The turmoil in the Middle East and north Africa has reminded investors everywhere that the world is a risky place. It’s fair to say that, while the notion of social upheaval had been a theoretical problem ever since the financial crisis erupted, most people have been worrying about China’s social harmony, not unrest in the oilrich Middle East.
With the threat of an oil price spike derailing what recovery we’ve seen (as we discuss in this week’s issue of MoneyWeek magazine), we believe it makes sense for investors to keep positioning themselves defensively.
While higher oil prices will push up inflation, they also crimp economic growth. That leaves us facing a nasty combination of low or no growth, alongside rising prices – or stagflation, to give it the technical term. This is an unpleasant condition unseen in most major economies since the 1970s.
For one thing, it means you need stocks that can withstand the toughest economic conditions, and in particular, companies with ‘pricing power’. Indeed, Warren Buffett has declared that “the single most important decision in evaluating a business is pricing power”.
We’re talking about classic defensive sectors here. And among the most attractive is the pharmaceutical sector. Invesco Perpetual’s Neil Woodford recently told Money Marketing magazine that he reckons big drug makers represent one of the best investment opportunities he’s seen in his career. The sector accounts for about a quarter of his portfolios just now and he plans to raise this to around a third. You can buy into Woodford’s Edinburgh Invesment Trust (LSE: EDIN) via an Isa.
Another factor to consider is that, as investors grow jittery about the prospect of unrest spreading throughout emerging markets (the Chinese government is certainly taking great pains to deny that there’s any chance of a ‘jasmine revolution’ happening there), developed markets could well be the beneficiaries.
One of the most attractive developed markets is Japan. As my colleague David Stevenson noted in a recent Money Morning, the stockmarket is cheap on most measures, but better yet, while rising inflation would be a big problem for Japanese government bonds, it would be good news for Japanese stocks. Exporters would benefit from a weaker currency, while domestic investors might realise that they’d be better off investing in equities rather than government debt.
Of course, as a sterling investor, you have to consider the currency impact. It’s possible that any gains in the Japanese stockmarket would outweight the impact of the falling exchange rate – the pound has many problems of its own to contend with after all. But it is also possible to buy funds, or classes of existing funds, that are hedged against the risk of a falling yen. For example, the JO Hambro Japan fund offers a sterling-hedged share class (ISIN code: IE00B6386R19) which is Isa-eligible.
And, as always, we think you should be holding gold in your portfolio. There are many sensible reasons to buy gold – from the growing demand from increasingly wealthy emerging markets, to its use as the ‘ultimate’ form of money, one that can’t be debased by governments. But first and foremost, we see it as insurance. If gold is rising, it generally means things are going wrong elsewhere in the financial system. Whereas when your gold is falling in price, the chances are the rest of your assets will be perfoming nicely. There are several gold-tracking exchange-traded funds (ETFs). One we like is ETF Securities Physical Gold (LSE: PHAU). The ETF is physically backed by gold bars held by HSBC, and it is also Isa-eligible.