David Kuo talks to Allister Heath, the editor of CityAM.
You can listen to or download this podcast here.
David:
This is Money Talk, the weekly investment podcast from the Motley Fool. I'm David Kuo, and today we are going to look at how we can prosper from the economic recovery. With me today is Allister Heath, editor of City AM. Welcome, Allister.
Allister:
Thanks for having me.
David:
Now, I have to say, I've said this many times before, and I'm sure I will say it many times in the future – I never start the business day without reading City AM, it's as natural to me as putting cornflakes in a bowl.
Allister:
Well that's good, that's the kind of reflex I like to hear about, so it's a very good thing.
David:
Yeah, exactly. Now, the great thing about your paper, apart from the insightful articles, is that it is free, and there appears to be a shift these days towards complimentary newspapers, the latest being the Evening Standard, saying that it would be distributed free, and at the same time Rupert Murdoch is looking at different ways in which he can monetise his internet content. Now, what is your take on this changing face of the media?
Allister:
It's obviously very interesting, there's two conflicting things going on. The first is, because advertising revenues have collapsed, and a lot of media companies have suffered, some people think that it's now harder to sustain media properties that rely only on advertising for their revenues – I don't agree, I think you can still do it as long as you do it properly, and if you think things through a little bit, and the other big thing is that – so that's basically Rupert Murdoch shut the London paper, his free evening paper in London, and that's why he thinks that the way forward is to charge for websites, in fact to charge for all content. But I don't think one has to do that, I think Rupert Murdoch's a great man, a genius of the media, but I think in this particular instance, he might make some money out of his websites, but not everybody can do it – there's so much free content available on the internet, for example, provided by the BBC, that it's very very difficult to charge, except for specialist content, so I think he'd be in trouble, at least to some degree, when it comes to charging for content online.
When it comes to free newspapers, let's see what the Evening Standard makes of this, I mean they're not used to this kind of market, they're used to having quite an expensive cost base, quite a traditionally produced newspaper, and so on. Their model is very very different to that of free newspapers around the world, I mean there's hundreds now of free urban commuter newspapers around the world, and the Evening Standard will be the first, if they succeed, they'd be the first proper, traditional, paid-for newspaper to become a free newspaper. Now, I just think they're going to have to transform themselves much more than they realise to be able to achieve that.
David:
Do you think they'll be doing a cut down version of the Evening Standard, rather than to give away the entire Evening Standard for free?
Allister:
Yeah, I think they'll start by giving away the whole Evening Standard for free, the problem is …
David:
They'll start taking pages out of it eventually?
Allister:
Well, the problem is, the cost of doing that is very high, it's a very large newspaper, it's probably at least 64 tabloid pages long, in some cases more, when there's supplements and so on, that's very expensive to produce, they've got a glossy magazine once a week, it's also very expensive to produce, they want to take up their circulation to 650,000 copies a day, that's something like three times what they print at the moment – that's a massive increase in costs. At the same time you lose, whatever, £12 million a year or something in cover price revenues, so how do you make your money? The only way to make your money is to massively increase the volume and the yield of your advertising, the whole success or failure of the enterprise hinges on them being able to do that, and I am not entirely sure that they'll manage.
David:
But maybe I'm being simple here, Allister, but I mean it's only 50p – what is 50p these days? People spend more than that on a coffee, and yet you're asking them to part with 50p to read a newspaper, and yet they're reluctant to do so?
Allister:
Regrettably, people have decided that they don't really want to spend anything on buying news, and that's fine, because we can thrive by doing that, we've come along with a newspaper that is sustainable and works, and is growing in circulation and revenues, and we've basically defied the recession, and we're doing OK, and I love the concept of a free newspaper, I think it works. But the point is, it does mean that not all publications will be able to survive in this new world.
David:
So what is the outlook then? – this is probably a good point to introduce this, because we've got listeners who have investment in Daily Mail and General Trust, Johnson Press, Trinity Mirror, Independent News & Media – so what do you think is the outlook for the media shares?
Allister:
I think media shares, at least a few months ago, were massively undervalued in general, but obviously things have recovered to some degree now, but they're still almost certainly undervalued. This is simply because people exaggerate the decline in advertising, they think it's permanent, while it's largely but not entirely cyclical. OK, it is partly permanent, because advertising is shifting away from newsprint and into search advertising, largely on the web. There's only one real growth engine now in advertising, and that's search-based advertising. It's not even display-based on the internet, it's not, the little ads where you click on a car ad or something on a website; that's stagnant, if not declining slightly, it's been hit by the advertising recession like all other forms of advertising, but the one thing that's defied everything is search-based advertising, that's the reason why Google's revenues are so massive, bigger than TV company revenues and so on. So yes, advertising's been hit, advertising is shifting, but there will remain a lot of advertising around for media companies to have, and as long as those media companies can adjust their costs, and as long as they find models to continue to attract readers and to generate revenues that way, then I think there's a lot of exaggerated pessimism in the sector.
David:
But haven't they already pared down their costs a great deal?
Allister:
Some have, some haven't – it depends what you mean by low cost. A lot of people have cut costs in the wrong way; what we've done, for example, at City AM is, we're producing a quality real newspaper, with the real ethics and values of a newspaper, but on a low budget, and we give away for free and we make that work. Unfortunately, you still have a lot of resources being misallocated in some media companies, I think.
David:
OK, so can we now turn our attention, just as Rupert Murdoch has, from the newspapers to the political arena, and have a look at the next general election, which I believe has to be held before 3 June. Now, the smart money, including Rupert Murdoch's money, is probably on a change of government from the colour red to the colour blue. Now, how do you think investors will be affected by this change of government?
Allister:
I think the first question is obviously, who will win, and I agree, I think the Conservatives will win. However, I think the majority now looks like it's going to be between 40 and 70, and the reason I say that is, I've just looked before coming here at a few polls, and the polls suggest about 40 seats majority, and a very detailed marginal poll by a website called Politics Home, and provided by YouGov, suggest a majority of 70. So a majority of 40 to 70, that's not much – that's just enough for a government to function properly, and it's quite tough, when you've got that sort of majority, for a government to push through very unpopular, very difficult measures; for example, massive reductions in public spending. So I think these are the two questions: OK, the Tories will probably win, but by how much? And depending on how much they win by, that will affect investors in different ways, so if I were an investor, I'd be very careful, I'd look at the majority, I think that's very important. I think a lot of investors have assumed wrongly that a huge Tory majority is in the bag, I don't think it necessarily is. Why? – two reasons, one: the Tories have a huge amount of way to go compared to their results last time; and secondly, the election system is biased against the Tories and the LibDems, and supports Labour, so I think that's quite important.
Let's say the Tories do win, and let's say they've got a workable majority, I think quite clearly there's going to be bigger reductions in public spending than were Labour to be elected, though who really knows, obviously? And I think the great question we need to figure out, and we're not sure yet, no-one really is sure is, how radical, how revolutionary, will David Cameron's Conservatives prove to be? Do they realise how bad the situation is here in this country, or are they going to try and manage the decline a little bit for a few years? If they're revolutionary, and try to overturn some of the stupid decisions that have been taken in the last few years, then it's possible that long-term growth prospects would go up, Britain would once again be a bit more attractive as an investment location, and so on. If they don't, I feel we're going to be stuck in a long-term period of stagnation and reduced capital value growth, and so on.
I think people don't really realise often how bad the situation is now, we're very uncompetitive as an economy; we've got a massive crippling budget deficit which needs to be plugged very quickly; we've got a massive public sector that we are not paying for, we're not raising anything like enough tax revenues to pay for all the sides of the public sector, so we need to change all of that, and all those things matter massively to investors, they will determine tax rates, they will determine return on capital, they will determine inward investment, they will determine gilt yields, I mean, what's going to happen to gilt yields? – are they going to start surging because the budget deficit won't be brought back under control, or will they be tackled? So these are all the questions, and at the moment it's too soon yet to know, but I think the most important thing is to set up the questions, and then to assess what happens over the next year to 18 months.
David:
Well, one question that must be at the forefront of whichever government takes over is that the national debt at the moment is likely to reach 100% of GDP, it was only a couple of years ago when it was about 40% of GDP, and people thought that was quite high, but 100% of GDP? Now, tax payers and companies will be forced to put their hands in their pockets and pay for that, and to actually bring that debt level down. Now, how is that going to affect people? Are they going to have money to invest, if they have to fork out all this money to pay down the national debt?
Allister:
I think national debt of 100% of GDP is terribly high, but, funnily enough, it can be managed, just about. I think it's once you start going above that, that you have a real crisis. Obviously it's a horrible situation to be in, and it means probably three, four, five percent of GDP almost goes into paying the interest on that, but you can just about get away with it. The real problem is, how do you prevent it from just exploding out of control, and going to 150% or something? And to do that, you've got to reduce the huge gap between revenues and expenditure, and to do that I have to say I hope the Tories primarily cut expenditure, because putting up taxes any more is going to be quite tight; (a), if you put up income tax, or tax on capital, as I suspect a lot of people might want them to do, you will destroy incentives even more, it'll just not be worth working here or investing here if you pay, you know, capital gains tax, if it goes up to 40% or 50% - why would anyone want to invest here?
David:
Well some people, like Tracey Emin, has already indicated that she wants to leave.
Allister:
And she's not the only one, and the astonishing thing about that is she wants to go to France, of all places! I think about that, I remember ten, 15 years ago, some of us actually moved from France to the UK, and now the whole situation's been overturned – we've got higher tax, bigger government almost society than France, it just shows the extent of Brown's revolution in this country.
So anyway, will income tax and tax on capital go up? – or it will it be value added tax, for example, that goes up? I suspect value added tax will go up to 22%, even 25% - that would be a massive drag on retailers, and anyone who depends on consumer spending for the next five years. However, it would be less damaging overall for incentives than higher income tax, or higher capital gains tax. I think the brunt of it will have to come from spending cuts, so any company that depends on the public sector – contractors, all these construction companies and so on, they're all going to be hit quite badly over the next few years, whole sectors of the economy that prospered.
David:
So we're talking about companies like Capita and all those who are reliant on …
Allister:
Yes, it's going to be difficult for them to continue growing as fast as they did in the past few years, because public spending will be slashed everywhere that it's possible to slash it, and don't forget the Tories have made all these promises and certain parts of spending will continue to grow. So everybody everywhere else will have to be cut to the bone, any spare cash reserve will be cut out. It's going to have to be the biggest cuts ever pushed through by a British government, I don't know how they'll manage to do that, they may fail and so on, but that's what they're going to have to try and do. So whole numbers of sectors are going to suffer. But I think the big question is gilts – what's going to happen to gilts? Well, we've got a forced market in gilts at the moment; roughly speaking, over the past year, the Bank of England has bought all the new gilts that the government has printed, so 20% or so of the total amount of gilts in the British economy are held by the Bank of England, up from about zero a year ago. So that's an astonishing thing to have happened, and when the Bank stops quantitative easing, when the government's gilts are actually having to be bought by private investors, what's going to happen?
David:
Well, who wants to buy it, when the yield is so low?
Allister:
Well, the yield's going to have to surge, and if the yield surges, there'll be a knock-on effect on the cost of borrowing to all companies, so all companies are going to be hit, so this is how the recovery's going to be anything other than quite feeble. I think we're on recovery, I think the recession's over, and I think growth has returned very slightly, but I think over the next year or two, it's just going to be tough.
David:
So looking at the pound, this is probably quite a good time to have a look at the pound, and see how that is going to fare as the recovery starts to pick up, or if we do get any recovery at all. We're already seeing the pound almost at parity with the euro, and it's at a five month low against the US dollar – does that indicate to you that investors, or foreign investors, are pulling their money out of the UK and going into other currencies?
Allister:
In part, yes – obviously the value of a currency is determined on the basis of its relationship with other currencies, so if other currencies are even weaker, then obviously its turning could be propped up in that sense, but I do think that there's a growing realisation that the UK's becoming once again the sick man of Europe, the last time we were was the 1970s, and that's quite horrible. It suggests, generally speaking, that people will assume the UK's going to be low growth, high problem area for the next few years, they do all assume that there's just too many gilts being printed for comfort. So given that, I can't see how sterling can really be strong over the next few years, it's very very difficult to see that.
David:
So should investors be looking for overseas investments then? – I mean, to look at investing in dollar earners or euro earners? – anything apart from sterling, in order to preserve their wealth?
Allister:
I wouldn't say anything other than sterling, that's the thing though, because the dollars have also got certain problems, America's got quite serious problems too. I think it's a question of choosing certain economies that are growing well, or certain economies that will have much higher interest rates over the next few years, and those economies will tend to be those that are doing better; for example, Australia, Australia's not actually gone through a recession, Australia's banks are still highly rated, so Australia's quite an interesting country, and so it's almost certain that the interest rate differential between Australia and the UK's going to be quite high over the next year, growth will probably be high in Australia and so on.
So those are the kinds of things to think about.
David:
They also have a lot of commodities out there?
Allister:
They've got a massive amount of commodities.
David:
Correct, yes.
Allister:
If the economy does recover, as I think it is, and if China kicks back in and doesn't collapse in some sort of new bubble, which is the other big danger …
David:
Heaven forbid!
Allister:
… exactly, the demand for raw material will go up, which means the Australian economy will be boosted and so on. So I don't think it's a simple – I think the world has changed anyway, I don't think it's, is it dollar? – is it sterling? – is it euro? – no, it's more complicated than that, and investors just need to seek out those economies and currencies that are different from the rest.
David:
Well at the moment, investors are seeking out the UK stock market, and of course the American stock market, which is causing the sort of massive surge in equity prices, and Professor Nouriel Roubini of New York, now he actually warned people, and he said, "Don't expect a V-shaped recovery" – he thinks it's going to be U-shaped; and of course we also had Michael Geoghegan of HSBC, who said it's going to be a W-shaped recovery. Now, what kind of recovery do you think we'll get, Allister? – because I know you have your pet theory?
Allister:
Yes, it's quite a weird one – I believe in a square root shaped recovery.
David:
Can you explain to people what a square root shaped recovery is?
Allister:
Basically, it means a short-term recovery followed by stagnation, effectively. I do think there's going to be growth in Q3, Q4, maybe Q1, whatever, so there is growth. Most people still think we're in a recession, but I don't think we are. I mean, there was a services sector PMI out today, and it showed growth is there, there is some growth, but the pressures on growth over the next year seem to be immense, the Bank of England can stop quantitative easing, taxes will go up, public spending will be cut, people will pull out of the UK, whatever - there's just too much pressure ahead, there's no way it's a V-shaped recovery, it's impossible. Could it be W-shaped? – well, I just think it's going to be, well as I say, a square root shape, but then I quite like strange mathematical symbols.
David:
You see, I was going for the L-shaped recovery, which means that we go down, and then we just sort of having this long flat line afterwards for a long time.
Allister:
I'm slightly more optimistic than that, in other words, because I see some growth over the next year.
David:
So what should people do then? – should people just simply put their money under the mattress? – or still stick their money into equities?
Allister:
Well, equities have bounced massively, there's a huge recovery in equities, so anyone who went into equities, even just random equities, has probably made a lot of money. People who went into banks, and Barclays in January and February, have made an absolutely fortune – huge.
David:
I mean, they were down on the 50p level.
Allister:
And there's guys who have made 300 – 400% on those kinds of stocks in just a few months, huge fortunes have been made actually. The problem we've got is, I don't think equities are over-valued at the moment, I think if you look at, even if you look at Schiller's long-term P/E index in America, they were massively undervalued actually, in January/February, because the world was ending, and yes, if the world was ending, then equities …
David:
They'd be worthless!
Allister:
… exactly, but the point is, the world didn't end, and so on, so I think now roughly fairly valued, according to long-term measures. The problem is, why have they bounced back so much? A lot of it's artificial, a lot of it is liquidity-induced. If you're buying gilts, OK, if the Bank of England is buying gilts, someone's selling gilts, and where's the money going? – it's going to equities, it's going to things like that. So there's a lot of liquidity around, it's gone into certain assets and boosted them, no doubt.
David:
But where does this money come from? – people were saying that we had this credit crunch, and there was no money around, so where has all this money come from to invest in equities, to actually force the price up?
Allister:
I think it's – apart from for a short period of time, the situation's always much more complex than simplistic assessments of the credit crunch actually suggested; part of what we call the credit markets were shut down, but if today, or tomorrow, someone just goes out and wants to get a mortgage, if you've got a downpayment, then you can get a mortgage, there are people getting mortgages. My credit card was suddenly increased, without me asking for it, just like in the old days, the other day. People haven't suddenly had all their credit cards cut off, so there is actually credit that's available.
Secondly, if you're a big company, you can borrow in the credit markets. Your biggest problem is if you're a small company, and your other biggest problem is, you need constantly to put big downpayments on everything, like mortgages and so on, because basically banks are pricing in the possibility of further drops in house prices at some point, and they don't want to be caught out again, in the main.
So it's a mixed picture, and the government have printed, let's say £100 billion worth of gilts.
David:
A bit more than that?
Allister:
Yes, but it's probably whatever's printed over this past six months of the year, and the Bank of England's bought everything, and money's been created, and the money supply is growing at a very small rate, but it's growing, let's just say, it depends how you measure it, 3%, 4%, 5%; given the economy's shrunk, that's created some money, and a bit of money's been flushing around, and that money's gone into certain assets. I mean, it's a tough one, to be honest with you, right? No-one really knows where this money's coming from, no-one really understands these mechanics very well, even the Bank of England doesn't really understand it, most economists don't understand it, but I think it's fair to say that there's been some liquidity created by the authorities globally, and some of this liquidity's probably gone into equity markets, which helps to explain why they've bounced back.
David:
But that's the danger, isn't it? – that this money was supposed to be targeted to help ease the credit crisis, it wasn't mean to be hot money going to the stock market to actually make quick returns?
Allister:
Well, funnily enough, I'm not too sure, and that's my strange view of this, because if you actually look at what the Bank of England were saying, they were only interested in boosting the money supply, they didn't want the money supply to collapse, as it did in the 1930s. So they are relatively happy, they think they've done that. Now, has that kicked off credit? – not particularly, but do we really want to go back to the levels of lending that we saw a few years ago? – no, I think it's absurd, you had far too much lending, so it's a very difficult situation.
The other big problem is, you've told the banks, correctly in the long run, but problematically in the short term, that they need to hold much more capital, in other words, save lots of money and keep it rather than lend it, and that's obviously hitting lending. The majority of the reduction of the availability of credit in this country, about 70% of it, comes from the reduction in lending from foreign banks, and don't forget you've effectively stopped UK banks going bust. So it's actually quite rational, what's happened, in a horrible sort of way.
David:
And of course, in your paper today, you reported on the number of American banks that have gone bust – that's a very sort of frightening situation to be in?
Allister:
Yes, with 98 so far this year, in the main what's happened is they've just been bought by other banks, so you're talking about 98 banks have gone bust in America this year, it's a massive figure. Most of them are small banks, they're banks in small states and so on, but they're banks, so banks are still going bust left, right and centre.
David:
They're almost equivalent to our building societies over here, which get mopped up by the Nationwide – one that sort of says, well I can't really survive any more, Nationwide comes along with its hoover, and it just hoovers them up, and suddenly that building society no longer exists?
Allister:
Yes, exactly. People often forget, but I think the most important lesson about economics and recessions and crises and bubbles and busts and so on, is that they've been a constant of the world economy, either forever, or at least the last 500 years, and if you look at history, in the 1980s the US had a very very severe banking crisis called "the savings and loans crisis", where hundreds and hundreds of small building societies went bankrupt, and there was an incredibly costly bail out exercise, and all that sort of stuff. These things happen, in the 1970s we had a really big banking crisis in the UK, which was very very similar to what's happened to HBOS and Northern Rock, it was called "the secondary banking crisis". Banks were relying on the money markets to finance themselves, rather than deposits going bust, these were special institutions, and they just went bust, and it triggered a massive crash in the commercial property market, far worse than what we've seen over the last year or two, and it took down a lot of people, and a lot of people became very rich as a result, also by buying the property quite cheap. So these things happen, for some strange reason no-one remembers anything, we're myopic and we've got a short memory, and often unfortunately people like me who are quite young talk about these things, and don't have a sense of history, so I think history's very important in understanding what to do in the future.
David:
Of course, and the final question for today's podcast is one that's dividing economists, I think, all over the UK – are we going to get inflation or deflation as a result of what's going on?
Allister:
I'd say neither, but that's cheating slightly. No, I think, with the money supply growing at the small rate it's growing at, I can't see how you can get serious inflation, it's impossible; however, in the same way, I can't see how you can get serious deflation, so therefore I suspect we'll get reasonably limited consumer-priced inflation, but that is a point, it's consumer-priced inflation, and I think the lesson of the past few years, and the lessons of economic history is, it's a mistake actually to focus on consumer-priced inflation – you've got to focus on overall liquidity, overall money supply, and it doesn't matter really whether – there's too much money around, it doesn't matter if you've got low consumer-priced inflation if you've got massive, rampant property price inflation, asset price inflation. What matters, the authorities must try to match up the demand and the supply of money and liquidity, and that's very different from obsessively targeting an artificial measure of a basket of bananas or whatever, chocolate bars.
David:
But are you saying it's the responsibility of the Monetary Policy Committee to go round pricking asset bubbles every time they see one?
Allister:
No, I'm saying it's the responsibility of the Monetary Policy Committee just to understand how the economy works, and just make sure that the money supply doesn't grow too fast. I remember talking to economists every day who were very worried about how fast the money supply was growing in 2004/2005/2006 – nobody listened to them; if they had, I think the bubble would have been much less intense. So it's not targeting asset prices, that they certainly don't have a clue where they should be at, but it's simply making sure money and liquidity aren't exploding.
David:
But you see, I mean back in 2000, we had the dotcom bubble – that was being formed, and a lot of people said it didn't make any sense, because that bubble looked as though it was ready to burst, and it did, and it brought about a mini-crisis all over the world. Now, people were saying that we have a housing bubble, which burst, and that also caused catastrophes around the world. Now, some people are saying, have we got a gold bubble at the moment? – because lots of people are just piling their money into gold, and gold is over $1,000 an ounce, I saw an advert in the paper today where I think the company was preying on people's fears by trying to sell them these one tenth of an ounce newly-minted American gold coins. Now, what is your take about gold? Is it a bubble being formed there?
Allister:
I think there might be, I'm not especially concerned about it, because I could see the price going a bit higher, I don't think it's a crazy situation, I could see it going higher, I think if people genuinely do believe that the dollar, for example, will collapse in value, which it might, because there's still all these imbalances, and in the long run I do think there's too many dollars around, but I'm just not a gold bug, I think too much emphasis is really put on that particular price, and also I don't think anyway, if it collapses in value it'd be very bad for those investors who put their money in it, and I think they should be careful, but I don't think it will destroy the world economy, unlike the collapse in the property bubble, for example.
David:
OK, well, so what is your outlook for investors for 2010 and 11?
Allister:
I think stable house prices and property in general, so less of a recovery than people think, and also much more subdued equity markets than people think, possibly even some declines in the short term, when people realise that the recovery, while it exists, is not a V-shaped recovery, I mean we need to destroy this view that there's going to be a V-shaped recovery, and until the markets and all asset prices price that in, there's going to be the possibility of severe disappointment, and hence declines in the short term, so I think that's the key.
David:
So what you're saying is that the going is going to be tough, but nice and steady?
Allister:
Yes, stagnation rather than further growth.
David:
I don't think I like the idea of a stagnation!
Allister:
I don't think anyone does!
David:
OK, well thank you very much for coming in today, Allister. Now, you may not know this, but I end each podcast with a quote, and the quote is meant to sum up everything that this podcast is all about, and today's comes from John Maynard Keynes, and I'm sure you're very familiar with this quote, and it says, "The market can stay irrational for longer than you can stay solvent" – I think it makes an awful lot of sense, and I think people need to be very cautious, I think, going in to 2010/11, it's going to be OK, but the market can be more irrational than you can stay solvent. So this has been Money Talk, I have been David Kuo, and my guest has been Allister Heath, editor of City AM. If you have a comment about today's show, you can post it at fool.co.uk/podcast, and if you have a suggestion about future topics, you can email me at moneytalk@fool.co.uk, and have a great everyone. Thank you, Allister.
Allister:
Thanks a lot.
