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It is all getting rather 1977 out there — a royal jubilee, strikes, painful inflation and second place in the Eurovision Song Contest.
Back then we entertained European audiences with a chirpy ditty whose opening line was “Where are we? Rock bottom!” This about sums up the UK today. We are expected to have the lowest growth rate next year of any G20 country, apart from Russia.
My own musical tastes were a little more boisterous in those days. Like many other teenagers, I was enjoying the Sex Pistols’ punk anthem “God Save the Queen” — essential listening due to the BBC banning it — and new band Talking Heads.
This was also the era of what became known as “stop-go” economics, when governments flipped between stimulus and constraint, alternately creating boom and bust.
The concern is that today’s financial rock stars, our central bankers, will follow the 1970s’ playbook. They may currently be more cautious, raising interest rates slowly to counter inflation, but they are raising them nevertheless. Andrew Bailey at the Bank of England — a Johnny Rotten versus Fed chair Jay Powell’s preppy David Byrne — has made it clear he is unafraid to inflict pain on the economy to root out the inflation problem. Most of his peers agree, so expect more socio-political disquiet — “anarchy not just in the UK”, to misquote Rotten.
Low unemployment
A major difference from the late 1970s is that unemployment is lower. The shortage of workers in less-skilled jobs is not just a UK phenomenon — it is global. The unions may not be as powerful as they were then, but wages for the lowest paid have lagged behind for decades — so many workers are in a much stronger position to demand rises or move.
And they will need to if inflation proves persistent, as those who suffer most from inflation tend to be the poor, the old (on fixed pensions) and the young (especially if indebted).
Bear in mind, too, geographical factors. The effect of raising interest rates in the US may not be the same as raising them in Europe. The US labour market has tended to be more flexible — this is a vast economy and workers can move around easily. It is more self-contained, exporting just 10 per cent of its GDP, versus 30 per cent for the UK and 47 per cent for Germany. And it produces much of its own fuel.
The Federal Reserve can therefore raise interest rates to control inflation with less concern about causing a recession. However, as it does, the dollar rises, which increases inflationary pressures in the UK and Europe — especially as the commodities we import are priced in dollars.
Investing for recession
For the first half of this year equity investors were mainly worried about rising inflation — this tends to make stocks on high multiples of earnings/sales/thin air come down fast.
The focus for the second half is already turning towards risk of recession. The equity portfolio that coped best in the first half of this year had lots of oil shares, a focus on value, very few technology shares (and other shares with low profits) and plenty of dollars. The portfolio that copes best in the second half could be different.
Oil stocks might have seen the best of their run, as slowing economies will lead to reduced demand. The price of Brent oil has fallen 10 per cent recently. However, investment in gas infrastructure probably needs to continue for some years. If you have the stomach for volatility — and I mean ups and downs sometimes of 7 per cent a day — you might consider Halliburton and Schlumberger, two of the industry’s biggest servicing companies.
And value? The “value” universe can include a lot of cyclical stocks, from non-food retailers to housebuilders and banks. Recessions are usually not happy times for these, especially if they are also seeing wages or input prices rising.
While speculative technology stocks are likely still to struggle, some of the more established technology companies — which performed badly in the first half of the year — might begin to be seen as defensive against a slowdown. The best are less susceptible to inflation than manufacturing companies, because they employ proportionately fewer people and have limited input costs. And some have more resilience to recession — software subscriptions tend to carry on being paid even during tough times.
Take Microsoft. It is unlikely to see much slowing in subscriptions for its Azure cloud-computing business, though perhaps if companies downsize it will see a fall in Microsoft Office “seats”, or paid-for users. Its shares are down 21 per cent this year (in line with the S&P 500).
Perhaps more interesting is Salesforce.com — its shares have fallen 32 per cent this year and have nearly halved from their peak last November. Its software to help manage employees is well-established and integrated within businesses. Companies may cut back their sales teams, but they are likely to retain the software. Salesforce.com looks to have many years of strong growth ahead, but may be vulnerable to further share price falls if sales expectations are not met in the short term. Given its bigger price correction, investors who can embrace a bit of risk may favour it over Microsoft.
For the cautious investor, the industries that tend to cope best with recessions are those that deliver things you cannot do without — such as healthcare, consumer staples and perhaps even cosmetics. Car production fell by 75 per cent in the Great Depression, but lipstick sales rose.
Research suggests that in times of recession impulse buying drops, we defer major shopping decisions, we substitute premium food products with cheaper ones and we go out less. We focus on the essentials, but the essentials may include small luxuries such as an espresso machine coffee, chocolate and face cream.
In these categories, companies such as Procter & Gamble and Nestlé may appeal. Nestlé has another strength — it produces pet food. Here, substitution may not be an option. Few owners can bear that doleful or disdainful stare after you have dared to tip a tin of cheap, rank brown stuff into your pet’s food bowl!
Moving from concerns about inflation to concerns about recession suggests a different sector balance in a portfolio. The geographic balance, however, remains much the same. As long as US interest rates keep rising and the US economy is less troubled than others, keeping a fair amount of investments in dollar-priced stocks remains, for us, key to coping with a tough second half of the year.
Given all the problems we are facing, the anthem for the prudent investor today may not be “God Save the Queen” so much as the later Talking Heads’ hit, “Road to Nowhere”. Safeguarding our portfolios — first from inflation and now from recession — is the priority for most of us. Opportunities to invest in a recovering economy will come in time, but for now patience seems wise.
Simon Edelsten is co-manager of the Artemis Global Select Fund and the Mid Wynd International Investment Trust
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