Your Most Asked Finance Questions Revealed

Investors have had much to cope with in 2023, with a constantly shifting narrative around inflation and the economic outlook, combined with geopolitical risks being elevated.

We all know that markets go up and down, and that’s why we believe it’s important to remain principled when it comes to investing and simply remain loyal to your personal financial plan which factors in these periods.

We are excited about what is ahead. And to show you why, we have collated the most frequently asked questions that our clients have in recent months posed and we will  offer our insights in the simplest, most unfiltered possible way.

Q1. Why do you think there’s likely to be a recession in the UK? How bad, and what are the risks?

Recessions are often thought of as events, and we label them as such. The Lehman Brothers default of 2008 or the Tech Boom bust of the early 2000s. In truth, they’re not usually specific events with specific dates but rather processes. These processes involve a messy interaction between businesses, consumers and governments that leads to the economy slowing down, so much so that it eventually contracts.

While each recession is labelled differently, the process often follows a very similar pattern. Primarily, interest rates tend to rise sharply – if mortgage costs go up, households think twice about their next purchases. Additionally, prices (particularly necessities like food and energy) tend to rise sharply, squeezing incomes. This leads people to tighten their belts as they focus on the things they need (to heat their homes and feed their families) over the things they don’t (a new car or a holiday abroad). And finally, company profits tend to fall as spending comes down. If people buy less stuff, companies earn less money. And when profits fall, companies tighten their belts, potentially laying off workers as a result.

As things stand, these patterns are present today. We have seen the sharpest rises in interest rates in a generation. And we have also seen the sharpest rise in prices in a generation (even if they might be easing now). The impact is clear, consumers are slowly reining in their spending. Housing is slowing down and global manufacturing is contracting. Consequently profits, as measured by earnings per share, are down from the highs, with possibly more to come. These factors leave us positioned cautiously.

It isn’t all doom, though. Just like recessions, recoveries aren’t events with specific dates. They are processes with very similar patterns to the past. So while those patterns are currently pointing to a recession, this won’t be forever. Eventually, our view is that interest rates and inflation will come down. And when they do, this will set in motion the subsequent economic recovery that will eventually take place.

Q2. In a world of higher interest rates, is investing still worth it? Surely cash is now more attractive?

There is no denying interest rates on bank accounts are more attractive than they have been in a long time. But inflation is far worse than it’s been in a long time too…

So while it was grim getting paid 0% on savings following the banking crisis, it helped that inflation was around 2%. On this basis, your cash was worth about 2% less by the end of every year. Now, although you might get 3% or 4% on a savings account, inflation is at 9%! You get some interest, which is nice – but even after that, your cash is worth ~5% less by the end of the year!

Until savings rates are above inflation, cash is a negative return strategy – guaranteed.

We all know investing isn’t a guaranteed return, it is one which, over time, can help to beat inflation. In fact, investing in stocks and shares is a way to get inflation working for you rather than against you. Those price increases which make our shopping more expensive are being made by the very companies you invest in! Company earnings tend to beat inflation over time as the management teams increase prices and cut costs. That’s better than the bank manager is doing on your savings account!

Q3. Are we facing a banking crisis similar to 2008?

We think not.

The global financial crisis was many years and mistakes in the making. Risky lending practices that were facilitated by decades of deregulation ultimately led to an extreme housing bubble and its eventual bursting. This led to the collapse of a number of major financial institutions. Unfortunately, almost everyone was impacted since most people have some financial tie to housing… as Edward Leamer said, “housing is the business cycle”.

What is happening at the moment is different.

In the US, some non-systemically important banks have mismanaged their assets and liabilities risk. Rising rates meant that the bonds they held as collateral against deposits could not be sold for enough when people tried to redeem their deposits.

In Europe, for years Credit Suisse had been struggling with reputational issues as a result of being pretty near the centre of the majority of banking scandals over the past few years. On top of this, the bank was having serious profitability issues. This is what accelerated the speed and scale of deposit flight that we witnessed. Currently, no other systemically important European or US banks are finding themselves in this kind of hot water.

The 2008 crisis was economy-wide. What’s going on right now with banks is not economy-wide.

Q4. Why has the significant fall in oil and gas prices not yet fed through to much lower inflation levels?

Inflation is defined in different ways. For some, it’s just a number, defined as the growth in prices – an objective measure without debate. For others, inflation is something that is felt – we remember how much the weekly shop costs us compared to last time. Particularly when everything is going up.

For example we find it easy to remember that petrol prices had at one point doubled from the lows of the Covid recession to the highs of 2022. Every time we go to the pumps, we remember that feeling of filling up at or above £2 per litre. At the same time, food prices were going up, housing costs were going up… every cost was going up. Rising petrol was just another squeeze on incomes.

On the flipside, we don’t feel that much happier now that petrol prices are down by a quarter from their 2022 highs; or that they are below the level they were when Russia invaded Ukraine. What’s even harder to believe is that, as they stand right now, petrol prices aren’t that different to what they were 10 years ago. Prices have gone from around £1.35/litre to £1.45/litre in that time – that’s around 0.7% rise per year.

So it turns out the fall in oil prices has led to falls in the cost of filling up. However, while it might be in the numbers, until other prices fall more widely, we are unlikely to feel it.

Going forward, we believe the overall inflation basket is close to peaking and will start to fall soon. The last inflation numbers in the UK shows inflation falling substantially from its peak, though not as much as had been forecasted. It will be a slow and a bumpy process, but eventually, we will start to see and feel inflation coming down to more normal levels.

This blog is for general information only and does not constitute personal advice. The information is aimed at retail clients only.

It’s important to remember; the value of your investments can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

Source – 7IM