Investing in Capital Goods to weather economic uncertainty

Over the last few weeks, a number of things have made me think about the current economic uncertainty and how I am thinking about investing in such a climate: 

1. Double Dip?

At the end of August, AIM listed James Latham Plc (LON:LTHM) , a long established successful importer and distributor of timber primarily for the construction industry, issued a trading update which was quite upbeat about current trading but also said the following: "However much of the work is immediate and it is difficult to predict the level of activity likely during the winter months. Some sectors that were hard hit in the initial stage of the recession, such as commercial vehicle manufacture, are busier, but anticipated cuts in the Government's capital expenditure programmes will hit many areas of the economy. Credit insurance cover is now more available but bad debts are above normal levels and continue to give concern".

Comment: I firmly believe that the UK economy will experience a double dip recession, and, indeed, for the reasons set out below the shape of the UK economy for a number of years to come will be similar to  that of a horizontal sheet of corrugated iron.

2. The Consumer Failed to Deliver

Last week I read an out of print booklet written by Terry Arthur in 1992 entitled 'The Consumer Failed to Deliver Last Year and Other Fables.' - the principles underlying the Fables are so apposite to today despite being written nearly 20 years ago that they need sharing. The following extract from  Fable 1 'Spend and Grow Rich' well illustrates the principles underlying the author's thinking:

Two workmen were digging out a quarry with a gigantic excavator. One said to the other 'It's a crying shame; this quarry would provide work for a thousand men with shovels'. The other replied 'Or a million men with teaspoons'.

We all know (don't we?) that the excavator has not put 998 men out of work. It has enabled 1000 men to work with greater productivity (and thus greater rewards); two of them in a quarry and the rest elsewhere. The pyramids were a marvelous example of collective human achievement but they did not bring riches to the labourers. Only capital goods can do that. Capital goods are the difference between rich and poor countries. The rich countries may be more 'capital-intensive' but they do not have more idle hands; they have more output.

How did the excavator get there? It was built by abstinence. someone, somewhere, decided to abstain from consumption to build it or have it built.

Comment: The LCF Research investment template (click here to see it) proactively looks for the current equivalents of the excavator developer. The key element of the template for identifying such companies is a strong value proposition, which quickly tells us whether a company has identified a worthwhile problem to solve, and whether the underlying thinking has produced or is likely to produce an economic solution.

A key challenge with the 'excavator' investment strategy is that by definition it requires long term mindsets across all stakeholders because of the time required to a) develop the knowledge which is the basis of the solution, b) develop the solution and c) await market acceptance of the solution.

3. Stanley Druckenmiller Closes His Fund Management Company

Last week, Stanley Druckenmiller, who runs $12 billion Duquesne Capital Management (which he founded in 1981) and was the man who helped George Soros 'break' the Bank of England in 1992, announced that he is closing his firm, citing that he was tired of the stress of managing other people's money on this scale.

Comment: Highly successful investors such as Mr Druckenmiller have delivered to their clients excellent returns over many years through being very gifted at spotting macro economic trends which are likely to produce mispricing opportunities. However, each event is a one off project and merely redistributes wealth rather than creating wealth in the manner of the excavator. I can completely understand why Mr Druckenmiller must have found life stressful, whilst followers of the 'excavator' investment strategy can find a surfeit of opportunities, as well as finding the activity both financially rewarding and enjoyable.

In summary, whilst believing that the UK economy will suffer from a series of ongoing dips, there are plenty of investment opportunities for investors pursuing the 'excavator' investment strategy capable of providing  attractive returns.

Charles Breese

LCF Research