Bad news on the economic front can mean good returns for those who buy wisely. Shirley Skeel investigates.
Without naming names, it seems that the investment gurus got it wrong again. Turn to the pages of the Financial Times of December 30 last year, where 10 prominent investment advisers unveiled their prophecies. The 10 predicted a 1990 year-end finish for the stock market's FT-SE 100 (Footsie) share index of 2,450 to 2,700. Wrong. As we went to print it was hovering sickly over 2,100.
And who got it right? None other than the astrologer. (Which would not be the first argument ever put forward for giving up the "pink 'un" for the more visually stimulating pages of The Sun.) Flip over the same Financial Times page of last year and astrologer Daniel Pallant has blithely mapped out the whole of 1990 - roughly getting his shapes of the market right, though his timing was a lethal two months late - and the Footsie ends the year just above 2,000. Near enough.
The pertinence of this is simply its blunt illustration of the dangers of trying to pick short-term trends. And that is the beauty of this recession: it deep freezes all lust for risk. For once, to "think rich", the investor has to think two, three or more years down the line.
As usual, opinion is divided on just how ugly this recession will get. Despite recent black news on the retail, manufacturing and employment fronts, there are some convincing reasons to go with Prime Minister John Major's rose-tinted view of a recovery from the second half of next year. The oil price shock is milder than in the past; the low US dollar should help to perk up exports; companies are trimmer, with lower stocks and higher profitability; and locally the real pound exchange rate is some 40% lower than at the 1980 peak, while interest rates are falling. On the other hand, there is also deep scepticism and fear of a global credit crunch.
Below we offer thoughts of the experts on investment during these gloomy months and how best to time your moves. The timing deserves caution - but never timidity. Perhaps the best commonsense rule on this comes from Schroders Securities consultant Roger Nicholas, who has seen three recessions come and go. His is a 2:1 rule: if you feel that the amount a stock (or other investment) could in time move up is twice the amount of its downside, with the same likelihood of a move either way (because who knows?), then buy. In the long run your gains will outweigh your losses, "unless you are very unlucky", mutters Nicholas.
Equities - short term.
Sectors that historically hold up well during a recession include: food manufacture and retailing, health and household, utilities and brewing. These are the inescapable necessities of life. But picking the right stocks at the right price is critical. At this stage many of the better stocks are already at a premium to the market. Hoare Govett head of research Simon Clegg, who expects that we will see a global recession, believes, however, that prices in these "safe" sectors "could yet go a bit further" relative to the market - with the exception of the hotly pursued food retailers. As he points out, institutions are cash rich, with over £30 billion in their coffers. In the 1979-82 recession such defensive stocks went to double the average price/earnings ratio. "You could see that happen again."
Even if these stocks are fully priced, there is comfort in knowing that the safe bets are often also good long-term performers. A good example, says SG Warburg head of research Stephen Carr, is Abbey National - one of the few banks to avoid the disastrous international arena. Of course, a buy into the market has to be weighed against other possible returns, and cash, at 12 to 14%, still looks pretty good. If you believe that things will get much worse then wait. What you do not want to be in yet is transport, construction, chemicals, media and banking, all of which are likely to fall further before an upturn.
In stock picking the prime criteria are: a strong balance sheet with low borrowings, and a good track record of earnings to cover interest payouts at least four times over; a dividend yield of over 5% (but tread carefully once it hits double figures), also covered at least twice by profits; strong cash flow; and quality assets (preferably ones that cannot walk out of the door). Diversification outside of the UK is also a plus.