Mark Dampier: Interest rate rise would spell economic disaster
Saturday 29 January 2011
Many column inches have been devoted to inflation and interest rates during the last couple of weeks. With inflation above target for such a long time, pressure is growing on the Bank of England to consider an interest rate rise. According to Neil Woodford, manager of Invesco Perpetual Income and High Income, two of the largest funds in the country, this would be a big mistake. He points out a high oil price of $90 a barrel has a big impact on the UK, but in the longer term it has a deflationary rather than inflationary effect. Non-discretionary inflation effectively acts as an extra tax, depressing demand. He believes an interest rate rise would be disastrous for an economy where there is little sign of wage increases and consumers are faced with utility bill rises of 25 per cent or more in the next five to seven years. I agree it is hard to see how the UK consumer would cope with higher mortgage rates on top of everything else.
Mr Woodford also believes the current fashion for commodity investments of various sorts has gone too far. In his view, quantitative easing is not necessarily helping the developed world because much of the extra money created leaks out into the developing world causing inflation, which is eventually exported back to the West in higher prices for goods. Yet with emerging markets raising interest rates to control their own inflation, it is quite possible demand for commodities will ease. If so, investments in this area could be vulnerable and this would, of course, be favourable for Mr Woodford's relative performance. Being an income fund manager there are few mining stocks he can buy because they tend to yield very little – plus he strongly believes the sector as a whole is overvalued.
Instead, he sees better prospects in more defensive tobacco and food retail stocks, but his real enthusiasm is towards pharmaceuticals and two of his largest holdings are GlaxoSmithKline and AstraZeneca. He describes current valuations as "insane", dismissing the challenges posed by changes in regulation making it tougher for companies to get approval for drugs. His view is that all businesses have challenges right now and, with attractive valuations plus spending on healthcare set to rise due to aging populations globally, the pharmaceuticals sector looks appealing.
The market remains sceptical, however, and pharmaceuticals stocks continue to be out of favour. Glaxo, for instance, languishes at a similar share price to 14 years ago and yields around five per cent. In particular, research and development spending is frequently seen as a costly drain on resources likely to produce little return. Yet this could be some way from the truth, and Mr Woodford believes the true value of these companies is way above the current price. He expects the gap to close in the next few years and if he is right it should mean some excellent returns for investors.
Although often portrayed as a doom-monger due to his bearish macro-economic views, Mr Woodford remains extremely upbeat about the prospects for the holdings in his own portfolio, which he believes should remain resilient amid the problems we face. The main one, as I have said on a number of occasions, is debt, and all the possible solutions to it are uncomfortable. Writing off debt is painful to the fragile banking sector and paying it back (by spending less) means standards of living fall. Politicians keep hoping to kick the can farther down the road but as Mr Woodford says, the can is getting heavier the longer they delay.
While Mr Woodford's funds have made positive returns over the last couple of years, his aversion to mining and energy stocks has weighed on performance, and they have lagged behind others in the sector. There is no way I would write him off though. He remains as passionate as ever and only invests personally in his own funds – a sure-fire way of aligning a fund manager's interest with that of his investors. I certainly share his confidence that he will see them through the potentially challenging times ahead.
Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.h-l.co.uk/independent
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