Generating income won’t get any easier
A COUPLE of years ago, musing on the prospects for monetary policy in the UK, I likened the economy’s need for low interest rates to caffeine dependency.
I also mentioned that I was on a self-imposed caffeine ban, and that I would treat myself to my first cup of coffee on the day the Bank of England raised interest rates. Well, I’m still waiting, and after last week’s interest rate cut the futures and options markets suggest that I won’t be troubling any baristas until late 2021 – or, much more disturbingly, until I am past my 60th birthday! This forecasting tool has been pretty volatile since the boffins at Morgan Stanley created it, but even so it has given a reasonably good steer on market expectations, and it’s clear that any hope of generating meaningful income from deposits is a dim one... and getting dimmer.
A chart crossed my desk recently starkly showing the amount of capital one requires to generate £10 per annum in income from a 10-year Gilt, based on yield-to-maturity. Twenty-five years ago it was just £83 – now you need £1,538! Admittedly inflation was running at 7.5 per cent at the end of 1991 against just 0.5 per cent now, but even so it’s impossible to make any sort of real return without taking risk, which goes some way to explaining the positive performance of financial assets.
The interim results season hasn’t been too bad, albeit it covers the pre-referendum period. Even so, the post-Brexit commentary is not that apocalyptic.
However, the economy has been supported by government stimulus and a frothy real estate sector, and the market won’t take kindly to any signs of that faltering. While not wishing to sound too pessimistic, we see a rising probability of a period ahead when both bonds and equities will fall, leaving cash, and possibly selected alternatives, as the safest asset class. Up until now we have been happy to use government bonds as our key “insurance” asset, but they look increasingly less secure at current valuations. John Wyn-Evans is head of investment strategy at Investec Wealth & Investment