Are you feeling, like me, that your shares haven’t being doing much for a while? A few are up, quite a few down, at best “flat lining”.
Although the stellar returns of a few years ago were great, Christmas cannot go on for ever and, really, we can live with low capital growth so long as the dividends keep coming and there is low inflation. With close to zero inflation and interest rates around 1% even 3% capital growth combined with a 3% dividend is a pretty compelling reason to keep faith with equities.
Interest rates have been low for longer than most people expected and that has been a bonanza for borrowers. This has contributed to the growth in London house prices, as has the influx of money from foreign buyers looking for a safe haven in this civil war strewn world we live in, although this may be tailing off. I recently visited St. George’s Hill near Weybridge and saw a large number of high-end properties that have been completed but are unsold. Either the developers or their banks are going to lose a lot of money.
American interest rates are expected to start gently rising soon and the UK will follow. This spells disaster for holders of fixed income bonds like UK government gilts. Through pure luck I was long of gilts when interest rates fell in the 1990s. The (tax free) capital gain I made scared me as I had thought it was a safe and boring investment. As interest rates rise the price of bonds will fall but what will happen to share prices?
This is pretty basic but is worth saying. Companies that have done well in a low interest era by borrowing heavily will need to change their strategy and it’s not always easy or even possible to do this. Northern Rock was a good example of how not to do it and how it was, in their case, impossible to extricate themselves from their profitable short-term strategy. You will remember that they borrowed super-cheap short-term money and lent it at a handsome mark-up to long-term borrowers. But when short-term money got expensive and effectively dried up they had nowhere to turn and went broke,
So beware companies with high borrowings. Glencore has just started to reduce its debt. Companies not reliant on borrowed money that have been under-performing in comparison to their highly geared peers will suddenly start to be stock market darlings.
Buying property on borrowed money won’t look such a doddle. As variable rate mortgages start to go up existing borrowers will feel the squeeze. This will cool off the UK property market – expect to see a downward correction. Landlords will try to raise rents to pay for the higher cost of money but in the face of falling prices will find it hard to achieve this; a sector to be wary of. Consumer spending will be adversely affected too: with higher mortgage repayments to meet there will be less money for avoidable spending such as eating out and holidays.
But it will not be all doom and gloom. The notional return on Premium Bonds (now 1.35%) will go up and they are one sort of bond (maybe the only one?) where the capital value will stay the same.