On Wednesday, Britain could see the biggest wave of industrial action since the General Strike in 1926. As many as two million public sector workers could strike over pension arrangements.
It isn’t the first and it won’t be the last fracas over government cutbacks. It won’t be easy. As government cuts in one place, spending pops up in another. The overall spend remains doggedly high. And seeing as we can’t carry on borrowing at these levels (£122bn this year alone), there’ll be plenty more fights to come.
Of course we’ll get through this. Other countries have been through worse and come out the other end. Sweden, for instance cut its public sector bill by 20% over the last 20 years or so. And after they did, they entered the great financial collapse of 2008 in pretty good shape. We, on the other hand, were borrowing heavily on the way into the recession.
The Swedes built up a massive public debt during the early nineties. As for us today, it was a banking crisis that caused the debt build up. They ended up with a public sector spend of 70% of GDP! The Skandies have always been proud of a large central state – but 70%!
They lived through the pain of public sector cut-backs. It can be done.
And in terms of investments there will be winners and losers. Today, I want to look at what Sweden’s crisis can teach us about how to protect our assets in 2011.
To save their economy, the Swedish shrunk the government
Last week, I suggested that lending to the government is looking less attractive by the day. An investment that’s supported purely through quantitative easing (QE) and speculation (the dumping of eurobonds in favour of gilts) looks dodgy.
The article stirred Right-Sider ‘Cloth Kap’ to comment: “The underlying problem for the West is simply far too much government. I can’t see it getting any better until everyone in the public sector finally realises that they are passengers at best…”
I’ve just worked my way through a recent report ‘economic lessons from Scandinavia’ published by the Legatum Institute.
The obvious conclusion is that a smaller state helps bolster economic growth. The benefits of tax cuts, reduced regulation and cutting down public sector services so that the private sector can get stuck in helped boost growth by 1-2% a year.
And boy, we could do with that. Another percentage point or two would basically double our GDP growth!
But of course you can’t get the gain without first taking the pain.
And that’s going to cause some heartache.
Regulation batters small firms
Small and medium sized firms are suffering most during this ongoing stagnation. They’re hit hardest by state over-regulation. Health and safety regulation, fiddly tax issues and all the stuff wafting in from the EU has been onerous on small businesses. And the banks have hardly been on-side since the credit crunch erupted. To top it all, SMEs (Small and Medium Enterprises) tend to be UK-centric and find it tough to reach out to growing foreign markets.
Research by accountancy firm RSM Tenon says that 70% of small firms are yet to see profits back at 2007 levels.
Large quoted companies are coping much better. As the chart below shows, UK dividends are up from £17.1bn in 2007 to £20bn today. That’s a growth of 17% despite the financial crisis.
Source: Capita IRG Registrars
Large firms have proved remarkably resilient. And it’s one reason I remain relatively sanguine about their prospects. There’s every reason to keep hold of defensive high yielding equities, especially now that they’re on ‘special offer’.
Data from Sweden’s Riksbank shows that while stocks dipped during the initial banking crisis of the early nineties, within a couple of years they were firmly into growth territory. And that was despite horrific government austerity. After the initial shock, government cut backs helped drive business growth.
Of course there are differences between our situation today and Sweden’s back then. Today, most of the developed world is suffering a banking crisis in unison. It’s going to be difficult for us to export our way out of trouble. And the Scandinavians have a less divisive social set-up. The growing ‘them and us’ rift between private and state workers is sure to get worse.
But the Scandinavian experience gives us reason for hope.
The darkest hour is before the dawn
There will be some dark hours ahead. Industrial action will affect businesses and stock-market sentiment.
But we mustn’t be overcome by pessimism. Now is not the time to be shaken out of equities.
Yes I’ve been calling for a tactical withdrawal from stocks ever since early summer. And yes, only last week, I called time on lending to government too.
While it’s a hated asset, I’ve been calling for a 25% allocation to cash. And I stand by that. I’m confident of opportunities ahead. For the moment, I’m keen on selected corporate bonds and I’m going to stick to that theme over the coming months.
But we must maintain our core bloc of equities too. Equities can deliver strong returns despite a stagnating economy. I’m not saying they will, but I’m prepared to give them a chance. And anyway, with my FTSE high yield recommendation, you can enjoy a 5% yield while you wait to find out.
My assets are currently allocated to 25% cash, 25% shares, 25% bonds (mainly corporate) and 25% other (including commodities and precious metals).
Yes, my allocation to shares is low and cash is high. That’s because I expect to find opportunities over the coming year or so. The darkest hour is just before the dawn. And I suspect we’re not there yet.
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