● Borrowing costs in Europe have surged again this week to euro–era highs. It’s clear “the markets aren’t going to let this eurozone problem lie“, says John Stepek in Tuesday’s Money Morning. “This story is going to run and run”. And it “either ends with Germany paying for everyone else, or with the eurozone breaking up”.
But “how is all this going to affect the UK?” In one way, Britain has been helped by the crisis. “By comparison with Europe, we look a safe bet. Britain’s cost of borrowing has slid. The yield on a ten-year gilt is now 2.2%. Given that inflation is still 5% a year, that’s pretty impressive. Lenders to Britain are accepting the prospect of a near-3% loss in real terms (ie after you adjust for inflation).”
Of course, the government would like to claim this is because of their austerity plans. “But it’s not. Britain has a worse deficit (annual overspend) than Italy or Spain. The main reason for Britain’s apparent immunity to market fear is the Bank of England being happy to print money to buy gilts. Investors are assured of a willing buyer with technically limitless funds. When people are more concerned about the return of their capital, than the return on their capital, that’s about as good as it gets.”
But here’s the bad news for Britain, says John: “The eurozone is likely to drop back into a recession in the very near future. Europe is our biggest trading partner, [so] the chaos there makes the hope of exporting our way to health even more forlorn”. An even bigger threat is that Europe’s problems trigger a second credit crunch. “Eurozone fears are already pushing up funding costs for banks, which are then passed on to consumers”.
Nasty. So what should you do? As we’ve been saying for a while, stick to defensive stocks. “And check out the current issue of MoneyWeek magazine where we highlight some riskier, but higher-yielding opportunities for the more adventurous investor: Three risky but lucrative ways to spice up your portfolio.”
● I agree, says David Stevenson yesterday, the outlook for the UK consumer is only getting bleaker. The main problem is that “pay packets are growing much more slowly than the cost of living. So there’s less spare cash to spend on non-essentials.”
OK, British high streets still look busy. And October’s retail sales were better than expected, rising both month-on-month and over the year.
“But don’t be fooled – the figures aren’t as upbeat as they seem. These sales came at the expense of profit margins. Britain’s retailers only managed to unload more stuff by cutting prices. So the net effect on the bottom line won’t be positive at all.”
Moreover David doesn’t think this recent sales rally has legs. “The Nationwide consumer confidence survey is a good guide as to how likely people are to spend what money they do have. With consumer expectations just dropping to a record low, the next move in retail sales looks likely to be firmly down”.
That’s more bad news for retailers. But he “wouldn’t dismiss the entire high street out of hand. The damage to sales and profits from the consumer spending slowdown is steadily being factored into the sector’s share prices. That means one or two general retailing shares are starting to fall to potentially interesting levels. A good example is industry bellwether Marks & Spencer (LSE: MKS), which now trades on a p/e ratio below ten and a 5%-plus yield, as we show here: Why M&S shares might be a good bet for contrarian investors.
“But as for most stocks in the sector – steer well clear.”
● In fact, market and economic uncertainties have put some people off investing in shares altogether, says Tom Bulford in his free Penny Sleuth email. But he reckons they’re wrong. People who worry about poor long-term returns from the stock market are missing the point.
“Many shares have delivered great returns over the last ten years”, says Tom. “Looking at just the FTSE 250 and AIM, I count 145 shares that have doubled shareholders’ cash in the last five years.” He has personally managed to find a fair number of successes, yet he doesn’t consider himself ‘terribly smart’. “But then, I don’t invest my money in ‘the stock market’. I invest in companies that happen to have their shares traded on the stock market”.
And most winners share certain qualities. “A focus on one central business proposition. Innovative products. Good financial characteristics, like positive cash flow. Stable managerial teams. The trick is to reject everything else and learn to live with stock market volatility, which is not so difficult once you get used to it”.
To read more – and it’s a thought-provoking piece – click here: Why I think Tim Price is dead wrong about stocks. And here’s the link if you’d like to sign up to Tom’s free email.
● Another useful source of information for investors is MoneyWeek deputy editor Tim Bennett’s weekly video tutorials. Each week Tim tackles a vital part of the financial system and explains it through a short, easy-to-watch video. They’ve proved a massive hit on the site and some have even gone viral on youtube. This week Tim looks at ‘clearing houses’, which have recently caused mayhem in the bond markets. Find out what clearing houses are and how they work here
● Merryn Somerset Webb has been blogging this week on why British taxpayers should be “enraged” about state spending.
“In what adds up to an astonishing abdication of leadership”, she says, “there seems to be a cross-party consensus that the almost unbelievable rise in public spending over the last decade (by over 80% to 46% of GDP) is something we can’t and shouldn’t reverse. There is much talk of “the cuts”, but beyond the endless posturing of Parliament and the media we haven’t yet seen any fall in public spending at all”.
“We need to ask why the state needs to spend 46% of GDP this year“, says Merryn. Because “cutting spending and then hugely cutting taxes with the benefits going to working people and smaller companies … would stimulate consumer activity and push resources away from non-growth sectors and back to ‘growth capable’ sectors.”
The blog sparked a strong reaction from readers, with most commenters agreeing that the state needs to be cut back. David, for example, has his own formula for determining government spending. “The level of government expenditure as a percentage of GDP should be around the percentage of the population that earn the average income. In Australia where I am that would be about 36% of GDP. That should also be the top marginal tax rate. The government should be able to work within that.”
Meanwhile JAW fears that cutting spending won’t be easy. “Cuts? You can’t take a bone away from a dog once you have given it a juicy one. We pay the government to redistribute wealth from those who create it to those who have no intention of creating very much of anything.” His solution would be to cut funding to the arts, sports and the EU.
It’s a controversial topic and one that affects us all so if you haven’t read the piece yet click here and get involved in the debate.
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Have a great weekend!
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