Please Take Note: Early Warning and Opportunity
17 June 2021
To all Financial Friends
The Last Three Months
The last three months have been fairly dull in performance across all assets. However, most of our student’s equity funds will have seen some rise. Average equity performance remains broadly in line with a potential 8% pa return overall on average, as a baseline for the longer term. UK smaller companies have outperformed while technology funds have progressed, and gold has been positively interesting. As forecast, in earlier emails, gilts and fixed-interest funds have fallen against the threat of inflation and potential rising interest rates.
We encouraged moving from gilts and fixed interest to inflation linked gilts and global inflation linked bonds a few months ago staying 2 steps ahead of the market. This move is paying off steadily at this stage. Good also to see some above average rise in infrastructure funds also highlighted here previously.
General Commentary and Preparation for Future Action
Inflation and the 'turning point'
Past commentary has indicated the need to look ahead to observe the possible turning point arriving. The turning point in my mind is when interest rates have to rise as a means of controlling inflation (by lessening the money we have to spend and holding back price rises). Inflation in the UK in May rose to 2.1% while in the USA 5% inflation hits the headlines. Financial Friend emails and Course modules have been highlighting the threat of inflation as a key factor to bear in mind.
The USA Treasury have indicated their first interest rate rises to arrive in 2023 - we shall see if they can hold back that long. The Bank of England say they will not hesitate to increase interest rates if needed to contain inflation. When America sneezes the rest of the world catches a cold! My favourite long term trusted senior global economist friend, Dr. Peter Warburton continues to expect 5% inflation here as we move into 2022!
Why Does This Matter to You and Your Investment Portfolio?
Consumers, the business world and governments here and abroad, all carry alarming levels of debt. If interest rates rise, will they be able to meet the payments due and pay off the loans at maturity? When inflation hit the headlines a short while back, equities took a tumble. That is odd as equities normally rise with inflation as does gold. I suspect the fear of debt defaulting was behind this sudden but short-term loss of confidence.
If investors perceive the potential of interest rates rising, with the problems this could bring, then a downward correction in equity values could well occur.
The Conundrum for the Financial Authorities
We need to stimulate the economy out of the Covid virus financial crisis to preserve jobs and our future standard of living. To do this interest rates need to be held low to give us all more money to spend and keep things going. However, inflation is like a roaring lion which once let out of its cage is hard to control. Back in the 1980's my clients were able to invest for a 5-year term at a guaranteed interest rate of 13%!! Interest rates were that high! The standard way to control inflation is to increase interest rates. Do you see the catch 22 situation we are in?
What and When Might You Need to Consider Action?
To stave off problems for the economy, it seems authorities here and in the USA are planning to hold back interest rates. Meanwhile inflation is expected to rise. This should encourage equity investment and performance for the time being. If your portfolio is heavily weighted to equities, then being aware of the possible coming 'turning point' will lead to consideration. You may consider reducing, or even replacing equity holdings with inflation linked gilts and global inflation index linked bonds fixed interest funds.
Remember that gold and precious metals can rise when other assets fall. Also infrastructure funds are seen as a defensive equity holding in such times. Investors are always seeking yield (income) so high yielding funds and assets might be considered as a holding in these times?
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PLEASE NOTE: A financial or economic commentary like these, are written to explain, interpret or give an opinion on economic events and markets to help readers understand what’s happening and why it matters. Designed to help you make informed decisions of your own by making you aware of opportunities, risks and potential rewards in the market.
