Rue, Britannia

04/20/2009 12:01 am EST


Chris Gilchrist

Editor, The IRS Report

Chris Gilchrist, editor of the IRS Report, says economic recovery will take time.

Q. The near-term outlook for the UK economy seems relatively dire. The view from the outside suggests it's burdened with many American vices (overborrowing, overbuilding) but lacking some of America's strengths (regional diversification, reserve currency). Are you seeing any bright spots?

A. I think it's far too early to believe in "green shoots." Yes, we are seeing a recovery in transactions in the housing market, but from a very low base; likewise, we get some data showing surprising resilience in consumer spending. All this tells me is that we've seen the low in the inventory cycle-destocking has to come to an end and in many consumer sectors it probably has. But we're surely going to see more unemployment in the financial, retail, and capital goods sectors this year, plus balance sheet deleveraging and a higher savings ratio. So I go with the long, U-shaped recession model. One bright spot in the UK is export businesses, thanks to the 35% fall in sterling.

Q. London stocks have lagged the global rally from their March lows. Do you think they'll catch up?

A. Oil and mining account for around 25% of the capitalization of the FTSE100 index, because such a big proportion of the index was accounted for by financials, [which] have been decimated. I suspect the resources stocks, especially mines, have had too big a recovery given the likely poor demand for the next few years, and wouldn't be surprised to see them fall back. But it looks as if the banks and most financials have already made their lows. I think we'll see huge sector divergences this year, not just here in the UK but in all major markets, so the broad indices are going to be a poor guide to what's happening. 

Q.  How much fiscal flexibility does the British government really have? Has the G20 summit shored up Prime Minister Gordon Brown's standing? And how much is the political uncertainty hurting economic performance?

A. The recent wobbles in the UK government debt market reflect worries about the [country's] fiscal position. At the back of everyone's mind is the fact that sterling doesn't have significant external support and if the government loses credibility, we could see a speculative run on the currency.

In fact, as we saw in Japan in the 1990s, the government can borrow a lot more and probably will without causing disaster, and central banks will accommodate this. If the recession is deep, all European governments will end up spending far more than they expect now. 

Recession is bad for stocks, but most FTSE100 constituents earn most of their profits in currencies other than sterling. That makes the performance of the UK economy less significant for the UK stock market than is the case for any other major economy. It also means that the performance of the US and European economies are hugely important for the UK stock market.

Q. What sectors of the London market do you expect to outperform in the near term? What other safety/yield plays do you favor along the lines of Royal Dutch Shell? (NYSE:RDS.B, LSE: RDSB.L)

A. Class-act large-caps like Diageo (LSE: GDE, NYSE: DEO), Cadbury (LSE: CBRY, NYSE: CBY), and AstraZeneca (LSE: AZN, NYSE: AZN) probably have up side, but I think we'll soon see attention turning to small-cap stocks with strong finances that are in fast-growth business sectors.

Q.  London's role as a financial capital is even more important to the UK economy than Wall Street's is to the US. Do you expect a big comeback? Which economic sectors will drive growth?

A. The financial world is going to get a lot duller than it was from 2000 to 2007. Regulators will see to that. But London will still stay the center of world forex trading and insurance. The fact that the stuff that blew up the system was invented on Wall Street won't do London any harm.

Once we can admit that those smart New York bankers shafted us, our bankers can go around blaming them and peddling simpler ways of helping China and India develop their financial services industries, which is where the real money is over the next 20 years-that, Web 2.0 software tools and apps, and alternative energy.

Q. What's the outlook for consumer spending?

A. Households are going to save more and pay down debt, so consumer spending will be weak this year and probably into 2010. We're going to see a lot of corporate bankruptcies, but that's the price shareholders have to pay for letting greedy managers take on too much leverage. I reckon that by 2010 conglomerates will be back in fashion. Remember all that stuff about spreading the risk? So how about a nice, dull four-business conglomerate churning out steady dividends? Maybe there's still some work out there for the investment bankers.

Q. Thank you.

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