Financials, energy and healthcare are three of the unloved areas offering up the best value opportunities at the moment, according to Cato Stonex (pictured).
The fund manager at THS partners has started the year with a positive outlook, despite low commodity prices and China’s slowdown leading to negative sentiment across markets.
Performance of indices in 2016
Source: FE Analytics
“I think there’s a little funk in capital markets, and capital markets and investors are all about uncertainty. We had a taper tantrum two or so years ago when there was first talk of raising interest rates, and obviously the Fed raised rates in December and people are not quite sure how to see that,” he told FE Trustnet last week. 
“It’s psychological. People really hate to be on their own. They like to do what everybody else is doing, and so crowd psychology is a big thing in markets.”
In the below article, Stonex explains why there are attractive opportunities in the sectors that are turning even the most bullish investors pale at the moment.
Financials
Many investors remain sceptical on financials and banks in particular due to the part they played in 2008’s crisis, as well as a string of well-publicised scandals over the years which have led to hefty fines and dividend cuts.
Another reason that investors are nervous on banks is because many are expecting developed economies to retain low inflation rates or even to slip into deflation, despite the UK Consumer Price Index rising to its high level in a year earlier this week.
“There’s a number of people who say that deflation means debt becomes unmanageable which means that banks are a bad idea, but in a modern economy when most people have a mortgage, a loan for their car or a credit card, the idea of deflation is not possible,” Stonex said.
“Democracies don’t ‘do’ deflation because deflation only benefits those people who sit with cash and everybody who has to work for a living gets poorer and poorer. That’s not something that politicians are going to do.”
“In any case, money is close to free in terms of its price in Japan, the US and Europe. So the idea that inflation stays low and decreases is very remote unless something goes horribly wrong. And yet, that seems to be what the market is talking about.”
The manager describes himself as being “diametrically opposed” to the markets’ views on banks, and as such has increased his weighting in RBS which is his favourite UK holding in the sector.
Despite being one of the worst-hit banks during the crisis, Stonex points out that it’s now under the watchful eye of new chairman Howard Davies, yet remains undervalued by markets.
Performance of stock since 2008
Source: FE Analytics
“Davies is a very steady man - he’s a former deputy governor of the Bank of England,” Stonex said. “He has Ross McEwan as the CEO who’s very matter-of-fact, and RBS will be doing traditional boring banking. If they do that and earn 10 per cent return on capital then we’ll get these close-to-40p shares for £2.30.”
“We think that when people realise these institutions are boring, regulations are all behind us and deflation is no longer a worry, its 35p price tag will probably require a P/E of 10 or 12x which will take the share price to about £4, so you can almost double your share price and you’ll get nice dividends.”
“Over the next three years we think you’ll be able to make a 100 per cent return on RBS, which makes us sound slightly strange because it’s out of sync with the mood at the moment.”
Energy
A vast majority of investors have fallen out of love with the energy sector due to a plummeting oil price, but Stonex says that there are certain areas within the space that look particularly attractive at the moment.
“Energy is deeply, deeply depressed and that’s excellent news, because we think there is a growth story in energy and that’s gas. Gas is clean, or at least cleaner than coal, and most people don’t like nuclear power,” he explained.
“With gas there’s a certain amount of technology within its liquefaction and transportation that means it is easier to produce electricity through gas without the need to spend billions on pipelines, and particularly in countries like China and India where pollution levels are rather horrendous.”
“We’re fairly certain that those countries, as well as our own, and all those agreements we’ve made to lower co2 emissions mean that the demand for gas is going to grow and prices are low so we’ve bought a few companies that we’re excited about.”
One such company is Golar LNG, which is in London and registered in Bermuda. It is one of the world’s largest operators of Liquified Natural Gas carriers, having invented the world’s first Floating Storage and Regasification Unit which significantly reduces the cost of the extraction, transportation and regasification of gas.
The manager is also looking to buy into other energy transportation companies at present.
Healthcare and pharma
Many investors are bearish on pharmaceutical and healthcare due to previously high valuations, government spending cuts and comments from US presidential candidate Hilary Clinton on her plans for the sector.
However, Stonex says that the sector has significant tailwinds in the aging population in advanced economies and the increasing demand for private healthcare in emerging markets.
“We’re very sceptical of the big pharmaceuticals because we think they charge too much and deliver too little, and most of the profits from the big pharmaceutical companies are made in North America where they really charge a lot,” he explained.
“Over in the UK, NICE [The National Institute for Health and Care Excellence] says that a year of human life is now worth £35,000. So, if the drug that somebody brings out extends life by six months but costs more than £17,500 nobody gets it, and you can understand that upsets a lot of people but given that healthcare is a huge part of our annual spending it’s difficult to do anything about this.”
“We think there are some very interesting healthcare stocks, particularly in biotech. There seem to be some serious advances in turning fatal diseases into chronic diseases.”
An example that the manager gives is the improvement of cancer treatments, which can now increase life expectancy in patients by decades in some cases.
There are two research areas within oncology that he thinks are of particular interest, one of which is the production of medication that helps to regulate the body’s immune system to prevent cancerous cells from spreading.
A company that he buys into and focuses on this is Innate Pharma, a biopharmaceutical company based in France.
“Anything that can help regulate or prevent unconstructed cell growth from happening is a very interesting approach to cancer treatment and there seem to have been many advances in this area recently,” Stonex continued.
“We found Innate Pharma a couple of years ago. So far it’s done very well and they have an awful lot of very good technology that they have licensed out to many of the much bigger drug companies.”
The other oncological story that the manager is interested in is proton therapy, which came into the public eye last year when five-year-old Ashya King’s parents flew their son abroad for the treatment against NHS recommendations.
“[His parents] were right, that technology is now much improved and it is essentially radiation treatment which is much more closely focused and specific than it has been in the past,” he said.
“In the past you couldn’t treat or attack these cancerous cells with radiation therapy without damaging lots of the surrounding tissue, but this no longer has to be the case.”
Within the pharmaceutical space, Stonex will only invest in smaller companies as they tend to be more innovative and, if they’re successful, will be bought by larger firms.