Investing in uncertain times

"Expansion comes to an end at the upper turning point, or peak. Contraction, which begins at the end of the expansion phase, lasts until the lowering points, the trough or revival," said Wesley C Mitchell, director of the US National Bureau of Economic Research in 1927.

Where are we in the current cycle? It is difficult to assess and separate the cyclical influences from structural change.

It has been evident that a rapidly ageing population in Japan has significantly retarded growth.

In China and America, the population is ageing too. Productivity gains are difficult to create when globalisation and automation have pressured wages and stunted final demand. These issues cannot be addressed by monetary and fiscal policies in the short term.

Uncertainty

56% of world GDP and 81% of free-float global equity market capitalisation is supported by virtually-zero interest rates. The "tiny steps" upwards in rates were expected in the USA and UK, whose economies have demonstrated GDP growth. 2015 could be the year for this to happen.

The UK stockmarket is partly discounting this event, but also has to anticipate the general election in May 2015. This leads to much uncertainty - witness the effects of the Scottish independence referendum. With apologies to Quentin Letts of the Daily Mail for the embellishment of his headline: "Salmond - hooked, netted, landed, gutted and smoked!"

The UK economy, in parts appears to be doing very well. Boston Consulting Group reported recently that the UK is one of the lowest-cost manufacturing countries in Western Europe. Car production has risen here by 50% since 2009 and, with investment by BMW Mini, Jaguar Land Rover, Nissan (NSANY) and Honda, should rise by a further third by 2017.

The UK too now derives more GDP from internet-related expenditure than many of its competitors. According to a report from McKinsey, expenditure on telecom infrastructure, broadband bills and online retailing in the UK exceeds 6% of GDP, higher than Korea, Japan, Sweden, China, USA, France and Germany (China is at 4.4%).

UK headline corporate tax rates have now fallen to 21% and the effective rate (i.e. paid on average) is down to 16.3%. The UK has the second-largest aerospace industry (including defence) after the USA.

We regularly comment on the pace of change that affects companies, industries and markets. We also try to disaggregate large numbers to provide better intelligence.

For example Gartner Group forecast that worldwide combined shipments of devices - PCs, tablets, smartphones and mobile phones will reach 2.5 billion this year - an increase of 7.6% from 2013. However, within that year-on-year growth, PC shipments declined by 10% - their worst fall in PC market history.

Healthcare and pharma

Following a takeover bid for our successful investment Shire Pharmaceutical by US company Abbvie (ABBV), we have been looking to deploy some of that capital back into the healthcare and pharmaceutical sector.

One company that we hold and have added to recently, and have visited their Camberley site, is BTG. This company has grown out from its biotech roots and now encompasses three divisions: speciality pharmaceutical, interventional medicine and royalty income.

Specialty pharma revenue is mainly from a product called CroFab, an anti-venom solution for rattlesnake bites in the USA, plus DigiFab for digoxin toxicity (for heart failure) and Voraxaze for methotrexate toxicity (in cancer chemotherapy) in US hospitals and on a named patient basis.

This is a high cash generative part of the business. Interventional medicine is primarily oncology beads to treat primary liver cancer. These micro beads can also be loaded with chemotherapy agents and radioactive isotopes.

Royalties come from discovered therapies/drugs licenced to big pharma, almost entirely now earned on Zytiga, for prostate cancer, from Johnson and Johnson. The underlying drug is now expected to produce $2 billion (£1.3 billion) in revenue for JNJ this year. Other licensing includes Lemtrada for multiple sclerosis - approved in the EU, but awaiting approval in the USA.

Significant potential upside comes from within the second division-interventional medicine such as various vascular products, in particular FDA-approved Varithena foam for the non-invasive cure of varicose veins.

Another company where we have added to our holdings is Royal Dutch Shell. Although the largest company listed on the London Stock Exchange, their new chief executive, Ben van Beurden, seems to be creating some change (in terms of capital efficiencies) in this literal "super-tanker".

Recovery

The group have indicated to the stockmarket that they plan to return in excess of $30 billion to shareholders in 2014 and 2015. Given the expected level of dividend payments, this should mean $7-8 billion of share buybacks over the same period.

Recovery in Shell's earnings is global, but a turnaround in their North American business is of interest. For most of 2013, the Americas division reported a loss. Since the fourth quarter of 2013, this part of the group has reported better results, especially in the Americas upstream, reflecting a higher contribution from high-margin barrels from the Gulf of Mexico.

With the start-up of the Cardamon project in the Gulf and continued ramp-up on platforms there, i.e. Mars B and Na Kika phase 3, profitability in the region will continue to improve. This is against a general capital expenditure (capex) budget where Shell is driving capital efficiency, involving spending $35 billion of organic capex in 2014, topped up with $2 billion of acquisitions.

Organically this is down 8% year-on-year. These lower spending plans are also augmented by a $15 billion divestment programme. With a price/earnings ratio for 2015 of 9.4 times, plus a 4.6% dividend yield they now appear to have recovery potential.

Recent merger and acquisition activity has also occurred in the palm oil plantation sector. We initially invested in New Britain Palm Oil at its IPO in December 2007 to gain exposure to the growth in consumption of palm oil and have held the stock since then.

NBPO is a fully integrated palm oil producer with its own transportation fleet and two refineries in Papua New Guinea and Liverpool. The management team has been in place since the IPO and the firm has a competitive advantage in terms of environmentally friendly production methods.

Its entire supply chain has been certified sustainable by the "Roundtable on Sustainable Palm Oil". This provides the company with a strong platform to supply downstream, high-value products to large EU buyers who have declared their intention to source 100% sustainable palm oil.

The stock has experienced some volatility with some years of missed earnings but our "buy and hold" approach has been beneficial with the stock being up 129% since we first invested. The company was bid for by Malaysia's Sime Darby on 9 October 2014.

Potential Takeovers

Sime Darby, one of Malaysia's largest conglomerates and one of the world's biggest producers of palm oil, offered an 85% premium (£1.07 billion, or 715p a share) to acquire NBPO. Currently, the position accounts for 0.9% of the AXA Framlington UK Select Opportunities fund.

Another of the fund's holdings, Synergy Health, has also been bid for. This stock is well represented in the fund (2.3%), and the resulting rise in the stock's share price has been a boost to performance.

As we look back 100 years and remember and commemorate the terrible losses of the First World War, it is also interesting to reflect on how financial markets reacted to a different crisis from that experienced in 2008. Financial markets crashed the week before war was declared.

The Treasury closed the banks for four days and interest rates, having been raised, were then slashed. A moratorium on debt repayments was implemented.

As cash was scarce with the banks closed, new banknotes were issued and put into circulation, but in small denominations. These new notes were not issued by the Bank of England but by the Treasury, and signed by John Bradbury, the permanent secretary of the Treasury and nicknamed "Bradburys".

Great attempts were made to revive commerce and lending and when the banks reopened on Friday 7 August, Great Britain was at war. A run on the banks had been averted, but the London Stock Exchange was closed for much longer. It had shut on 31 July that year, but did not reopen until the end of the year - five months later! There was no quick rally - share prices bottomed in 1918.

Drastic action was needed in our own credit crisis of 2008. The after-effects are still being felt as governments try and reduce their deficits. Reduction of debt is deflationary. Many companies we meet are rising to the challenges of the new era, some are not. The next twelve months will carry a great deal of uncertainty through which to invest.

Nigel Thomas is portfolio manager at AXA Investment Managers.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.