A Rainy Day in London

10/09/2008 12:01 am EST

Focus: GLOBAL

John Snowden

Contributor, The IRS Report

John Snowden, contributor to The IRS Report newsletter, says the British economy will slide deeper into recession and the markets will move lower, too.

Q. What is your outlook for Great Britain's economy in the next 12 months?

A. We are on the cusp of a recession, but we have yet to feel the real crunch from a retailing viewpoint. The forthcoming all-important Christmas trading period will give more of a guideline by [the middle or end of] January. There is as yet no real sign of confidence returning, which would suggest we are in for a long haul. Borrowings are at an all-time high and will probably double again next year. This may mean higher taxes as well as labor unrest which would be detrimental for the economy.

Lower oil prices do help and commodity prices are falling, and will start to be reflected in government statistics by early next year. Hence, economy fears are turning towards deflation rather than inflation

Q: So, at what point do you expect to see actual recession in the UK?

A: My guess is that Christmas festivities may distort the reality, but I am sure that by February 2009, we in the UK will be feeling the full weight of recession.

Q. Mortgage lending in Great Britain is at a three-year low and UK lender HBOS (LSE: HBOS.L) was just rescued by being purchased by Lloyds TSB (LSE: LLOY.L) in a $21.6 billion deal. Do you believe the housing industry in your country has hit bottom yet?

A. Mortgage lending is so depressed because many house sellers refuse to lower their selling expectations. Banks remain suspicious of one another and mortgages have become more expensive and more difficult to obtain. I believe we are just about at the halfway stage. I expect some signs of recovery next spring but no real action for at least another year.

Q: Consumer debt in the UK is a bigger percentage of GDP than it is in the US. What does that mean for the British economy?

A: Britain is rapidly moving into a no-win situation. The government has spent all its reserves and is facing its largest-ever deficit of £50bn, which we are now told will mushroom into £100bn next year as we try to spend our way out. On top of that, sterling is "going to hell in a handbag" with shopping in the US no longer a bargain and a European holiday nearly 20% more expensive than this time last year.

Construction, travel, and retail spending are already contracting and the financial sector will have to rebalance and go back to basics. This process is now rapidly under way.
 
Q: John, stocks in London are about 30% off their highs. Do you expect them to hit bottom any time soon?

A: At this level, stocks meet the criteria for a bear market. But that does not necessarily mean they represent good value. It is too early to start a major buy program. Instead I would continue to sit on cash and/or buy bonds within five years of maturity.

The UK has yet to experience the big sell-off, which will take the FTSE 100 Index down to between 4200 and 4700. (It traded below 4600 this week-Editor.) A longish period of retrenchment lasting a year or more will follow before we can look to a strengthening economy.

Q. You recently cautioned investors to avoid financial stocks. Yet, many of Great Britain's banks-often labelled "stodgy"-actually look a lot healthier than those in the US. London's Barclays (NYSE: BCS) just agreed to buy bankrupt Lehman Bros. investment banking and trading businesses, while HSBC Holdings (NYSE: HBC), was named as a potential buyer for Morgan Stanley (NYSE: MS). Would you buy either of these companies' stock at this time?

A. UK banks generally were in a healthier state than their US counterparts as the likes of Lehman had huge declines in asset values and the UK banks were not as involved in the credit crunch. I would continue to avoid Barclays. HSBC is a stronger and more diversified global bank that was only lightly involved with the mortgage market. I would suggest splitting an investment unit into three parts. Buy the first tranche on a weak day in the market and look to add on, say, a fall of 20% from the original buy price and on another 20% from the second purchase.

Q. You are actively searching for drug, pharmaceutical, and developing biology companies and have also just added a "green" pick to your portfolio. What makes these companies attractive?
 
A. Several of the UK major pharmaceutical companies have underperformed during the last few years and most have good pipelines of new products. Of course, they will not escape a fierce economic downturn, but this sector is better protected than most if that fallout should occur.

I am not particularly a "green fan," but rather a stock picker. I picked Plant Health Care (PHC.L) as it looked attractive in an economic downturn. PHC is a leading provider of naturally based products for agriculture, commercial landscaping, and land reclamation industries. There is now a big incentive to replace products like fertilizers that are based on oil with less costly alternatives. Companies like PLC [will] work with major firms to improve crop yields and soil fertility.

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