My musings, then some good reads from the web.

Something remarkable has happened. The UK consumer has finally woken up to the financial crisis, the public deficit, spending cuts, and tax rises.

Now I’m not saying there’s been no pain in the UK in the past three years. Jobs have certainly been lost, and some have already seen the loss of publicly-funded benefits and perks. And it’s easy to forget here in London that house prices more nationally have actually fallen about 20% – in a sustained way – in some areas such as the North and Wales.

But in general, the UK consumer has been remarkably resilient.

When I wrote early last year about how the UK was booming, I was thinking mainly about our export economy — the rapid upswing in manufacturing and a recovering financial sector. I admit I didn’t appreciate the extent to which lower mortgage payments meant that far from struggling, the great majority of UK households had even more money to spend.

Theoretically, that is still the case. But something seems to have changed with the VAT rise that came in at the start of the year – perhaps abetted by the arctic snow that closed down UK high street for Christmas. Having gotten out of the spending habit for six weeks, the UK consumer may be going cold turkey.

Retailer after retailer has been reporting plunging sales, with Dixons, Mothercare, and John Lewis the latest to stumble back to command with a bloodied casualty report in hand. One analyst says today in the FT:

“This is the worst I can remember seeing in about 30 years. Since the middle of January more or less, retail has fallen off the edge of a cliff.”

Reasons abound. Beyond that VAT rise, there’s the shocking statistic that real disposable incomes in the UK have fallen for the first time in 30 years. And good luck boosting your salary by getting another job:

News that staff turnover has hit a five-year low is hardly surprising when you consider the state of the UK labour market. People with household bills to pay are not going to leave their jobs until they have a decent job to go to.

Unemployment is rising, public spending cuts are on their way, and those companies which are increasing output are simply increasing overtime rather than hire new people.

The other shoe to drop, as our American cousins inexplicably say, could be renewed pressure on house prices, with the Bank of England warning that loan defaults are rising:

The Bank predicts the total number of mortgage defaults will rise during the next three months as fears intensify that the cost of living will remain high and interest rates will rise.

In its Credit Conditions Survey, it suggested that lenders were concerned about “the potential impact of increases in interest rates on default rates”.

Now I am not one of those bloggers who regularly writes doom and gloom stories. In fact, I’ll admit to being surprised by how quickly the UK consumer seems to have turned. After a while, you start to wonder if the bell really tolls for the Spend Now, Pay Never population.

House prices plunged in the US and unemployment soared, but not here. Ireland’s ridiculous credit boom and four-fold increase in house prices took it to the edge, but London prices are now nearly back to the peak. Other poster children of the good times like Iceland and Spain have also clearly suffered. Only the UK and Australia seem to have escaped the hangover.

In Australia’s case, that’s not hard to understand: the country is stuffed full of resources in the middle of a commodity surge, and the population is relatively small.

But the UK has dwindling natural resources in the North Sea, and while its main driver of growth – the financial sector – got back on its feet faster than any predicted, it’s still not close to covering over the gaping hole its collapse left in the nation’s finances.

No, I think the average UK citizen has simply willed away a worse slump. After well over a decade without a recession and with huge swathes of the population made heady by soaring house prices and easier money from the public purse, they didn’t think it could happen here – and for several years that self-belief has been self-fulfilling.

It’s probably too soon to be sure the chickens have come home to roost. Much of the pain in the spending cuts is pushed out into the future (such as changes to retirement ages, and shifts to the inflation measures used), and I’m doubtful whether most people are aware of them. And while taxes are rising and curbs to easy money like child benefits for the middle classes and over-generous housing benefit – not to mention persistent inflation – is now clipping consumers’ spending power, interest rates are still low, which is acting like a daily soothing infusion of morphine into a sickly patient.

From an investing standpoint, one thing I’d urge is you don’t take the UK stock market to be a proxy for the UK economy. Around three-quarters of the earnings of the FTSE 100 are generated overseas, and the rest of the world is doing fine. Having swallowed some painful medicine via a proper house price crash, even the US is finally on the mend – a recovering consumer appetite there could keep company earnings headed higher for years.

Some good weekend reads from around the web.

There are many reasons to be a passive investor rather than trying to pick stocks or funds to beat the market: It’s cheaper, you’ll probably do better anyway, and it takes a lot less time than reading company reports or hunting for the next Warren Buffett.

A less frequently touted advantage is that passive investing saves you from having to make uncomfortable choices.

Regular readers will know that I actively manage a portion of my net worth, for my sins, despite suggesting most readers should follow the passive approach. And this past week brought out the best and the worst emotions in active investing.

The main reason I choose to actively invest some of my money is the most honest, but also the least edifying – it’s fun.

For example, for 12 months or so now I’ve been selling down shares a bit when the market has got ahead of itself, and loading up on companies I like when it dips. Unfortunately I only got my portfolio back up to about 10% cash and fixed interest (and only bank preference shares at that) before the recent wobble, which has limited my warchest for hunting bargains in a market I still judge decent value.

I only have a vague idea of how far my meddling has put me ahead of simply sitting in the market – and I have absolutely no idea if the outperformance is down to dumb luck. Ask me again in 30 years!

But I do know for sure that it is generally enjoyable.

That kind of attitude quite rightly enrages my co-blogger The Accumulator, but at least I’m honest about it. (It’s one reason why I first asked him to blog here).

Difficult choices

Taking advantage of the fear and greed of the public schoolboy traders in Canary Wharf is one thing, however. But looking at the market in the wake of a natural disaster, potential nuclear contamination, and heartbreaking loss of human life isn’t my idea of a rollicking good time.

Having previously read in some detail about the horrible human sacrifice at Chernobyl, my heart aches to think of the core 50 workers at Japan’s stricken Fukushima nuclear plant. They are likely committing themselves to a horrible lingering death in their efforts to get the situation under control. And while they are doing it for their country, it’s their bosses and shareholders in TEPCO who are most geared to their success, as well as investors and management in nuclear facilities across the globe.

As one who fears environmental meltdown on a global scale, nuclear power is an extremely difficult issue for me to make my mind up about. But I don’t need to think hard to feel awful for those workers – nor to wonder exactly what would happen if there was a similar nuclear accident in the UK or the US, rather than in a country with a strong tradition of personal self-sacrifice like Japan, or a long tradition of using troops as cannon fodder like Russia.

And what about as an investor? Here we get to the awkward moral issues.

If you’re a passive investor, you can sit through all this and look disdainfully at those who’d “try to make a buck” out of human misery. But if you’re an active investor, you can’t afford to leave crisis investing out of your strategy grab bag.

In both cases money will remain in the markets – and indeed in both cases returns will follow the decisions of active investors – but the active investor is the one who will be staring into the mirror in the morning, or washing her hands over and over in the bathroom after clicking ‘buy’.

Intellectually, I don’t believe economies benefit from the breakdown in orderly markets. Quite the opposite in fact. Japan would be in a stronger position if its market hadn’t tanked nearly 20% in a week in the wake of the magnitude 9.0 earthquake and its repercussions. In that sense, anyone buying into their cheap-looking market is doing them a favor.

Equally, I can see why that sounds like self-justification from someone who knows, for example, that an investor who bought into war-ravaged Germany in 1948 saw a 4,000% return over the following decade, whereas an investor who bought the UK’s FTSE 100 at the end of the happy-clappy 1990s is still looking at an index that’s lower 11 years on.

The case for investing in nuclear-related plays – some uranium miners have dived 30% or more – is even more fraught, with enough moral murkiness to propel along a Michael Frayn play.

I can’t tell you what to do. I can’t tell you how to sleep at night.