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‘The reasons why investors were told that toll roads, airports, pipeline and power stations were an essential part of any investor’s portfolio remain in place. Many of these assets are natural monopolies. The cashflows are predictable. And they are relatively immune to the economic cycle’
That was one of the last things I wrote for The Intelligent Investor newsletter almost a year ago, in a special report titled Opportunities in Infrastructure. We included some of the stocks from that report in the initial Value Fund portfolio and have carried the defensive theme through almost every purchase we’ve made since. I’m pessimistic about the prospects for global economic growth and have mostly stuck with economically resilient businesses.
I want to expand on this a little as I’ve had two weeks holiday in June and, as usual, time away from the office has done wonders for my clarity of thought. Paul Krugman (Nobel Prize winning economist and New York Times journalist) is right. The Greek Crisis has spurred a wave of fiscal austerity measures that are downright dangerous. As Krugman put it in a recent piece ‘while long-term fiscal responsibility is important, slashing spending in the midst of a depression, which deepens that depression and paves the way for deflation, is actually self-defeating’.
Pulling the rug from under these economies now will usher in what Krugman is already calling ‘The Third Depression’.
The other side of the argument, perhaps put best in this Financial Times piece by Nouriel Roubini (31/5/10), is that the debt-fueled level of consumption that Krugman wants his government to maintain is clearly unsustainable. Substituting private debts with public ones is not a long-term solution. ‘Public debt is ultimately a private burden’, Roubini writes, ‘governments subsist by taxing private income and wealth, or through the ultimate capital levy of inflation or outright default. Eventually governments must deleverage too, or else public debt will explode, precipitating further, deeper public and private-sector crises.’
My moment of clarity was to realise that both Krugman and Roubini are right. Now is not the time for fiscal austerity. But neither is government spending a panacea. The US, the UK and Europe need to run short-term deficits but they also need long-term policy that is a genuine solution to the structural problems at hand: labour market inefficiencies, unsustainable pension and health care systems and a general standard of living not justified by current productive capacity.
What this means for Australia, with its exposure to Asia, strong government balance sheet and overleveraged consumers, I’m still unsure (perhaps a few more weeks holiday would help). But I remain extremely cautious and am reluctant to venture from the defensive end of the spectrum given the relative value on offer at the moment.
Owning defensive businesses doesn’t always mean you are protected against falling share prices. But in the past quarter, when the prospects of another recession (the so-called ‘double dip’) have come to the fore, our portfolio has held up relatively well.
The Value Fund unit price is down a comparatively modest 4.3%, while the All Ordinaries Accumulation Index has retreated 11.0% since the end of March. That only brings us back into line with the index since inception, however, and we certainly aren’t crowing about performance just yet.