The scholars among us will know that to fully understand a subject you have to be willing to read around it … and finance is no different. To understand what’s going on in the world right now needs much more than simply a glance at todays markets, so I’m going to share my thoughts on some of the broader issues affecting returns in 2023 ….
In response to the COVID-19 pandemic, major central banks took actions to ease monetary policy, the aim was to provide liquidity to markets and maintain the flow of credit. When interest rates are low, it typically stimulates economies because borrowers can access inexpensive loans. Central banks, therefore, use interest rates as a tool to stimulate the economy or to prevent it from expanding at a rate that is not sustainable.
The problem is, low interest rates can create a situation where demand exceeds supply; one of the triggers for high inflation. Whereas higher interest rates discourage people from borrowing and slows demand.
Global Inflation rate from 2000 to 2023, including a forecast to 2028
Source: Statista 2023
You can see clearly from the graph the peaks in inflation in the last 23 years. By early 2022 Global inflation had reached 8.73%, with UK inflation at its highest in nearly 30 years, peaking at 11.1% by October 2022.
In November 2021 the UK interest rate was at a record low of 0.1%. Fast forward to August 2023, the Bank of England’s (BoE) Monetary Policy Committee (MPC) raised interest rates for the 14th time in a row by 0.25% to 5.25% (the highest they have been since April 2008 during the Global Financial Crisis). The BoE analysis used market expectations that the rate will climb to 6.1%. The prospect of reaching 6.1% creates a fly in the ointment, with many fixed rate mortgage deals coming to an end in the next 18 months many borrowers could be severely hit at the end of their fixed rate deals, when their mortgages return to the current variable rate. The best case scenario between now and then would be for inflation to continue to fall. If that happens, we are likely to see interest rates coming back down … it’s worth mentioning at this point that as interest rates reduce, stock markets typically enjoy a healthy rally!
Bank of England official rate 2007 to 2023
Source: commonslibrary.parliament.uk/research-briefings/sn02802/
UK MORTGAGE INTEREST RATE 2010 TO 2022
Source: Statista 2023
As the mortgage interest rate and Bank of England official rate charts show, the younger generation who have stepped onto the housing ladder in the last decade or so have never known interest rates above 5%. When I worked for Nationwide Building Society, the mortgage interest rate hit 15.4% in February 1990. Just two years earlier the variable rate was just over 8%. The 1980s were a golden time for home ownership in Britain. Prime minister Margaret Thatcher championed a home-owning democracy, and the proportion of people owning their own home rose from 56% in 1980 to 67% in 1990. (Source: Statista) So, we need to bear in mind that we’ve benefited for many years by extremely low interest rates, making borrowing very cheap, not just for individuals buying their home and other items like cars, but for businesses too. We are simply returning now to what was previously normal interest rates!
As investors we have got used to synchronised markets. It is often said that when America sneezes, the rest of the world catches a cold. Starting with America, this summer we have seen just how resilient the US consumer continues to be in the face of the fastest monetary tightening cycle ever. Retail sales rose by 0.7% in July. That was about twice as fast as expected. That sounds like good news - and in one way it is. It makes it increasingly likely that America can dodge an expected recession next year. When you consider how far and fast interest rates have risen, this is quite remarkable. It reflects a very strong jobs market - US unemployment has fluctuated between just 3.4% and 3.7% since March 2022. The tightening measures are working and the US is expected to raise interest rates one last time. The main US interest rate, called the Federal funds rate, stands at 5.5% at the time of writing.
However, there is a downside to the higher than expected spending and jobs numbers, it makes a rapid reversal of the last 18 months’ rate rises less likely. The UK faces a similar issue, with surprisingly high wage growth data, while inflation remains well above the 2% target at 6.8%, most experts believe this more or less nails down another interest rate hike in September 2023 to match the US rate of 5.5%. Rising interest rates mean individuals and companies face added pressure to repay debts and a higher risk of defaults.
The story could not be more different on the other side of the world. China’s economy is struggling, Chinese retail sales increased by just 2.5% in July, slowing from 3.1% in the previous month, and falling well short of a forecast 4.5% rise. The Chinese economy is dependent on a healthy property sector and growing consumer spending. On both fronts it is struggling today, with falling house prices and financial problems at the country’s biggest property developers hitting broader confidence. China’s consumer prices actually fell in the year to July, by 0.3% - deflation not inflation.
Let’s turn our attention to global inflation for a moment. I believe that whilst it’s a lot of information to take in, the following charts give us a pretty good picture of what’s going on in the world … clearly Venezuela and other countries have big issues and are at one end of the scale, making the UK’s 6.8%, the US’s 3.2% and Spain’s 2.3% not look too bad at all, and despite not yet achieving their ultimate targets it does demonstrate strong economies!
Source: Statista 2023
So, what to do when one part of the world is hot and another is not? And when the chance of things reversing is quite high. Remember that at the beginning of the year, most investors expected China to bounce back from Covid rapidly and for America to head towards recession on the back of higher interest rates.
Knowing how to invest in this environment is not easy. In part that’s because a different investment approach is required for a high-growth, inflationary environment than for a low-growth, deflationary one. In a world where growth is hard to find, investors tend to favour companies that have a demonstrable ability to increase their profits consistently over time. This is the so-called ‘growth’ style. When economies are stronger and inflation and interest rates are higher, investors put more of a premium on capturing returns today than on the expectation of benefiting from growth in the future. Cheaper stocks, often providing a high dividend yield, are favoured in this environment. This is known as the ‘value’ style.
Global investment funds benefit from the ability to fish in a wider pool of possible holdings than the UK. They also give the investor currency exposure.
When the markets fall, it pays to stay focused on your long-term investment goals. The first half of 2023 has been better than anyone dared hope at the start. To date, most major world economies have avoided recession, Equally, while geopolitical risks continue, the likelihood of a significant shock has diminished.
The answer in terms of investments, we believe, is to have a well-balanced and diversified portfolio. That means investing across different asset classes and regions, but also adopting a range of different investing styles. Holding both multi-asset and equity funds in your portfolio will help to minimise the chance of being caught on the wrong side of the prevailing trends. It is also worth remembering that multi-asset funds are not just there as a return-seeking asset in a portfolio, but for downside protection and diversification. They provide a vital offset against riskier assets, such as equities and an important ballast to market volatility.
As you can see, there’s a lot to think about and it’s important to receive the right advice for your own situation!
Speed Financial Solutions are a highly qualified and regulated financial services provider looking after clients throughout Spain and the UK. Established in 2010, we provide a discreet and comprehensive service to individuals, and our service is tailored to suit your needs taking advantage of tactical opportunities as they arise in respect of your financial planning.
Our Principal, Andrea Speed, is a qualified Discretionary Investment Manager specialising in Investment and Risk, Taxation and Trusts, and a qualified Pension Specialist. Andrea is also a Fellow of the Chartered Insurance Institute (CII), which is the world’s largest professional body for insurance and financial services in the world.
Fellowship is the highest qualification awarded by the CII (Level 7) and is universally regarded as the premier qualification. It is a major achievement in the financial industry and demonstrates the acquisition of skills and knowledge at the highest of levels. Along with a Fellowship, Andrea is a CII Chartered Financial Planner.
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This communication is for information purposes only based on our understanding of current legislation and practices which is subject to change and is not intended to constitute, and should not be construed as, investment advice, investment recommendations or investment research. You should seek advice form a professional adviser before embarking on any financial planning activity. Whilst every effort has been made to ensure the information contained in this communication is correct, we are not responsible for any errors or omissions.
Andrea J Speed FPFS (DM), M.A.
Principal, Fellow and Chartered Financial Planner
Speed Financial Solutions
30 August 2023