Certain large corporations, gold, Japan and countries involved in the “currency war” should be elements of a charity’s investment portfolio, says editor-in-chief of MoneyWeek Merryn Somerset-Webb.

Somerset-Webb, who also writes for the Financial Times, was speaking on the global economic outlook at the Charity Investment Forum 2012 last week.

Somerset-Webb began her talk to around 140 delegates on the pessimistic outlook for global growth, starting with the ominous warning:

“We don’t know what happens next. But we know for absolute sure is that it’s not going to be good.” 

She continued: “We know that the US, UK and Europe cannot genuinely use austerity to get out of the debt problem we have. We know that there are not cuts big enough or the beginning of the political will or the democratic mandate to allow people to cut things to the extent needed to make the debt go away.”

She added that the growth needed wasn’t around: “We are only in this mess because we believed in growth. We convinced ourselves that income and GDP growth would allow us to pay back these huge levels of unsustainable debt.

“That’s why people lent us money. People believed in constantly growing income. Everybody made the classic investment industry mistake of extrapolating growth for ever.”

Europe

Somerset-Webb also explored the problems in Europe, which she said remained chronic, and only remedied for the short-term:

“It went away to the extent that if you default so you can borrow more and print money are in any sense solutions. The long-term problems remain. If you don’t have growth it can’t hold together.”

Somerset-Webb said countries have three options: defaulting for real like Greece, defaulting on citizens by reneging on promises such as taking away pension payments, or defaulting via inflation:

“This is where we are in the UK,” she said. “Creating devaluation and creating inflation at the same time. Our currency collapsed and our inflation is running at 4 per cent and it’s going to go up further.

“It might not be this year, or the next. But it will go up. Four per cent is just the beginning,” she said.

She said it was becoming a near-impossible environment to invest but advised some stocks still looked worthwhile.

Nifty 50

Somerset-Webb said that gold was good insurance in a portfolio: “It’s an insurance against the incompetence of politicians and it’s insurance against the collapse of a paper-money system.”

She added that even if it went down in value, this would be positive, as it would indicate the start of an upturn.

She also advised considering investments in what she described the “new nifty 50” – large corporations such as Nestle, as a defensive stock:

“The nifty 50 is back,” she said. “They’ve got strong balance sheets to cope with inflation, especially if they are in a strong emerging market. They’ve got pricing powers to cope in an inflation. They can give you a good dividend for the income you need.”

But she added a strong caveat: “The problems with these companies is the reason you want them,” she warned.

“Investing is more complicated than it used to be.”

Corporations destroyed the market

“US profit margins are at a record high,” she said. “It’s managed the weird feat of rising over the last three years as output falls.

“So they’ve got the money but you have to consider why.”

Somerset-Webb explained that the incentives for corporate managers had changed over the past years: 

“Before, margins widened and narrowed with economic activity. Now when things get bad margins stay the same or widen.”

This was because, she said, managers kept wages down, put prices up, and had huge incentives to outsource.

“The long-term view went by the by,” she said. “Those benefiting from profit got richer, and those who benefited from output, poorer. There is a fall in real wages, people can’t consume, demand falls and you don’t get the rises in output that benefits us all.

“It’s hard to see how proper growth can come until wages rise and income is redistributed. There has been rising income inequality out there for years, everyone has been on the case and companies have done nothing but make a profit.

“Now there is a backlash and the government could be an agent for change. US and UK corporations have destroyed their own market by driving down the real wages of employees.”

Somerset-Webb said either the government would have to step in, or companies will come under pressure and the margin of defensive companies could fall.

“Expect big government, which is very bad for big companies with cash on their balance sheet. Remember that cash can just be taken. US tax receipts are falling fast, and in the UK it’s not as high as expected. Governments need money and they will take it where they can or at least contain it within their borders.

“We are entering an era of very big financial repression where you can’t rely on government to do what it should or what’s right.”

“Currency war”

Elsewhere, Somerset-Webb said where to invest would depend on who won the currency war.

“London Business School has found when currency falls, equity markets outperform.

“The Swiss are there, Japan will follow. Looks at who is devaluing currency in developed nations – UK are the winners at this.”

She also said Japan could be a good investment as it was cheap, had a stable banking system, and a weak currency.