Thematic investing, or investing based on emerging themes, is fraught with some danger. Many people invest in the latest hot theme and get burned soon enough. Others mindlessly put their money into a company based on a theme without regard to valuation or quality of management – another sure-fire way to end up in the red.
And let’s face it: the future is inherently uncertain. If picking future investment themes was easy, everyone would be sipping piña coladas in Bora Bora. The best investors know this and place their bets according to probabilities. That is, they invest when the odds are in their favour and invest large amounts when those odds offer significant upside with minimal risk.
The question then becomes this: which investment themes might give you the best odds of success over the next decade? It’s a tough question. If there’s one thing for which I have a high degree of conviction, it’s that the world is currently drowning in debt and that debt will need to be cut, one way or another. If that’s right, you’ll want to avoid sectors which have benefited most from the three decade long expansion in credit. The finance sector is an obvious one and the bear market here is likely to last decades. The tech sector is another – think of all the tech start-ups and others which will evaporate when the silly venture capitalists funding them don’t have access to cheap and abundant money. There are many other sectors which will suffer too.
In other words, you’ll probably want investment exposure to themes which may still thrive in a world of shrinking credit. There won’t be many of them but Asia Confidential has a few ideas. Asian outbound tourism has been, and should continue to be, a strong theme which transforms the global tourism sector. Privatisation of state-owned assets appears a sure thing – in the developed world as well as China – given bloated government balance sheets. Acquirers with deep pockets should benefit. Low to mid-end consumption should do well as developed world consumers tighten their belts while Asian ones start to spend more with increased wages. Finally, gold is likely to thrive as the credit boom turns to bust and faith in government policies and currencies is shaken.
Asia outbound tourism
I remember doing a research report as a sell-side analyst in Indonesia in early 2006 looking at the potential boom in visitors to the beautiful beaches of Bali due to a growing influx of Chinese tourists. It was considered then a far-flung theory as Bali was still suffering from a series of terrorist bombings and Chinese tourists only accounted for about 6% of total visitors to the island. Since then though, Balinese tourism has surged and the Chinese have played a significant part in that. China now tops Japan as the country with the second-largest number of visitors to Bali behind Australia. And Chinese tourists account for nearly 12% of total visitors to the island, double that of 2006.
Back then, there were no airlines offering direct flights from China to Bali. Now there are several. That’s not counting the many charter flights which the Chinese take to the island. In Bali today, there are also slews of foot massage shops, jewellers, status artwork and other items catering to Chinese consumers, Chinese restaurants and Chinese speaking guides.
These trends are not only happening in Bali, but in every tourist destination across the world. Chinese tourists are driving growth and their needs are being increasingly catered too. And those needs are very different to tourists from the U.S., Europe or Japan. For instance, Chinese tourists spend much more money on shopping vis-a-vis hotels. Various studies suggest two-thirds of Chinese overseas tourists spend more than 20% of their budgets on shopping with 25% spending greater than 50% of their budgets on shopping.
The trend of increasing Chinese outbound tourism looks set to continue. In 2012, the Chinese outbound tourism market became the world’s largest, moving ahead of the U.S. and Germany. The number of annual Chinese outbound tourists now totals 83 million, up almost 8x since 2000.
The great thing about this trend is that it appears to be in its infancy. Think about how the Japanese, having fully recovered from the ravages of World War Two, took to the skies from the 1970s and transformed tourism destinations such as Hawaii and Australia’s Gold Coast. They also transformed the airlines, hotels, amusement parks, travel agents, restaurant chains, spa and beach resorts as well as duty free stores which catered to them.
The same thing is likely to happen as China and other Asian countries catch the travel bug. The companies which best fulfil their needs will be big winners.
I like the Macau casino operators in the long-term even though valuations are somewhat stretched at present. Macau accounts for almost 30% of Chinese outbound tourism and that number should increase as transport infrastructure to the territory improves. Among the casino companies, U.S.-headquartered Las Vegas Sands (NYSE:LVS) is probably the pick of the bunch.
I also like Hong Kong retailers as a play on Chinese tourism. Hong Kong is still the dominant destination for Chinese tourists and is likely to remain so. Though be wary of some of the high-end retailers who’ve benefited from the lavish spending habits of corrupt Communist Party officials. That may not last.
Finally, hotel operators with significant Asian exposure should do well. Thailand conglomerate, Minor International (SET:MINT), is my preferred stock in this space.
Privatisation of state-owned assets
In 2011, the world’s biggest private equity firms were busy raising money to take advantage of over-indebted European countries needing to shed state-owned assets to stay afloat. Wholesale asset sales never really happened though as these countries papered over cracks, with the help of a few trillion dollars from the European Central Bank.
Europe’s problems haven’t gone away though. And the problems aren’t limited to Europe, as governments in the U.S., U.K, Japan and China have similar issues. Put simply, all of them have too much government debt. And one way or another, that debt will need to be cut back. Whether through write-downs, austerity, inflation or a combination of all of them, the debt will be reduced.
One way to cut debt is through the privatisation of state-owned assets. I think that this will be one of the enduring investment themes of the next decade. Ironically, it seems probable that the paragon of communism, China, will be the first to accelerate the sale of government-owned assets in an effort to reduce the influence of state-owned enterprises (SOEs) and encourage competition.
Which companies will benefit from the broad-based sale of state-owned assets? Well, most would point to private equity firms such as Blackstone and TPG. But I’d suggest otherwise as these firms rely on outside funds and in a credit-deprived world, these funds will dry up.
Instead, I’d look to conglomerates with deep pockets and minimal debt to take advantage of asset sales. Some of the large North American companies such as Berkshire Hathaway (NYSE:BRK-A) and Brookfield Asset Management (NYSE:BAM) should be in poll position.
In Asia, it’s a bit trickier as the private companies bidding on state-owned assets will need high-level government connections to be successful. Particularly in Japan and China.
Low to mid-end consumption
In the West, excess debt and declining real wages have resulted in consumers cutting back on spending since 2008. That’s been bad for high-end retailers but good for businesses such as dollar stores. It’s a trend which is likely to continue for many years to come.
In Asia, the situation is very different. Consumer balance sheets are in great shape, barring South Korea. Savings are abundant while debt is minimal. Better yet, wages are growing rapidly, even in slowing economies such as China, India and Indonesia. Excess savings and rising wages augur well for future spending.
Moreover, you have countries such as China which are encouraging people to spend more. It’s part of China’s strategy to re-balance its economy away from being over-reliant on investment for economic growth.
As a consequence, low to mid-end consumer companies across the globe are likely to do well going forward. In the developed world, consumers will continue to trade down. In the developing world, you should have people spending more, albeit still at the lower end given most of the region, including China and India, remains poor.
I’m not an expert on consumer companies in the developed world but discount operators should outperform from here. Dollar store companies in the U.S., U.K. and Australia have recently underperformed on hopes of economic recovery, which may provide some interesting potential entry points.
In my neighbourhood of Asia, Hong Kong headquartered, Giordano (HKSE:709), is one of the best low-end clothing retailers in the region and is inexpensive at current levels. Other exceptional consumer brands worth looking at include Chinese beer giant, Tsingtao Brewery (HKSE:168), and Thailand television operator, BEC World (BSE: BEC).
Long-time readers will know my preference for having gold in an investment portfolio. Gold has two things going for it. First, if you think that debt contraction is probable in future as I do, that brings risks to the world’s financial system. After all, the still thinly-capitalised banks own much of the debt which will need to be restructured/written down. Therefore, it’s be wise to own assets which sit outside the financial system. That’s where gold comes into play.
Secondly, the current policies of the world’s central banks may be preventing the contraction in debt which needs to occur to cleanse the financial system. In my view, central bank moves to reflate the credit bubble are likely to lead to a larger credit bust down the track. In many ways, gold is the anti-central bank. The less faith that you have in central banks, the more gold that you should own.
As for the best ways to play gold, exchange-traded funds (ETFs) and stocks both have counterparty risks, though I do find the latter attractive given they’re arguably the most hated assets on the planet. Physical gold is my preferred way to play this theme though as it’s the least risky of these options.
If a prudent investment strategy involves holding physical assets outside of the financial system, then agriculture should also be considered. Unlike many of the hard commodities, agriculture has a serious supply-demand imbalance which should result in prices remaining elevated for years to come.
Agriculture inventories are at multi-decade lows. That means inventories are being drawn down as consumption exceeds production. Global agricultural production has only increased by 2.1% per annum over the past decade and the OECD forecasts that growth rate will decline to 1.5% over the next ten years.
The principle reasons behind the lack of supply are limited expansion of agricultural land, increasing environmental pressures, rising production costs and growing resource constraints.
Meanwhile, demand continues to grow solidly primarily due to growing populations, higher incomes and changing diets (higher calorific intakes) in developing markets. On the latter, for example, it’s well known that meat consumption increases as a country becomes wealthier. The OECD predicts that the developing world will account for 80% of the growth in meat consumption over the next decade.
While droughts in recent years and subsequent surges in agricultural prices have grabbed television headlines, it’s worth remembering that these events merely exacerbated the already tight supply in soft commodities. And it seems that tight supply will only worsen unless there are major technological breakthroughs to improve agricultural productivity.
As for where best to get investment exposure to agriculture, I’d suggest you look at commodities where supply-demand imbalances may further deteriorate, such as sugar, coffee and potash.
In the U.S., good arguments have been made for an urgent upgrade of creaking infrastructure. Increased spend on infrastructure could create jobs, improve security at ports and electricity grids as well as keep the U.S. competitive with China - all of which could be financed at exceedingly low interest rates thanks to Mr Bernanke’s quackery. But political gridlock means it probably won’t happen.
In the developing world, the problem is not of repairing infrastructure, but building it. Some countries such as Singapore and China are host to some of the world’s best highways, airports and ports. Others such as India and Indonesia remain in the dark ages.
For instance, Indonesia spends just 1.7% of GDP on infrastructure, compared to China’s 8%. More than 40% of Indonesia’s roads remain unpaved. The country has only 11 miles of railway line per person, less than half that of Thailand, India or China.
Anyone who’s been in a traffic jam in Jakarta can attest to the underspend. Are traffic jams in Jakarta the worst of any capital city in the world, I wonder?
The likes of Indonesia don’t have any choice but to improve infrastructure, and fast. Otherwise, supply bottlenecks will choke economic growth. The cement sector in Indonesia is an oligopoly and a great way to play to the increased infrastructure spend to come. Indocement (JSE: INTP) is the pick of the bunch.