January 21, 2008
By Laura du Preez
Africa as the breadbasket for Asia; cheap, powerful micro-computers that you can wear; rapid developments in biotechnology, nanotechnology and alternative energy sources – these are some of the hot trends of the not-too-distant future, says American investment guru John Mauldin. We look at some of his predictions.
When you consider where to invest in the years ahead, bear in mind that there will be more change in the next 20 years than there was in the entire 20th century, says John Mauldin, the man who writes an investment newsletter that is read by well over one million people.
Mauldin was a partner of several financial services firms before he started his own investment advisory company, Millennium Wave Investments, in Fort Worth, Texas. He is also an author and commentator.
Millennium Wave Investments is a private wealth management company that specialises in alternative investments and hedge funds, and is also a commodity trading adviser.
Mauldin writes and edits "Thoughts from the Frontline", a free e-letter that provides weekly insights into market issues. He also edits a weekly e-letter called "Outside the Box", which contains the writings of original thinkers on a variety of investment-related topics.
"Thoughts from the Frontline" already has a sizeable readership of more than 1.5 million and it is likely that it will grow its readership as the reach of the internet grows.
Plotting future investments
Mauldin says one of the biggest innovations ahead will be the introduction of three billion new people to the internet within 10 years.
"Computing power will continue along its exponential path of faster, more powerful and cheaper. In the not-too-distant future, you will have computers more powerful than anything you now have on your desk but the size of your wallet.
"It will be connected to a cheap (yes, a word that we can use even in South Africa), high-speed wireless broadband that will change the ways we communicate. You will soon be able to talk over the internet with family and friends over a rich video environment that will be three-dimensional in nature on your large, inexpensive plasma screen."
Technological change of this nature will present both challenges and opportunities for you as an investor, he says. What you need to think about is which companies will provide the technology of the future, how business will be structured, how businesses will compete and what the world will be like with a wireless communications blanket and powerful, wearable computers, Mauldin says.
Another macro-trend to watch is biotechnology, which is technology based on biological systems or tissue cultures that are used to modify products or processes. Biotechnology is used especially in agriculture, food, science and medicine.
Mauldin believes biotechnology will advance rapidly, and the results of this will be both good and bad.
For example, most of us will be pleased to hear that biotechnology will allow us to live longer and better lives than our predecessors. According to Mauldin, experts say the first human being who will live to 150 years of age is alive today, and that person is probably in his or her early 50s.
One of the downsides of this is that neither individuals nor governments have planned financially for the additional 10 to 20 years in retirement that many of us will live for. A man who lives to 150 years will need to be supported for 85 years in retirement if he retires at the traditional age of 65 years.
In the middle of the next decade, Mauldin says, European governments are going to run out of money to pay the pensions of their citizens.
The number of immigrants that European countries will need in order to collect enough taxes to meet their pension commitments is so high, he says, that it will not be possible to admit this many immigrants. Instead, there will have to be a reallocation of budgets.
The United States will face the same problem but about four or five years later than European countries, Mauldin says.
One of the things that governments will reconsider when they review their budgets, he says, is the agricultural subsidies enjoyed by European and US farmers. Once these subsidies are withdrawn, the most competitive farms will be in Africa, where land is cheap, Mauldin says. Infrastructure in Africa will have to improve, he adds.
Asia’s growing populations will have an increasing need for food, and the more affluent populations will want to upgrade their diets to include more meat protein. Increased meat production and human demand for agricultural products will increase the need for grains and feedstock. The result will be that Africa becomes Asia’s breadbasket.
If you are an investor with a long-term horizon and deep pockets, cheap African farms would be a good bet, Mauldin says, because "one day we will look up and say we should have been investing in these farms".
In addition to biotechnology, Mauldin says, nanotechnology, robotics, artificial intelligence and alternative energy sources, such as hydrogen fuel cells and biomass, will change the character of our world. (Nanotechnology is an extension of existing sciences to the molecular scale.)
The investment in alternative energy sources will be huge, he says. Already a large number of Silicon Valley start-ups – new companies in the San Francisco Bay area where there is a concentration of high-tech businesses – are focused on developing renewable energy, Mauldin says.
"Your car will be electric within 20 years, but the source of the power is still not certain."
In one of his "Thoughts from the Frontline" e-letters entitled "A Thousand Barrels a Second", which was posted in August last year, Mauldin recommends a book of the same name by Peter Tertzakian, which looks at when the world’s oil supply might reach breaking point and other challenges facing an "energy-dependent world".
Mauldin writes that just as the world switched from whale oil to kerosene and from coal to diesel, we will see a change in how we find and use energy.
"That is inevitable. But the transition will not necessarily be easy or smooth. And there are some surprises along the way. The things we ‘know’ and the assumptions we make about the conservation of fuel and peak oil are probably wrong, and we need to get some key concepts down as we consider how the world will adjust to rising oil demand but at some point potentially falling production."
Mauldin says each of these fields – technology, biotechnology, nanotechnology, robotics, artificial intelligence and alternative energy – will produce new business giants, giving us new companies and industries into which we can invest.
But there are only a handful of people who are truly innovative and entrepreneurial, Mauldin says. These are the people who create chaos and drive ideas and research, and they are serviced by other people who attach themselves to these innovators.
The developed world does not have enough of these people, he says, while countries such as South Africa have lots of these people but need to support and nurture them and need to ensure that regulation does not stifle them.
Globally, we should rethink the education system, Mauldin says, and make the most of good teachers by using them to present learners with what they need to learn in video presentations, while less skilled teachers act as invigilators.
Our education system is stuck in the 17th century and is not suitable for the information age, he says. These are policy issues we need to think about.
Awash with capital
Another important macro-trend is that the world is awash with capital, resulting in investment assets with high valuations and low yields.
Most of the developed world’s stock markets are in the top 20 percent of their long-term highs in terms of valuation, Mauldin says. Numerous studies show that stocks offer lower-than-normal returns after such periods of high valuations, he adds.
Mauldin blames the capital surfeit for the current situation in the US housing market, where one in every four mortgages granted is what is known as "sub-prime". These "sub-prime mortgages are valued at about US$665 billion, Mauldin says in a recent "Thoughts from the Frontline" e-letter.
Growing personal incomes, rising corporate profits and increased savings globally have resulted in an ever-growing supply of capital looking for a home. The massive US trade deficit has compounded this global capital liquidity as Asian and Middle East central banks, in particular, take their dollars and reinvest them in US government debt. This has helped keep worldwide interest rates lower than would typically be the case.
Mortgage banks have too much money to lend, with the result that they are lending without doing proper checks and obtaining the necessary documentation, such as proof of the borrower’s income.
"Recent research suggests that as many as 20 percent of these mortgages sold in 2005 and 2006 are going to default or [suffer] foreclosure … If the number of defaults is even half of that predicted, then someone is not going to get their full capital back, let alone the interest.
"And we are seeing home foreclosures at record levels in every part of the US due to the large number of sub-prime mortgages," Mauldin says.
"The sub-prime mortgage market is going to be a scandal by the end of this year, as these loans have been packaged and sold as investment-grade bonds by numerous investment banks, mostly to European and Asian institutions. Some of these collateralised debt obligations, or CDOs, are going to default and there is going to be a major wave of lawsuits," Mauldin says in his e-letter.
He believes the housing market will trigger a slowdown in consumer spending, the first since 1991, bringing on a recession.
Despite his warnings, Mauldin says investors need to be cautiously optimistic. You need to be careful, but you should have enough optimism to invest in the markets. If you are a pessimist, you will never get into the game, he says.
And when you enter the game, don’t just look for shares on which you can make a quick profit. Look for those with long-term prospects.
In one of his newsletters, Mauldin writes: "The real deal is this: you can make a lot in stocks. But you are far more likely to make good money compounding dividends. Over the long run, 60 percent of market returns have been made on reinvesting and compounding dividends, not on capital gains."
Eating his own cooking
When it comes to his own investments, Mauldin likes to eat his own cooking and has all his retirement savings in a fund of hedge funds. The rest of his portfolio is composed of private equity, while his listed share portfolio consists of just a single share – a healthcare company.
The reason he bought it is a long story, but is one based on value. The share is up almost seven times in the past seven years, and he keeps selling some shares with every new multiple, but it just keeps going.
Mauldin prefers to invest in hedge funds because it is possible to make money in any kind of market; unlike shares, hedge fund managers don’t need rising markets to make money for investors.
In one of the two books Mauldin has written, Bulls Eye Investing, Targeting Real Returns in a Smoke and Mirrors Market, he argues why traditional portfolios shouldn’t be your primary investment vehicle in the years ahead, and why you should rather invest in absolute return portfolios, such as hedge funds.
Bulls Eye Investing made it on to the New York Times bestseller list in 2004.
His endorsement of hedge funds comes with a proviso: that you should consider various risks. These risks include the fact that some funds:
Often engage in leveraging (borrowing to invest) and other speculative investment practices that may increase the risk of investment loss;
Can be illiquid (the assets cannot readily be converted into cash);
Are not required to provide periodic pricing or valuation information to investors;
May involve complex tax structures and delays in distributing important tax information;
Are not subject to the same regulatory requirements as mutual funds (unit trusts);
Often charge high fees; and
In many cases the underlying investments are not transparent and are known only to the investment manager.
In Bulls Eye Investing, Mauldin explains what you need to do to check out any hedge fund manager you plan to invest with and ensure that you are comfortable with their investment philosophy.
While hedge funds have their pitfalls, Mauldin does not believe they are the territory of cowboy fund managers. He recently rebuked Forbes magazine for an article it ran entitled "The Sleaziest Show on Earth: How Hedge Funds are Robbing Investors", labelling the article "the sleaziest journalism on earth".
The Forbes article highlighted a list of hedge funds that have lost investors money.
But Mauldin points out that there is about US$1 trillion invested in 8 000 hedge funds while the article listed only eight funds with investor losses of about US$1.03 billion over a number of years. The bulk of that – US$971 million – was in two large funds, the Lancer fund and the Safe Harbor Fund. The other six funds averaged losses of less than US$10 million and were mostly Ponzi-style frauds and not hedge funds. (Ponzi-style frauds are pyramid schemes that use the money of later investors to pay the earlier investors.)
Investors have lost far more in investment frauds such as WorldCom and Enron, and through bad advisers and stock brokers, Mauldin says. The list of investor losses as a result of these factors "is a lot longer than eight funds and a billion dollars", he says, adding that the fact that investors have lost only the investment value of one-tenth of one percent of the US$1 trillion invested in hedge funds is a "miracle" rather than "sleazy".
Mauldin says a background check or even a Google search on some of those involved in fraudulent activities in the eight hedge funds listed in the Forbes article would have highlighted that they were banned from the investment industry or had seriously chequered pasts. "Simply verifying brokerage statements or reading the fine print on audits would have turned up problems in the others."
Besides hedge funds, Mauldin has about 15 to 20 percent of his investments in private equity deals, including his own business.
Mauldin says he is a great believer in small businesses. "Very few people create wealth from their investments. There are a few exceptions, but most people who acquire wealth do it either by saving money or through the building of a business."
As for the rest of his personal finances, Mauldin says his insurance adviser takes care of his life and disability assurance needs. And as a frequent business traveller, he makes extensive use of credit cards to pay for the goods and services he needs, and in this way accumulates Air Miles.
In his latest book, Just One Thing, Mauldin and 11 investment guru friends have each contributed a chapter outlining the one investment lesson or strategy they would like their children to learn from them.
Mauldin has seven children, five of them adopted, aged between 12 and 29. And one would have expected that with his experience he would have had at least one investment lesson for each child, but Mauldin chose just one issue to highlight in his book. And that one thing?
"The world is going to change rapidly as they grow, and they must never get complacent. Adapting to and taking advantage of the changes rather than fighting them will make their lives much easier."
Developing beyond recognition
* This is an edited version of John Mauldin’s "Thoughts from the Frontline" e-letter posted on February 9, 2007.
It has been an altogether marvellous 11 days in South Africa, speaking to over 1 000 people at 12 venues, giving a half dozen media interviews and meeting with many individuals.
It had been 12 or more years since I was last in South Africa. The difference cannot be more palpable. The last time I was there, talking with friends and acquaintances about the future of South Africa, the mood was so pessimistic that you had to remove sharp objects from the vicinity before you started the conversation. This week, I want to give you some impressions of not only South Africa, but talk a little about emerging markets in general.
Finding value in South Africa
As I observed South Africa, it was force-fully brought home to me that there is more to the emerging-market story than China, India and Brazil. There are any number of countries that are seeing robust growth and contributing to the world economy. It was reported at Davos this year that for the first time the developing world has a larger share of world GDP than the developed world. Today, we focus on an emerging-market country that does not make as much news as it should.
As I mentioned above, the mood among those I talked with in South Africa in the early 1990s when I was travelling often to South Africa was quite pessimistic. The economy was not good due to international economic sanctions. Changes and elections were coming, and it was not clear what would happen.
I travelled for (mostly) business into 14 other sub-Saharan countries. With a few notable exceptions, most countries were not doing well and things had progressed from bad to worse over the previous 10 to 20 years. It was a tough time to try to do business, but it was a great education.
The contrast today is amazing. Before we get into some facts, let me give you a few impressions. First, there are construction cranes everywhere in the four cities I visited: Johannesburg, Pretoria, Durban and Cape Town.
Twelve years ago, the 30 miles (48km) from Johannesburg to Pretoria was mostly agricultural land. Today it is one big city. There was a significant number of rather nice new housing developments, many, if not most, being built on speculation all along the freeway.
Johannesburg is a world-class city, on a par with New York or London or any major city in terms of facilities, shops, infrastructure ... and traffic. There were new shopping malls all over, and the stores were busy. The restaurants were excellent. The hotels I stayed in and spoke at were excellent and modern. The Sandton area is particularly pleasant.
Durban is a tropical jewel on the Indian Ocean. Again, there was construction everywhere – a green, verdant city of a million people, with modern roads and great weather.
I have been to Sydney, Vancouver and San Francisco. I love all of them. But for my money, Cape Town is the most beautiful city I have been to. The Victoria & Alfred Waterfront area, where I stayed, is fun and vibrant. Again, an amazing amount of construction everywhere, especially in the Waterfront area, as investors from Dubai are pouring money into creating a massive residential/ business/retail/restaurant development. There are several similar, quite large developments going up in different parts of Cape Town.
And it was not just the people I spoke to that were optimistic. Grant Thornton (an international accounting firm) did a survey in the 30 countries in which it does business. The four countries with the most optimism and confidence were India, Ireland, South Africa and mainland China.
Why such confidence? I think there are several reasons. The South African economy has been growing at a reported almost five percent a year for the past several years, which is quite strong. It has had 32 consecutive quarters of positive growth. But the official figures may understate the reality by a significant amount. If you look at the value added tax, or VAT, receipts, as well as other tax figures, some economists estimate the economy may be growing by seven percent or more. Why the difference?
There is a large "informal" economy in South Africa. While much of the income may not be reported, when something is bought and sold in the retail sectors, taxes are collected.
The stock market has grown by over 25 percent, 47 percent and 41 percent for the past three years. Such a bull run is always a boost to confidence. But there are also some real fundamentals underlying the emerging-market bull markets. South Africa has a strong commodity sector, with numerous commodities, not just gold. JP Morgan thinks that earnings growth for South African companies, even adjusting for some anomalies, will be 20 percent this year, which should mean another good year for their local markets.
This link between commodities and stock market prices is reflected not just in their stock market, but in emerging markets worldwide. Look at the close correlation for the past 10 years between the prices of commodities and the emerging-market equity index. It is more than just a China story.
Football as an economic driver
The attention paid to football is rising to fever pitch in South Africa. And for good reason: they will host the World Cup in 2010. They expect some three million fans to show up. The government is using the occasion to spend R400 billion on all sorts of infrastructure projects. They are doubling the size of the major airports. Walking past the construction at the Johannesburg airport, you have to be impressed with the size of it. New roads and other forms of infrastructure are being added to prepare for the influx, but it will have the added effect of making the country more competitive, just as infrastructure in China has been a boost to that country, and a lack of infrastructure has limited India.
The World Cup will also be a boost to tourism, already one of the most important sectors of the economy. Cape Town is becoming an international destination for vacations and conferences. The growth in tourism has been strong, showing 20 percent growth last year from 2005.
Are there problems in South Africa? Of course, and some of them are quite serious. But that is the case in nearly all (I cannot think of an exception) emerging-market economies. While the overall crime rate is dropping, it is still far too high. Some rather high-profile crimes of late have resulted in a strong outcry for serious change.
Corruption is an issue, but that is the case in almost every emerging-market country. The high levels of poverty are evident. Although employment is growing, and more and more of the poor are being brought into the economy, there is still a lot of room for progress.
The telecommunications infrastructure is hampered by a lack of serious competition. Access to the internet is limited in many areas, and it is really slow. This will improve in the coming years, but it is a serious handicap to business.
There are power shortages and a need for more power-generation plants to keep up with growth.
But all these areas are (mostly) going to improve. I see a lot of opportunity in South Africa, in particular, and Africa in general.
There is much to like about emerging markets. That is where a great deal of the real potential growth in the coming decades will be. And South Africa will be one of the better stories. If you are not doing business there already, you should ask yourself, "why not?".
Your tired but happy analyst
John Mauldin
This article was first published in Personal Finance magazine, 2nd Quarter 2007.See what’s in our latest issue
  
 
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