cap is less than half that amount, such a transaction puts the company in a very difficult situation at a time when precious cash reserves are king. Unless the company scraps the Airbus deal and temporarily suspends it’s dividend, it runs the risk of becoming insolvent in no time and is unlikely to be bailed out either.

But Easyjet is not the riskiest of the three. That prize would go to cruise ship company Carnival. In the wake of all the well publicized coronavirus cases occurring on cruise ships, I cannot see that industry recovering for at least several months. Unlike flights, which are a necessity, it is not a necessity to take a cruise. It’s share price has reacted accordingly falling from a 52 week high of £41.75 in May 2019 to a 52 week low of just £6.06 earlier this month. The share price is currently £8.69. If the company wants to ride out this crisis, it will need to embark on some pretty substantial cost cutting measures going beyond simply cutting the dividend. Earlier this month, the company increased it’s borrowings to give it more financial flexibility, but the consequence of this is that the company has got itself into debt even more.

Personally, I would think very carefully about investing in either company as cheap as the shares may be. The trick is to find high quality blue chip stocks that are beaten down, but fundamentally have a robust enough margin of safety that will see it through the worst of a crisis without having to resort to options such as taking on more debt or any kind of dilutive rights issue.

Oil and Gas Industry

The other industry that has taken a hammering is the oil and gas (o&g) industry. As the market crash began to develop steam, the price of oil fell a whopping 30% in just one day. Towards the end of March, the two largest UK listed oil and gas companies, Royal Dutch Shell (RDSB) and BP (BP.), were both trading at discounts of more than 50% of their share prices at the start of the year. As I write this, their share prices have recovered a bit off their recent lows, yet they still have a way to go to reach their previous levels from the beginning of the year.

I think o&g prices will be incredibly volatile over the new few years and long after the worst of this current coronavirus pandemic is over. Even though o&g prices may currently be at very low levels, it doesn’t take much for prices to suddenly spike again in very little time. In the coming weeks and possibly months, o&g prices may continue to stay low or go even lower to lows that are unthinkable. When investing in o&g companies, especially when prices are low, it is always important to invest in companies that have very low production costs and/or a large downstream business. Such companies are able to weather lower o&g prices better than those that are either producers with high production costs or worse o&g exploration companies.  The latter are much more vulnerable to lower o&g prices and a prolonged slump in these prices can have a very real existential impact on these businesses as their operations become economically unviable.

For those reasons, I am attracted to the more solid players in this industry who will be able to get through this challenging period the best. I already mentioned the two main players, Shell and BP. Their share price erosion has now meant that both companies now pay even higher dividends. Yet there is always the very real possibility that these dividends get temporarily cut, which I actually think is a good thing in the short run if only to boost essential cash reserves. There is currently a lot of negative sentiment in the o&g industry and its not a popular industry. I have a contrarian mindset towards this industry and believe that in due course there will come a time when o&g prices will be much higher than their current levels.

Consumer brands companies

There are some consumer brands companies that are presently very under-priced. A neglected industry that immediately springs to mind is the tobacco industry. Like the oil and gas industry, it is a very unpopular industry and sentiment continues to be poor. What I find interesting is that whilst sentiment has been poor for some years now, there was a period not so long ago where there was a lot of hype in the nascent cannabis industry. I recall the share prices of exotic hot Canadian pot players such as Tilray ascend to ridiculous valuations that were very debased from their fundamentals. I fortunately stayed well clear of all the hype and I am glad that I did as today the current share price of Tilray is a mere fraction of what it was at the apex of the hype.

Rather than chase these hot pot plays, there was and is far more value to be had investing in some of the large public tobacco companies such as British American Tobacco (BATS) or Imperial Brands (IMB). Both companies have been depressed for some time and currently pay very large dividends. In the case of Imperial, it’s dividend is now more than 10%. In the current economic turmoil we are all experiencing, there is no guarantee that these dividends will not be cut, yet I remain certain that the share price of these companies will recover. Whilst it is true that less people are smoking traditional cigarettes than before, these companies will increasingly become entities where they do not have all their eggs in one basket. Going back to the much hyped cannabis industry; who’s to say that once cannabis becomes increasingly legalised in a growing number of jurisdictions across the world and there is more robust consolidation in this industry, those large players don’t also get a piece of the action?

I am also interested in those large consumer brands companies of essential products. The two biggest ones on the FTSE 100 are Unilever (ULVR) and Reckitt Benckiser (RB.). Both are global, robust and defensive non cyclical companies. Yet there is one smaller company, which I think offers a lot of upside to long term investors. This company is called PZ Cussons (PZC). It has been undervalued for a while now and currently has a total market cap of less than £1bn, which I think is very cheap. What’s more, it is well exposed to emerging markets with high growth potential. It is best known for owning the Imperial Leather soap brand and also the Carex brand too. This is important to know since as this current coronavirus pandemic has escalated there has been an acute shortage of hand sanitiser products. Carex is one of the leading producers of hand sanitisers in the world and whilst it may not have a monopoly, I expect record sales for PZ Cussons’ Carex brand when their next financial report covering the last few months is published.

Index Funds and Investment Trusts

Rather than focus on picking individual company stocks, I also like looking at index funds that track entire stock markets and also well run investment trusts. Investing in index funds is ideal for those who don’t want to invest in individual companies and undertake all the fundamental analysis that goes with it. What’s more, by investing in a small select number of index funds rather than lots of individual stocks, you are also cutting down on your dealing costs, which can eat into precious cash.

In the UK, the two principle stock markets are the FTSE 100 and the FTSE 250. The FTSE 100 contains the largest 100 UK companies by market capitalisation and the FTSE 250 the next round of large UK companies, which are not part of the FTSE 100. The FTSE 250 companies, although smaller than the FTSE 100 ones, have generally more growth potential. Yet what the FTSE 100 companies may lack in the growth potential of the FTSE 250 ones, they make up for by paying generally larger dividends. Both indexes are trading at vast discounts to their levels befor the start of the crash. If you are a long term investor, buying some units in both a FTSE 100 and FTSE 250 index fund at current levels could be a very smart move. One could also slowly drip feed money on a weekly or monthly basis. This may also be a good move if these markets continue to fall before they recover.

I have selected a few LSE listed investment trusts, which I consider sound and well managed. One investment trust which I recommend more for income than growth and is currently trading at quite a discount is the City Of London Investment Trust (CTY). It consists mainly of large multi billion pound FTSE 100 companies paying good dividends and thus the trust pays a decent dividend. Some of these companies have temporarily halted their dividend payouts and that is I feel reflected in their current share prices. I expect this trust though to recover strongly when the markets recover and for the companies in the trust that have cut their dividends to reinstate them. The trust also has one of the lowest fees in the industry.

Another LSE listed investment trust I like which is focused more on smaller FTSE 250 companies is the Henderson Smaller Companies Investment Trust (HSL). This trust also pays a dividend although its smaller than what CTY pays and the trust’s fees are also higher. However it has much more potential for growth, without it being reckless.

Both CTY and HSL are currently trading at discounts of more than 30% of their January highs.

The Templeton Emerging Markets Investment Trust (TEM) is also trading at a large discount and is one of the best trusts invested in some of the largest emerging markets comapnies in the world. I prefer this trust over ones focused on just single emerging market countries and I recommend drip buying on any dips in this current downturn.

Finally, I am always keeping an eye on the largest LSE listed investment trust by market cap, the Scottish Mortgage Investment Trust (SMT). This trust contains many high growth companies in its portfolio from holdings in some of the largest tech companies in the world to several promising unlisted companies. NASDAQ listed tech stocks have been some of the best performing stocks during the ten year plus bull market. However it remains to be seen whether the next ten years will be equally generous to these companies. Like other stocks, SMT has also suffered during the current downturn although its held up better than others. I have included this trust as although I still think it is rather richly valued, it may wobble more over the coming months and could present a very good buying opportunity for the long term.

Precious Metals

I continue to remain very bullish on precious metals. In particular, gold and silver. Rather than typical investments to make money, precious metals for me are a form of insurance in a world simply awash in debt, cheap money and uber low interest rates. One of my biggest fears is the effect all this accumulated debt will eventually have on the world’s major currencies, especially the US dollar. Several economists are predicting many years of deflation and sustained low or even negative interest rates, but I beg to differ and think that all this debt and enormous current stimulus packages to soften the blows inflicted by the current coronavirus pandemic could likely lead to inflation rearing its ugly head. As I explained in my previous articles, this will lead to central banks raising interest rates and all this outstanding global debt becoming more expensive to service.

All these factors considered I think gold will do very well over the coming years and even from its current high levels, I don’t think the price is expensive. Silver, on the other hand, is very cheap compared to gold and perhaps for value investors, there is more upside and an even stronger case for silver. I like silver very much for those reasons and think it could rally much harder than gold.

Regarding investment opportunities for exposure to both metals, I think the best mining companies are the biggest ones, Barrick Gold and Newmont Mining, which are both listed on the Toronto and New York stock exchanges. I am not so keen on the smaller mining companies with high production costs and too much exposure to politically unstable countries. One can of course buy physical gold and silver from a dealer and keep it in a vault. Bear in mind though that storing silver, especially in modest amounts, will be more costly than storing gold. I like very much gold and silver ETFs, which are backed by physical bullion in a vault. It is very important that each unit of such an ETF is directly backed to a portion of the physical metal in a vault. Two precious metal ETF securities I recommend are the Wisdom Tree Physical Gold ETF (PHGP) and the Wisdom Tree Physical Silver ETF (PHSP).

 

By Nicholas Peart

(c)All Rights Reserved 

 

Image: PublicDomainPictures

It’s Only When The Tide Goes Out That You Discover Who’s Been Swimming Naked

low tide

This is probably one of the wisest bits of advice related to the current market turmoil. And it was said by none other than one of the most successful investors of all time, the Sage of Omaha himself, Mr Warren Buffett.

What this present crisis has exposed are those companies that are worst prepared to handle a downtown. A company should always have sufficient emergency cash reserves or at least some margin of safety to protect it in the event of a slump such as the one we are currently experiencing.

The most prudent companies always have this margin of safety. On the other hand, the most ill prepared companies overleverage themselves and take on large piles of debt during the good times. Then when the bad times arrive and the tide goes out, they are the ones who are most vulnerable.

Right now boring old cash is king. Some of the most indebted companies are currently facing a genuine liquidity crisis and the very real possibility of going bust as their cashflows have virtually dried up. However, those companies who have set aside enough cash, have no or at least manageable levels of debt, and don’t have unsustainable overheads (or a low cash burn rate) will survive this downturn period the best and will bounce back the strongest when the markets do eventually recover.

I think this is something we can all learn when we make investment decisions, especially when we buy shares in companies during a bull market. It is always important when doing your own due diligence on a company to figure out how well it would fare when the tide changes. When the tide goes out, will it be sufficiently covered?

 

By Nicholas Peart

(c)All Rights Reserved 

 

Image: TimHill

The Present Risks Of Holding Government Bonds

BankNotes photo

For a long time it has often been assumed that government bonds of developed countries are a safe investment. Whenever there has been a stock market correction, one always benefited by holding government bonds. Especially if they had a decent yield and it was above the rate of inflation. The difference now is that before the current market crash towards the end of February, interest rates in most developed countries were already at very low levels. Yet as the crash unfolded both the Bank of England (BoE) and the Federal Reserve (Fed) reduced interest rates even more to stimulate the economy. As I write this article, the current BoE rate is just 0.1% and the Fed rate is at 0%. Since 2016, the European Central Bank (ECB) interest rate has remained unchanged at 0% and so far there has been no plan to drop it down further towards negative territory, yet that could easily change in the coming weeks or months if the current crisis exacerbated by the Coronavirus pandemic shows no signs of improving.

The current yields on ten year government bonds in the following countries are just 0.8% in the USA, 0.39% in the UK, 0.02% in Japan, and in some countries such as France and Germany they are already negative at -0.03% and -0.37% respectively. For those bonds to increase in value these already pitifully low yields would have to fall even further. By investing in bonds with negative yields, you are essentially paying for the privilege of holding the bonds. And I have always wondered what would make one invest in bonds with negative yields?

In the case of Germany, if one had a lot of cash which they didn’t want to invest in other securities or deposit in a bank account, they would invest it in those negative -0.37% yielding government bonds. They may be too scared to deposit it all in a bank, which is financially not in great shape and may even be faced with the very real risk of going under Lehman Brothers style. The two main German banks, Deutsche Bank and Commerzbank, are both currently not in great shape financially and may need a bailout to save them. If a bank goes under, your money in a bank is safe up to a certain threshold and if you have savings deposits, which exceed the threshold amount, you will likely lose the entire excess amount if the bank goes bust. In contrast to other Eurozone (EZ) countries, Germany is in better shape than many other EZ countries. Furthermore, it’s national central bank, the Bundesbank, is running a massive surplus against the national central banks of most of the other EZ countries.

Unlike Germany, the yields on the ten year government bonds for Italy and Greece are positive at 1.21% and 1.43% respectively. Yet both countries have enormous and unsustainable levels of debt and are thus at a much higher risk of default. As I explained in some of my previous articles, I continue to remain of the view that it is becoming increasingly likely that the Eurozone will not last and that all Eurozone countries will revert to their own currencies. If this were to happen, it is highly probable that within the EZ area, there will be a huge flight of money to those countries such as Germany who will be least affected by any great devaluations of their new currencies. For example, the New Mark is likely to strengthen in value whereas the New Lira or New Drachma is likely to fall in value quite sharply against the new currencies of other stronger former EZ countries. Thus within the framework of the entire EZ, negative yielding German bonds are probably one of the safest securities to invest your Euros into despite the fact they come with a price. If the EZ falls apart and most EZ banks go under, those negative yielding German bonds will immediately be denominated into strongly valued New Marks. By contrast, those positively yielding Italian and Greek bonds will be converted into new weaker currencies.

In spite of all this, I think government bonds are overall very expensive where their risks vastly outnumber their rewards. Of course, their low yields reflect the low interest rates of their countries. However, if one were to look at the chart of the yields of ten year UK and US bonds over a 40 year period, it is clear they’ve been in a huge bubble for the duration of this time frame. In September 1981, the yield on 10 year US treasury bonds was over 15% and in that same year in October, the yield on 10 year UK gilts was over 16%. Yet since that time, the yields on both bonds has been in a downward trend and currently they both yield less than 1%. Some are predicting that the interest rates of both countries will fall into negative territory and therefore the yields of both bonds will also be negative suggesting that if one were to buy such bonds even with their extremely low yield, the yield may get even lower.

An unpopular opinion I hold, which many don’t share, is the real risk of dramatic and unexpected inflation. Many are predicting a long period of negative interest rates and deflation, but I am not so sure. What concerns me greatly is the huge amount of debt in many countries. Much of this debt is a result of an unusually long period of low interest rates. Since the middle of the last financial crisis in 2008, total levels of global debt have increased over 50%. And now with the current new crisis triggered by the coronavirus pandemic, this already staggering level of global debt is only going to get bigger as national governments plan huge rescue packages to prop up vulnerable businesses and households. In the USA, the Trump government is planning a $2tn stimulus package. In the past years since the 2008 financial crisis, large rounds of Quantitative Easing (QE) haven’t had too much of an affect on inflation. However this time it could well be different as the amounts of money printing rounds that national central banks will embark on could easily result in a great spike in inflation. This is very worrying as not only will this lead to central banks massively raising interest rates to tame this inflation, it will also make all outstanding government, corporate and household debt much more expensive to service. It is for those reasons that I think buying so called safe government bonds at current yields is a much more risky exercise than many realise.  Furthermore, as all those big accumulated existing debts become more expensive to service with rising interest rates, there will be lots more defaults which in turn will weaken the purchasing power of the currencies of major economies including the USA.

All these concerns naturally make me more attracted to precious metals like gold and silver, which, as tangible forms of insurance, will increase in value as the purchasing power of major currencies like the dollar and the euro declines. As precious metals are commodities, it is hard to predict their price movements. Yet if like me, you believe that they are a viable hedge against a world that is increasingly becoming smothered in debt, you will realise that there is quite a compelling case to owning some precious metals as a form of insurance against these economic vulnerabilities. Precious metals are the new safe havens rather than government bonds.

 

By Nicholas Peart

30th March 2019

(c)All Rights Reserved

 

Image: NikolayFrolochkin

 

MARKETS UPDATE: Thoughts On The Current Market Crash

comic-1296117_1280 (1)

The last two months have been an exceptionally volatile period for global stock markets. The current COVID-19 pandemic has taken many by surprise and its consequences have had a clear affect on the markets during this period. For a long time, I thought that markets were overvalued and due for an eventual correction. The roots of my worries were based on the increasing levels of global debt since the last financial crisis of 2008 that have been fuelled by an unusually long period of low interest rates. With low interest rates money is cheap and cheap money has been the cause of the high valuations of many stocks and other assets such as property. All this concerned me. I knew it wasn’t sustainable and that eventually something would have to give. Yet little did I know that the catalyst for this current market crash would be a virus, which is now affecting citizens and the economies of every country on the planet.

I wrote an article back in 2017 and another one last year stating my fear that markets were overheating. Throughout all of 2019, I almost became resigned to the fact that we were in a ten year plus long bull market that seemed to show now signs of slowing down. Save for a sharp but very brief correction in equity markets from October to December 2018, the markets duly recovered and subsequently continued to hit new highs. Earlier this year, the NASDAQ index hit over 9,000 points and by mid February it had hit a new record of over 9,700 points. Back then I decided to view a longer term chart of the NASDAQ index and had discovered that back in March 2009, in the wake of all the wreckage of the last financial crisis, the NASDAQ index had collapsed to just under 1,300 points. In almost 11 years, the index had increased over 7 times in value. In the UK, only the FTSE 250 index comes close to matching the NASDAQ’s performance, but even the FTSE 250 has been no match. During that same time frame, the index went from under 6,000 points in March 2009 to a record high of almost 22,000 points in January this year. That represents an almost four fold increase in value. Impressive but still falling short of the NASDAQ’s run.

The reason for the NASDAQ’s epic performance is quite simply the unbelievable success of many of the biggest technology companies in the world, which are all listed on it’s exchange. The following NASDAQ listed companies: Amazon, Apple, Facebook, Alphabet, Netflix and Microsoft: have all been quite simply ‘crushing it’ throughout the last decade.

In the UK, the two principle stock market indexes are the FTSE 100 and the FTSE 250. Even though the UK doesn’t have anywhere near the kinds of innovative and exponential tech companies that come out of the US, the UK has a lot of thriving successful growth businesses and lots of these are listed on the FTSE 250. The FTSE 100, on the other hand, is made up more of long established big businesses with multi billion pound market capitalizations. Examples of such companies include Royal Dutch Shell, BP, Rio Tinto, HSBC, Unilever, Vodafone and British American Tobacco. These are big behemoth companies, which may lack the growth prospects of the smaller businesses listed in the FTSE 250. Yet what they lack in growth potential, they make up for by paying quite large dividends to their shareholders as their businesses generate a lot of cash. The FTSE 100 overall has, by comparison, not been a great performer. Even though from March 2009 until the January 2020, it went from less than 3800 points to almost 7700 points. Even though the index more than doubled during this period, it’s also worth bearing in mind that just before the turn of the new millenium, on December 10th 1999, the index was over 6700 points.

What is noticeable about this particular market crash is just how dramatic it’s been. Before the very beginnings of this market crash, when the markets closed on Friday 21st February, the NASDAQ was trading at over 9500 points, the S&P 500 was over 3,300 points, the FTSE 100 was over 7,400 points and the FTSE 250 was just a few points short of 21,800 points. By the time the markets closed just a few days ago on Monday 23rd March, the NASDAQ was below 6,900 points, the S&P 500 was a little higher than 2,200 points, the FTSE 100 had gone below 5000 points, and the FTSE 250 was trading slightly north of 13,000 points. In fact, just a few days previously on March 19th, the FTSE 250 had hit almost 12,800 points.

In the space of little over a month, the NASDAQ had fallen around 27%, the S&P 500 had lost around 33%, the FTSE 100 had shed 32% and the FTSE 250 had lost over 40% of it’s value. Since these lows from last Monday, markets have made some gains owing to stimulus from central banks, yet at the close on Friday yesterday, a good chunk of these gains were erased.

Going forward

The question now is, how will markets behave over the coming weeks and months? Will the lows hit last Monday be retested? It is always hard to predict the future, but I think they will be. The difference between this crisis and others is that this virus has been very disruptive. Since there is still currently no cure for the virus, the only measures to contain the virus have been for governments to impose lockdowns and restrict the movement of people. The most affected industries include the airline and travel industries. The airline industry in particular has been greatly affected as the number of flights have been severely diminished. It is likely that even the most established airline companies will struggle going forward without some form of a government bailout. With their cash flows from operations dramatically reduced, they will be drawing on their precious cash reserves to keep the lights on. But the truth is, with the restriction of movement, most industries will be affected. If a lot of the most affected companies struggle to remain a going concern they will go bust and as a consequence many people will lose their jobs. As an increasing number of people lose their jobs, they will have no income and likely also little to no cash savings to keep them going. There will be a frantic need to create liquidity to free up emergency cash. And this is why there has been a sell off of almost everything, even the most defensive of assets such as gold. When people are desperate for cash they will sell anything. This notion that cash is trash is a myth. In a difficult crisis such as this one, hard cash is king.

So going back to my earlier question; will markets continue to fall? I think they will as I don’t see lockdown measures easing any time soon. I also see an increasing number of people continue to lose their jobs and as a result an increasing need for emergency cash as more incomes dry up. In this situation, markets will continue to sell off. Shares that may seem like a bargain now will get even cheaper. I think the situation is serious enough to say that it is likely that some of the lows of the 2008-9 financial crisis will be tested. Yet do I think there are currently bargain shares to buy? Of course. But at the same time one should ask themselves the following; how much free cash do they currently have to invest? Not essential cash to survive, but cash they can either afford to lose or not have any need to draw upon for at least five years. If the latter than I would recommend periodically drip-buying a select number of quality companies (that are not over leveraged, that generate a lot of cash and have sufficient liquidity to be able to ride out this crisis and thus recover once its over), investment trusts or tracker funds over the coming weeks and months.

Cheap money 

It is likely that as the current crisis continues to bite, they will be a lot of government intervention to help citizens and business. One solution that has been doing the rounds is the idea of creating ‘helicopter money’ whereby central banks print money which is then given directly to households to help them and keep them solvent. In the USA, the current Trump government is planning on putting together a $2tn rescue package to aid businesses and households most affected. With interest rates at close to zero, the idea of printing staggering sums of money is a tempting one. As mentioned at the beginning of the article, since the 2008 financial crisis we have had a long period of low interest rates. And since the first shocks of the current crisis began to appear, both the Fed and Back of England reduced interest rates even further. As of now, the current Fed interest rate stands at 0% and the Back of England interest rate is 0.1%. With such rock bottom rates, the temptation to just keep printing money to infinity is very strong. As previous rounds of Quantitative Easing (QE) since the 2008 financial crisis have barely had an impact on triggering inflation, the current conventional wisdom is that even bigger rounds of money printing will also barely stoke inflation. Even the former head of the European Central Bank (ECB) Mario Draghi who back in 2012 vowed to do ‘whatever it takes’ to save the Euro, recently commented that interest rates will remain low for a very long time. Others also share this belief. But what if, out of nowhere, in the midst of all this money printing, a tsunami of inflation catches everybody off guard forcing central banks to abruptly increase interest rates to control it?

In gold and silver we trust

If you have read some of my other articles you will see that I have always been a big fan of precious metals. And this is especially true now in our current economic climate where uber-low interest rates and cheap money have been reigning supreme. A consequence of more than a decade of low interest rates has been that total levels of government, corporate and household debts have increased dramatically. To exacerbate an already fragile economic situation, the current crisis has triggered central banks of major economies to drop interest rates to zero. On top of this, humongous rescue packages are being created to aid affected households and businesses. Although this may create short term relief, it will further accelerate already staggering levels of global debt, which have already been allowed to get out of control for too long. Taking on debt is fine when interest rates are low, but what happens if all of a sudden interest rates increase? I say this, because as I previously mentioned, not many people are taking into account the very real threat of inflation, which may finally be awakened out of its slumber in a big way as a consequence of larger than normal levels of money printing. When interest rates increase to control this inflation, suddenly all this cheap money floating around will seize to be cheap and all this gigantic debt will become more expensive to service.

I can’t help but think that all this will be nothing but beneficial towards the prices of gold and silver. Over the last several months, gold has been slowly increasing in value. It recently hit $1,700 an ounce and is currently hovering in the $1,600s. In my view, I think any dips in the gold price should be taken advantage of. It is unavoidable that there will be dips in the gold price as households scramble to free up cash, but over the coming months and years I think gold will do very well.

I am equally keen on silver. It is less scarce than gold and is more sensitive to industrial demand, but compared to gold it is currently extremely under-priced. For many years the silver to gold ratio (SGR) oscillated between around 20 and 100, and it was an incredibly rare moment if it ever went above 100. Over the last two weeks, this ratio broke the 100 ceiling and spiked to over 125 at one point. As I type, the ratio is 112. A consequence of this further distancing between the gold and silver price has caused some to say that silver is done and has lost its appeal as a store of value. Yet I disagree strongly. If anything, I think this is an incredibly good buying opportunity to have exposure to silver as I can foresee it playing catch up to gold in an epic way.

 

By Nicholas Peart

29th March 2020

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