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I approach investing my own money with a risk-first mindset. In my view, what can’t be bought is just as important as what we should invest in. Here is the stock market sector that is key to avoid in the current UK economic climate.
The big picture
The UK economy is facing several headwinds. According to official data from the Bank of England, inflation in the UK is now over 10%. However, the British Chamber of Commerce expects inflation to rise by 14%!
Simply put, such high inflation means that consumers spend far less on non-essentials like food and shelter, which means lower economic growth going forward.
Meanwhile, the central bank has raised interest rates to combat inflationary forces. However, higher interest rates (or tighter monetary policy) mean the cost of servicing debts increases. For consumers, this translates into higher credit rates, and larger debt payments for businesses.
Overall, the impact of these macroeconomic developments on the British economy is negative.
In such difficult times, I would like to avoid companies that do not provide essential goods and services or are in poor economic conditions.
Looking at the FTSE 350 prospect today, I see one particular sector that I don’t want in my portfolio.
Sensible goods and services
They are also called consumer cyclicals, in order to perform well in the business cycle, companies with consumer needs offer non-essential goods or services that are in high demand when the economy is strong.
As such, when consumer confidence and purchasing power are high, these types of stocks tend to do well. In this category we can include high-end apparel, entertainment, retailers, leisure activities, hotel chains and even automobiles.
However, when consumers have less money to spend, many people’s primary focus will be paying the bills: energy, food, mortgage and rent, rather than spending on a new watch, car or computer game.
Therefore, consumer discretionary stocks tend to underperform when the economy is in headwinds, as it is now. In fact, the FTSE 350 Consumer Discretionary Price Index is down by c.22% this year, at the time of writing.
When I look at the FTSE 350, examples of consumer cyclical stocks that I am now avoiding come to mind. JD Sports, next to, Curries And Games workshop.
What about long term?
As a long-term investor with an interest in fundamental analysis, I am always conflicted about dismissing stocks based on macroeconomic factors. However, one thing I learned working for Neil Woodford is that attractive fundamentals must be backed by a positive business case going forward.
Given the economic conditions above, I don’t see a strong business case for this sector of the stock market. However, I change my mind as the information changes.