The cost of false security

Investors have been paying a premium for the safety of investing their money in defensive stocks. But that's not to say they'll get it, says Merryn Somerset Webb.

A few years ago, we suggested that a good way to cut the benefits bill would be to raise the minimum wage. Why? Because it creates "welfare to workers": no one can live on the minimum wage in Britain, so the state ends up topping up the incomes of all those being paid it.

The net result is that the taxpayer makes up the wages of Britain's big companies, and so hugely subsidises their profits. If wages were higher, profits might be lower, but at the same time, thousands of people would be taken out of the benefits system. That's better for them and, as taxpayers at least, it is better for the rest of us too.

You can see more details on the argument on our blog. The good news is that almost everyone is coming around to agreeing with us (we like it when this happens). When it was suggested earlier this week that the coalition might cut the minimum wage, the protest was universal. Typical was Jeremy Warner writing in The Daily Telegraph.

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He notes, as we have, that it is odd to see large firms accumulating as much cash as they are at the moment, even as wages as a proportion of GDP hit a post-war low; that it is "totally absurd" for British taxpayers to subsidise low-paid work via means-tested tax credits; and that the dangers to employment of a rise in wages are "massively overestimated".

It makes sense to us. But the fact that this kind of discussion is gaining ground in Britain should highlight (yet) another danger for equity investors: the prospect of increased state interference in our favourite cash-generating machines. I've mentioned this before, but with the S&P 500 having just hit a new record high, it is worth returning to.

Look at the stocks that have led the rally. They aren't the industrials, the technology stocks or the materials that usually drive bull markets. Instead, as Michael Mackenzie notes in the Financial Times, they are still the defensive dividend-paying sectors preferred by nervy investors in tough (and inflationary) times. Think healthcare, consumer staples and utilities. That's not just the case in the US look to our own markets and even to Japan and you will see the same thing.

Investors might want to be in equities, but they clearly aren't particularly confident that we are seeing a real upturn in the economic cycle. So they are sticking with what they see as safety.

But while all company profits are vulnerable to rises in the minimum wage, these defensive firms are particularly vulnerable to other forms of interference (ones we are unlikely to approve of!) from cash-strapped states. Think regulation, price caps (particularly in the case of utilities), nationalisation, dividend controls, one-off taxes on cash and so on.

It may be that right now investors are not paying for safety, but overpaying for an illusion of safety.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.