HAMISH MCRAE asserts that traditional money principles are making a comeback

The recent market activity has sent a clear message: interest rates will remain higher for a longer period. This is due to strong employment growth in the US, persistent inflation in Europe and the UK. As a result, central banks worldwide are expected to raise rates and maintain them at higher levels for an extended period.

Unfortunately, the markets have not responded favorably to this news. Bond yields have increased, with the 10-year yield on US treasuries surpassing 4%, and our 10-year gilts nearing 4.75%. Yields on two-year and five-year gilts are also higher.

Equities haven’t fared well either. The FTSE 100 index experienced its worst day this year on Thursday, and even further decline on Friday. This confirms the old adage of “sell in May and go away,” although this year it would have been better to sell in April.

The main concern for equities is that the markets believe central banks are willing to drive the major economies into recession to achieve their 2% inflation target.

Higher bond yields have made them more appealing compared to equities, and potential recessions or slower growth negatively impact company earnings.

This trend is also troubling for mortgages. With the government paying nearly 5.5% on two-year gilts, a two-year fixed-rate mortgage will cost over 6%. Despite the creditworthiness of British home-buyers being comparable to that of the government, the markets perceive a difference.

The Centre for Policy Studies recently published a paper called “Retail Therapy,” advocating for increased retail investment in the stock market rather than leaving cash in deposit accounts.

This is a valid argument considering that, historically, equities have outperformed fixed-interest investments and cash over the long term. Over the past 50 years, UK equities delivered a real return of 4.9%, compared to 3% for gilts, and only 0.9% for cash. In the last decade, equities provided a return of 4.7%, gilts 1%, and cash experienced a negative return of -2.5%.

Surprisingly, retail investors own only 12% of UK shares, a significant decrease from the 50% ownership in the 1960s. Currently, we have £1.8 trillion in savings accounts, which is almost equal to the market capitalization of the FTSE 100.

Pension funds and institutional investors have also been selling their holdings in recent decades, which is a concerning trend. Encouraging individuals to invest more in equities will be a challenging task.

A broader issue that needs addressing is the misconception that the ultra-low interest rates of the past decade were unique and unlikely to occur again. It was an experimental strategy by central banks to stimulate economies without causing inflation, which ultimately failed.

Now we are entering a phase of higher interest rates, potentially exceeding inflation rates. In response, we must apply the old rules, such as making our savings work for us.

The country currently has a substantial amount of excess savings, estimated at around £200 billion, accumulated during the pandemic. While distribution is uneven, it needs to be invested wisely.

Additional rules include borrowing only for real assets like buying a home, rather than financing current spending. The Centre for Policy Studies also emphasizes long-term equity investments.

Taking advantage of tax incentives for savings and pensions is crucial for everyone.

Although it may sound mundane, managing personal finances with common sense has become more critical than ever in light of recent market volatility.

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