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“What many have known to be true for some time is now official, the UK is in recession. We hope that these comments by John Husselbee, fund manager of the City Financial MultiManager range, are helpful in stepping back and taking stock.”

– Andrew Williams, Chief Executive, City Financial

Last week government figures confirmed that the UK is indeed officially now in a recession for the first time since 1991. The economy shrank by 1.5% in the last quarter, the second consecutive quarter of decline which is generally accepted by all to signify a recession. This confirmation seems to rather contradict the spot of political gardening Baroness Vadera was doing the previous week. The green fingered Baroness, in a television interview on ITV, spoke about seeing the ‘green shoots’ in the economy. Her cautious optimism was clearly rather embarrassing for the Government as the economic data continues to deteriorate. It seems gardening has long been a popular pastime for Ministers, I remember Norman Lamont making similar comments as Chancellor during the last recession.

Of course, official confirmation that we are in a recession is hardly a shock. The evidence is all around us with businesses closing and unemployment rising every day. This crisis started in the financial sector and has swept out across the broader economy. Just take a look at the High Street, the downturn has hit the shops like a flu epidemic. As we know, flu takes its toll on the old, young, and the weak. We have seen Darwinism in progress as famous names have disappeared from our High Street. First Woolworths and more recently Zavvi have fallen into administration. And others elsewhere are suffering too. In the car industry prices have fallen sharply on both new and used cars, indeed one car dealer is offering a “buy one get one free” deal!

The real shock in all this is the magnitude and speed of the downturn. Even Mervyn King, the Governor of the Bank of England, in his speech in Nottingham last week referred to the economy having "fallen off a cliff." He cited the failure of the investment bank, Lehman Brothers, four months ago, as the point in time that marked the beginning of the collapse of confidence in the world’s banking system. This then led to an unprecedented and synchronised downturn in business and consumer confidence around the world.

But there has been and continues to be a concerted effort to prevent this recession from deepening into a depression similar to the one that Japan experienced in the 1990’s ‘Lost Decade,’ as it is referred to. Interest rates in the UK have been slashed to 1.5% and there has been a series of bank bailouts to cut the cost of lending and allow both businesses and households access to credit once more. Is this working? Well it is far from an easy task - banks are being asked to repair their balance sheets so this means they must hoard cash. At the same time they are being told to lend to their customers but to the frustration of the Government they are not doing so enough. And this is the same Government that has taken stakes in many major banks using taxpayers’ money.

One suggestion being made is to clear the decks and take public ownership of the banks, to nationalise them. It is certainly true that the Government can afford to take a long-term view and by doing so could remove the bad assets and provide capital to the markets. However, this is politics getting in the way. To nationalise the Banks in the UK could undermine the very fabric of capitalism and spell the end to New Labour, bringing a shift towards Socialism. It is important in a free market economy that there are allocators of capital beyond the Government, and that the banks play a key role in this. Furthermore, it is likely that if this Government takes ownership of the banks now, then a future Conservative government would, of course, privatise them for profit and to extend their period of government.

I believe we have several more steps to take before nationalisation and, from his speech, Mervyn King, seems to agree. The conventional instrument may be interest rates; however, he spoke about considering ‘a range of unconventional measures.’ There is quantitative easing to consider. Mr King described how the Bank of England would look to purchase a range of financial assets from the banks in order to expand their reserves and allow lending to function once more in both the corporate and household sectors. Some critics have argued that as a nation we have spent our way into trouble, so surely it is hardly a good idea that we try and spend our way out of it.

That said some of the other measures that have been taken by the Government have been aimed at encouraging consumers to go out and do exactly that - spend more. But will this work? The temporary reduction in VAT from 17.5% to 15% was dwarfed, to a large degree, by the large discounting by most UK Retailers and confidence amongst consumers remains low even though the cost of living has fallen with reduced mortgage payments, petrol prices and energy bills. House prices have also fallen and people will gauge their net worth relevant to this benchmark. The biggest fear is unemployment and despite the encouragement to spend many consumers may in fact prefer to save.

So where do we invest amongst all of this? Well to answer that, it is worth considering the behaviour of investors in a recession. A survey undertaken by YouGov Alpha illustrates how and when the consumer tightens his/her discretionary belt. When times are tough people become more frugal, a nation full of bargain hunters. The supermarkets have already noticed their customers opting for less expensive food in their ‘value’ range. Indulgence is avoided as people become more prudent in their shopping habits. There will be winners and losers in this environment. Whilst demand will contract for many providers, for some there is less competition. In fund management separating the wheat from the chaff is the role of the stock-pickers, there are a number of quality UK fund managers that we, at City Financial, have identified who I believe have the ability and experience to excel in these markets.

I am also keeping a close eye on where the Government and the Bank of England will be directing their capital. When they provided funds to the Banks, the beneficiary was the UK Gilt market. Yields in this market may now be fairly unattractive but there may still be room for further capital gains. If you know where to look there will be plenty of opportunity to make money in these markets. The behaviour habits of investors will of course change. Savers will begin to consider whether their deposit account, offering a very paltry rate of interest, is really the best place for their assets. They will look to find other ways of obtaining a relatively safe and reliable income. I very much doubt that they will be interested in returning to the highly complex and leveraged products that we saw so many of in the last few years and which led to this crisis in the first place. A move into more risky assets may well be required but so is the necessity to keep the approach simple.

John Husselbee, Fund Manager
City Financial MultiManager Range of Funds