Spotlight: Changed priorities

All equity investors did badly in 2011. Nearly every index was down while those of the emerging markets did worse than most.

Bank depositors were lucky if they found a bank that would pay them 3%. Even then, after tax and inflation, they still ended the year with less capital than they began. It is unlikely that 2012 will be any easier, for politicians are making both the sovereign debt crisis and the bear market worse, and not better.

Danger of conventional thinking

The value of US Treasuries and UK gilts were up by more than 10% last year, with both still in their multi year bull markets. This appears to confirm what about-to-retire investors have traditionally been told – sell equities and other risk investments and switch to certain income from bonds and annuities. But with retirement time now beginning to almost equal the years in work, this advice is dangerous for it assumes an investment world that no longer exists. British, American and German bond yields are not reflecting investment value but a world in serious financial disarray.

Government bonds are mostly in bubble territory, with 10 year yields below 2% and increasing doubts about the solidity of all governments, not just the unfortunates of the eurozone periphery. Jonathan Ruffer is one of the more imaginative of independent investment managers, and he spells out the reason for this in his most recent report for his investment trust shareholders. 19th century Swedish economist Sven Wicksell observed that there is an interest rate level that keeps borrowers and lenders in balance. Tilt interest rates up; the savers love it, the borrowers hate it – and of course, vice versa.

This was also the belief of the Bank of England since, for more than 300 years, it kept its base rate at between 2-3% before inflation, at what it considered to be the ‘natural cost’ of money. That is not the belief of today’s politicians, however, for the BoE’s base rate is now 0.5% despite inflation of 5% a year. Importantly, this interest rate keeps many voters from defaulting on their mortgages and preserves the fictional values of the banks’ large commercial property portfolios. Governments also hope that low interest rates and abundant money will persuade business and voters to start spending, and stimulate economic growth, despite rising unemployment and a severe squeeze on after-tax incomes.

Fooling some of the people all of the time

Gillian Tett of the Financial Times, writing recently about the changes in financial regulations and business strategy of banks and other financial institutions, gives a very clear warning to investors about this policy.