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Reverse gear

It was not long ago that Mervyn King was cautioning against the ravages of inflation. Now the D word – deflation – has been uttered. In case a 150 basis point cut to bring interest rates to their lowest level for more than half a century was not enough to convince you that the Bank of England governor had changed tack, his comments at last week’s launch of the quarterly inflation report demonstrated a dramatic U-turn.

It was enough to convince currency speculators that it was time to flee sterling. At an investment conference last week, I was asked if parity with the euro was in prospect. In the wild, volatile conditions that plague markets these days, it is unwise to say what might or might not happen, even if the prospect seems fanciful in the extreme.

Of course, a weak currency can restimulate inflation. Enough of our goods are imported for there to be a real effect on consumer costs. At a time when people’s pockets are under pressure, this is not a happy prospect. At least lower sterling helps exporters and with more than half the profits of our top 100 companies stemming from abroad, it may not do the market much harm, either.

Why is the BoE suddenly so concerned over the fate of our domestic economy? For a start, financial services constitutes a sizeable chunk of GDP, so turmoil in this sector will translate into tougher times at home, as collateral damage starts to affect peripheral activities. How many jobs will be lost in the Square Mile is far from certain but it will not be just highly paid investment bankers who will suffer.

Recession is not necessarily bad for shares although the drop in profits that companies are likely to suffer will undermine valuations and thus confidence. We can reasonably expect markets to turn before the economy starts its recovery, probably by several months. In other words, we may already have seen the worst, except that we cannot know for sure and sufficient bad news continues to emerge to keep nervous investors from committing.

A colleague tells me there have been 11 recessions in the US since the end of World War Two and they have all been different. This one might be categorised by the scale in which it affects specific industries and I am not talking about the financial community here. Take the automobile industry. It was diverting to see Volkswagen become the world’s biggest company by market cap last month, albeit briefly, but no one can be in any doubt that prospects for car makers look grim. In the US, car sales were running at 17 million units a year 12 months ago. Last month’s annualised total suggested a figure closer to 10.5 million – the lowest since 1983.

But the real situation could be far worse, particularly for high-cost producers like General Motors. It is estimated that there is one car for everyone of driving age in the US. A leading newspaper estimated recently that 1.5 million cars were bought each year on cheap money, using deals no longer available. If US consumers decide they no longer need that second car, sales could fall off a cliff. Is it any wonder GM shares are at a 65-year low?

At the Association of Investment Companies’ roadshow at Eastbourne last week, I detected more angst than usual. A largely retired and generally sanguine audience was nevertheless smarting over taking up the earlier RBS rights’ issue and wondering why managers looking after their money had not moved more to cash. Would that we of the investment community were gifted with second sight, I said. Then who were the sellers, came the retort. This gave the opportunity for some speculation over where selling pressure originated. With the likely culprits being pension funds and insurance companies under regulatory pressure and Joe Public, fleeing in the face of bad news, I could not help but wonder why I was not more optimistic.

Brian Tora ( is principal of the Tora Partnership


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