Old rules of money apply again, says HAMISH MCRAE

Longer higher. That is the message of the markets over the past week.

Strong employment growth in America, stubborn inflation in Europe and even more so in the UK will force central banks to raise interest rates globally – and likely to keep them high for some time to come.

The markets didn’t like it. Bond yields are up, with the 10-year yield on US Treasuries above 4 percent and our 10-year Treasury bonds close to 4.75 percent. Yields on two-year and five-year gilts are even higher.

In terms of equities, the FTSE 100 index had its worst day this year on Thursday, and was down again on Friday. It was an uneasy confirmation of the “sell in May and go” rule, although this year you actually still would have done better to sell in April.

The main reason for the gloom in equities is that markets are now assuming that central banks are willing to push major economies into recession if that is the price of getting inflation back to the 2 percent target.

Higher bond yields make them relatively more attractive relative to equities, and recessions (or even slower growth) hurt corporate earnings.

It is also not good news for mortgages. If our government has to pay nearly 5.5 percent on two-year government bonds, a two-year mortgage will cost more than 6 percent. You and I may think that a UK house buyer’s credit rating is as good as His Majesty’s Government, but I’m afraid that’s not what the markets think.

It was also unfortunate timing for the Center for Policy Studies to publish Retail Therapy, a paper urging more private investors to put their money in the stock market rather than leave their money on deposit.

It’s an important and valid theme because, over the long run, returns on stocks are higher than those on fixed income investments like gilts, and much higher than cash.

Over the past 50 years, you would earn a real return (taking inflation into account) of 4.9 percent on UK stocks, 3 percent on gilts and just 0.9 percent on cash. Over the past 10 years, it would have been 4.7 percent on stocks, 1 percent on gilts, and minus 2.5 percent on cash.

Yet only 12 percent of UK stocks are held by private investors, compared to 50 percent in the 1960s. Instead we have £1.8 trillion in savings accounts, almost as much at the market cap of the FTSE 100.

At least we have not fared as badly as the pension funds and other institutional investors, who have relentlessly sold their holdings over the past few decades, a scandal that we have called attention to in this paper and that the government is trying to address – as we report below.

But despite the financial case for more retail investment, and despite the fact that UK equities are worth even more now that they’ve come off the top, encouraging people to invest more in equities will be a long slog.

There is an even bigger problem here. We need to leave behind the message that the ultra-low interest rates of the past decade were unprecedented and will probably never happen again in our lifetimes. It was an experiment by the central banks to stimulate the economies without causing inflation, and it failed.

We will probably have interest rates for ten years now that will be higher than inflation, maybe even a lot higher, and we have to prepare for that.

In concrete terms, this means that the old rules apply again. One is that we should try to make our savings work for us.

The country as a whole is sitting on a huge pile of so-called excess savings, funds that built up during the pandemic shutdowns because we couldn’t spend them.

Best estimates put this at around £200bn – huge. It is of course unevenly distributed, with older and wealthier people having much more than young people, and some of the money will run out and be spent. But in the meantime it must be put to work.

Other rules are borrowing only to acquire real assets, including buying a home, rather than to fund current expenses. They include, the point the Center for Policy Studies is making, investing in stocks for the long term.

Of course everyone should benefit from the tax incentives for savings and pensions and so on.

It may sound boring to use common sense when managing personal finances, but this past bumpy week makes that message more important than ever.