The ‘new’ normal is a term constructed to denote that we are not merely in a downturn of one of the many cycles our economy goes through. Instead, the very cycle has shifted. After decades of over-extending themselves, debts were finally called in and banks and investors left showing the shortfall. As the saying goes, it is only when the tide goes out that you see who isn’t wearing a bathing suit and the effect of years of lending to those that couldn’t possibly afford to repay was finally seen.
Tougher regulation and a hit to confidence have drastically altered the climate in which we invest. Credit availability has fallen off a cliff, restricting company ability to fund itself, or expansion. With small and medium sized firms providing nearly 80% of new jobs in the UK over the past decade, this doesn’t bode well for employment. Furthermore, with mortgages harder to obtain and credit card debt on a tighter leash, it is harder for consumers to spend. Combine that with worries over jobs and, in an economy like the US, which derives over 70% of its output from consumption, a reduction in spending disproportionally hits growth.
In the UK Chancellor’s Autumn Statement, the growth forecast for the UK for 2012 was revised down from 1.7% to a mere 0.9% and within Europe, the OECD expects this to be as low as 0.2%. The National Institute for Social and Economic research gives the UK a 50/50 chance of recession, rising to 70% if the EU debt crisis does not reach a tidy and comprehensive conclusion.
Debt problems continue to provide a drag
Europe clearly highlights the challenge. The ability of entire countries to repay their loans is of concern. And the method of using debt to solve a problem of debt, in the form of bailouts, has been shown to provide only limited assistance. As the crisis has spread from the ‘periphery’ to the ‘core’; from the likes of Portugal, Ireland, Italy, Greece and Spain (nicknamed the PIIGS) to France and Germany, the situation has deteriorated. France is now at risk of a credit downgrade, implying a reduced likelihood in getting money back, although only slightly.
Crucially for us in the UK, the EU is our largest trading partner, accounting for around half of our exports, as well as providing 15% of the demand for US goods. Most worryingly, the outlook isn’t rosy. Focus on spending cuts and tax increases could actually be detrimental. Austerity does not foster growth and without growth, debt burdens become harder and harder to manage. Not only do loans need to eventually be repaid, interest payments to service this debt must be made.
Choose companies in which to invest carefully
Investing with this outlook in mind will benefit portfolios over the longer term. They may be tougher to find, but interesting investment opportunities are there for the picking. Firms that benefit in a low growth environment will navigate the tough climate well and those that offer attractive dividend yields will offer a valuable income stream.
Key characteristics of potentially profitable companies are those with a loyal customer base, producing essential goods or services. These will be better insulated
from economic weakness, with a more protected source of demand. In contrast, firms selling products which customers can either delay buying or be tempted to buy from a competitor will be under pressure to cut prices, eroding away margins.
Emerging market access will also be of benefit. Firms that can sell into growth markets can offset a falling customer base in the developed world with a growing
one elsewhere. Finally, a strong balance sheet will be fundamental to withstand the lower level of credit available from banks.
Most importantly, it is imperative to maintain a long-term time horizon. As newsflow out of Europe drives large swings in market values, investors that can patiently weather the storm will be able to ultimately see a quality portfolio realise its potential. We may have entered the ‘new’ normal but carefully chosen investments will greatly improve our journey.
