We’re blind to our biggest threat – so we need US stocks

The biggest threat is the one we don’t see. Sure, we know all about it, but that’s half the problem. We don’t see it any more than we hear the beauty of Vivaldi’s Four Seasons reduced to Muzak in the shopping centre. With both, we are anaesthetised by their bland predictability, so we ignore them. Only later do we pay the price.

If that suggestion is even half true, we can dismiss the apocalyptic possibilities of artificial intelligence (AI), the threat du jour that, currently, we can’t see beyond. The media’s obsession with AI and – worse – the phobia of those who should know better pretty well ensure that however AI evolves, it won’t be the destroyer of the human race.

Writing about the need to regulate AI, Mark MacCarthy, a technology expert at The Brookings Institution, the world’s richest think tank, hit the right note earlier this month, saying: “Policymakers should not be distracted by science fiction fantasies of AI programs developing consciousness and achieving independent agency over humans, even if these metaphysical abstractions are endorsed by industry leaders.”

That sounds sensible. Meanwhile, investors who are more rueful than fearful might gaze longingly at the ascent of shares in AI’s major techno beneficiary, microchip maker Nvidia (US:NVDA). The price is up 3.5 times since October and the shares now sell at maybe 22 times next year’s sales. Despite that – or perhaps because of it – such investors might want a sense of reality. For that, they could turn to the thoughts of Walter Gutman, author of one of Wall Street’s most influential newsletters through the roaring 1950s and ’60s.

In 1961, as mainframes ushered in a brave new world, Gutman wrote: “When computers are as familiar as cash registers, IBM will sell at a much less romantic value – you wait and see.” His point was that “there is a special moment when [investors] see that something amazing is coming out of mystery”. Before that moment, and too ignorant to care, they are indifferent to what the new technology might bring. After that moment, they don’t see reality, they glimpse a dream; in particular, the dream of wealth. And – added Gutman – “because no wealth you will ever have will equal your dreams, stocks go to particularly high levels when a lot of people think they might equal their dreams”.

Therefore, suggested Gutman, think of those select few not as growth stocks, but as dream stocks. True, the dream will morph into a mundane reality and prices will respond accordingly. But, while the going is crazy, it will seem that – just like the man said of RKO Pictures months before the Wall Street Crash of 1929 – there is no price that’s too high to pay. Much the same was said about Big Blue in the 1950s, about Xerox in the 1960s, General Dynamics in the 1970s and so on. Sooner or later all of them did their turn as Icarus, and we know the rest.

So if AI does not qualify as the biggest threat, what does? If it’s the danger that has become normalised, there is a case for saying it must be the war in Ukraine. For leaders of the developed world, increasingly the conflict’s chief function appears to be a virtue-signalling opportunity seen embracing Volodymyr Zelensky and supporting a ‘war for freedom’.

If so, they may be desperately short-sighted. Earlier this month, Kevin Ryan, a defence specialist at Harvard University’s Kennedy School of Government, suggested plausible reasons why Putin’s Russia has already decided to make a tactical nuclear strike on Ukraine. His reasoning distils down to two points. First – and partly due to aid supplied to Ukraine by Nato countries – Russia cannot achieve its aims using conventional military forces. Second, Putin’s red lines to justify to his domestic audience the use of nuclear weapons – both real and fictional – have already been crossed. Couple those with the evidence of Russia firing nuclear-capable Kh-35 missiles into Ukraine last year – when they were armed with conventional explosives – plus its intention to station nuclear weapons in Belarus by July and, says Ryan, “all the signs suggest Russia has made up its mind”.

However, scariest of all, according to Ryan, is that following a strike on Ukraine “hundreds of millions of Europeans will be bracing for war. But 7bn others around the globe will go about their business, alarmed but physically unaffected”. Put another way, Europe would be the theatre of the planet’s worst military conflict for almost 80 years, but most of the rest of the world would care as much as Europeans would bother about a nuclear spat in, say, South America – not great for supplies of corned beef, but life would go on.

A better demonstration of Europe’s marginalisation in global affairs could hardly be made. And from an investing perspective, this thought exercise more than ever calls for greater geographic diversification of portfolios and, specifically, more focus on the US. Currently, US equity markets account for about 40 per cent of global equity market value. Yet how many Investors’ Chronicle readers have anything like that concentration in their own portfolios?

Possibly that shortfall could be partly rectified by choosing the funds route, for which investors might want to consider this week’s suggestion to invest in the open-ended JPM US Equity Income fund (GB00B3FJQ375). Of course, cheaper closed-end investment trusts specialising in North America are available, as are cheaper-still exchange-traded funds.

With reference to the particular needs of the Bearbull Income Portfolio, the table shows data on 12 stocks, all of which would qualify for inclusion in the FTSE 100 index if they were UK-domiciled, and most of which rank among the great and the good of corporate America. These 12 (plus three others) were introduced earlier this year (Is the US the answer in the search for income?) and, since then, I have written in more detail about industrials conglomerate 3M (US:MMM) and pharma giant Pfizer (US:PFE). Both those stocks appeal, although it would probably be pointless putting Pfizer shares into a portfolio that already holds GSK (GSK).

However, another stock from the table that has a perverse sort of appeal is plastics maker LyondellBasell (US:LYB). Part of the reasoning is that shares in companies like these are cheap because they fall foul of the pursuit of global carbon emissions’ neutrality by 2050. Sure, this pursuit is illusory as much as it’s real, but it also forces companies into making poor commercial decisions. This especially applies to those that make what the energy scientist and writer Vaclav Smil labels ‘the four pillars of modern civilisation’ – fertiliser (basically, ammonia), steel, concrete and, apropos LyondellBasell, plastics. Of course, Smil might have added a fifth pillar, the production of oil and gas, since burning vast amounts of hydrocarbon is needed to make the other four; wishful thinking aside, there is no large-scale alternative.

So LyondellBasell is under pressure, and that shows in its management’s account of how the group is cutting its CO2 emissions. In particular, management is pushed into decisions it might not otherwise make, such as closing its Houston, Texas oil refinery by the year-end. Even so, meeting its 2050 targets assumes the use of green technologies that, as yet, barely exist, such as scaled-up carbon capture and storage.

Yet, all the while, global demand for plastics will rise since the modern world depends on them and LyondellBasell is a major supplier of the bulk plastics that others mould into, say, the keyboard on which I’m typing. It is the world’s second-biggest supplier of polypropylene – the stuff out of which, for example, car bumpers are made – and a major supplier of polyethylene (anything from water tanks to food containers).

As such, demand for its products follows global economic growth trends, and its profit margins are especially affected by the relative prices of oil and gas. Through it all, however, LyondellBasell has consistently produced satisfactory profit margins. The average of the past 10 years is 13.5 per cent, although last year’s 10 per cent will also be nearer the mark for 2023. Meanwhile, revenue and operating profit are both static. For both metrics, 2022’s figures – $50bn for sales and $5bn for profit – are not far off what they were 10 years earlier. That growth in earnings per share was 10 per cent a year for the 10 years to 2022 chiefly reflects the substitution of debt for equity as buy-ins have shrunk shares in issue by over 40 per cent in that period.

It’s a familiar tale in corporate America’s manufacturing industry and, for LyondellBasell, it has sustained the dividend, which – obviously – would be a major factor if I bought the shares for the Bearbull portfolio. At their current $89, the shares yield 5.3 per cent. But here’s another factor that makes them attractive among US yield stocks – LyondellBasell is a bit of a mongrel of a company. In effect, it is a Dutch company with most of its operations in the US. Yet for tax purposes, the parent company is a UK resident, which means its dividends are not subject to withholding tax. And even if tax residency switched to The Netherlands, there would still be no withholding tax. As such, then not even that 15 per cent non-deductible withholding tax, which hobbles almost all overseas distributions, would be lopped off dividends.

True, those statements, which are derived from the latest annual report, need double-checking. But, if true, it’s another little plus factor. Maybe it would push me into buying LyondellBasell’s shares, and there is no question that the Bearbull portfolio has cash to invest. Nor do I question that the fund needs more diversification away from Europe’s multiple risks.