Smokers Will Always Buy Mobile Phones, Marlboro Cigarettes and Food

The consumer is flagging. Pay freezes, higher prices on the high street and rising unemployment mean that people are keeping their hands firmly in their pockets. They have reined in their spending, worried about the state of Britain's finances and, more importantly, their own livelihoods.

Not surprisingly, companies are suffering as a result. During the first three months of the year, stock market listed companies issued 75 profit warnings – the most since the first quarter of 2009, a time when Britain was deep in recession.

Meanwhile, the British Retail Consortium said that retail sales had fallen at their fastest annual pace in almost six years, while Punch Taverns is to close 2,500 pubs as people spurn the chance of a night out.

The FTSE may have shrugged off the grim news and continue to hover around the 6,000 mark, but many fund managers are in cautious mood.

Andrew Bell, chief executive of Witan Investment Trust, warned that more bad news was to come. "Retailers are under the cosh. The consumer is being squeezed and it's not going to go away any time soon," he said.

PSigma Income fund manager Bill Mott blames the financial crisis and said it is the tail end of the banking crisis.

"The public sector was made to absorb the bad bank debt and now civil servants are losing their jobs.

The private sector may pick up some of those people but it is unlikely to be able to do so at the rate required," he said.
So where can investors seek refuge from the consumer downturn?

The surprising inflation figures published last week (inflation fell to 4pc) has resulted in a weaker pound and Mr Bell predicts that sterling will remain weak – bad news for holiday makers, but good news for exporters.

"As the British consumer cannot be relied upon to support the economy in the same way as they have in the past, it make sense for sterling to remain weak," he said. "As a result 'staycations' will be popular and brands with a strong international image such as Fortnum & Mason and Burberry, which opened its Beijing store this week, will do well."

At the other end of the retail spectrum, low-cost retailers such as Asda and wholesaler Costco are expected to thrive, he said.

Retailers will be forced to be more efficient and reduce their profit margins to keep the increasingly price-conscious British consumer interested. Those that have less-than-healthy balance sheets, or heavy levels of gearing, will find this hard.
"The strong will get stronger," said Mr Bell. "You will have to innovate and diversify to stay ahead."

There may be buying opportunities among the ruins. Although analysts said that while there will be no "Lazarus" opportunities as experienced the early Nineties, where companies such as Next almost went bust and then quadrupled their share prices in a short space of time, there are some solid companies with slow growth opportunities – and not just in Britain.

"What is happening in the UK will happen in the rest of the developed world – it's just time that will be different," said Mr Mott.

"At some point the United States will have to remove the special measure they put in place to stop the economy combusting."

He recommends high yielding, economically insensitive stocks such as pharmaceuticals. PSigma holds UK stocks GlaxoSmithKline and AstraZeneca, but also likes Switzerland-based Roche and Spanish company Crystal Pharma.

Mr Mott likes global consumer staples such as Diageo, Nestlé, Coca-Cola and Colgate Palmolive.

"Mobile phones, cigarettes, utilities and food – all these things are essential," said Mr Mott. "No matter how much the consumer is tightening his belt, he will always buy these things."

Defensive sectors such as telecoms and Marlboro tobacco also feature on Mr Mott's buy list, as well as certain food retailers. The same blue-chip names are core holdings of Neil Woodford's Invesco Perpetual Income funds.

Mr Woodford recently said he intended to increase his exposure to defensive stocks, in particular pharmaceuticals, as they were trading as value stocks.

Mr Woodford said: "The valuations are so depressed that, even if you ignore all potential future patents and only consider the existing products the pharmaceutical companies have, it is still a good investment opportunity."

Gary Potter, a multi-manager at Thames River Capital, is looking to funds that he believes will be able weather the consumer downturn and have managers that will use investment themes (good or bad) to their advantage.

He reminds investors that although the high street in general will be affected by high inflation and unemployment, many retailers are resizing and cost cutting – and they will do well.

Mr Potter readily admits that picking funds to play theme, rather than individual shares is tricky. "It is quite difficult to pick specific funds that are playing this theme, as a good manager will spot opportunities tomorrow that might not exist today and change their exposure accordingly," he said.

Mr Potter is looking at fund managers who can make those recovery plays, such as Richard Plackett of the BlackRock Special Situations fund, Schroder UK Alpha Plus fund manager Richard Buxton and Derek Stuart, who runs Artemis Special Situations.

"Majedie Asset Management is also a good fund," said Mr Potter. "Mark Costa at J O Hambro is a good long-term investor who can identify themes to play when the value is there, while Clive Beagles of the JOHCM UK Equity Income Fund is a contrarian pick – he's not afraid to be in an unpopular area when the share price is right."

Steve Gibson, portfolio manager of Fidelity's MultiManager Balanced fund, picked two managers who could relatively benefit from the squeeze on the UK consumer – Neil Woodford and John Wood.

"Mr Woodford's Invesco Perpetual Income fund and Mr Wood's JO Hambro UK Opportunities fund have both had a cautious view on the UK economy for some time and are focused on areas of the market that have low economic sensitivity, pricing power and that are trading at cheap valuations," said Mr Gibson.

"Many of the companies held offer sustainable dividend yields well in excess of their respective corporate bond yields."