Aurelia Butler

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Good morning. Yesterday, long bond prices stopped falling, and everyone exhaled. Kate Duguid, our fearless colleague from the bond desk, will survey the fixed-income wreckage in Unhedged on Monday, while Ethan and I are away. In the meantime, email me: [email protected] shocks and growth stocksI’ve argued at some length recently that there is not a simple mathematical relationship between moves in rates and the relative performance of growth stocks. Why, then, is it that at certain moments, rates move up and then growth stocks slump with Pavlovian responsiveness? The view that this co-ordination is simply down to the long duration of growth stocks is demonstrably wrong. But there is something here that needs explaining.Sven Ebert and Pablo Duarte, of the Flossbach von Storch Research Institute, tried to explain it in a paper published earlier this year. They argue that sharp changes in both inflation expectations and short rates have historically been followed by underperformance by information technology (that is, growth) stocks. So it is not the level of rates and inflation — and therefore the discount rate used to value future cash flows — that matters. It is the speed and direction of their changes.Ebert and Duarte use a multi-factor statistical model to track the impact on the US stock market of five variables — break-even inflation expectations, forward interest rates, the yield curve, credit spreads, and the three-month Treasury rate — and the interactions of these variables.They find that a shock increase in inflation expectations, and the associated upward shock in short rates, has a pronounced negative effect on the whole market over the next year and a half (holding the influence of the other variables constant). No surprise there: it is a Wall Street truism that stocks don’t like inflation (even if bonds like it less). What is more interesting is that IT underperforms the market as a whole after such shocks, while energy outperforms and consumer staples shrugs its shoulders. Here is their chart of the sector response after a positive shock from break-even inflation (which brings higher rates in its train):Ebert and Duarte point out their statistical model fits with visible patterns in the long-term data. Looking at IT sector returns, you can see irregular but suggestive correlations between break-even inflation shocks and low or negative returns over the next five quarters:It is important to note that study is based on a data set that goes back to roughly the turn of the century and up through 2022. Until the very end of that period, we were in a falling rates regime. It could be that if we are in a new inflation and rates regime in the next 20 years, the relationships they map may not hold up.More important, perhaps, is how to explain the relationships that the paper teases out. We cannot simply refer to higher discount rates on future cash flows, because the historical data shows that relationship between valuations and rates is all over the place. When I put this to Ebert, he said it may be that sharp changes in inflation expectations and rates may make discount rates and stock valuations very vivid in the mind of market participants. Growth valuations become an important market narrative.If that’s right, shouldn’t there be a trade in there somewhere? It appears that growth stocks fall in response to inflation and rate shocks in a way that may not reflect changes in fundamental value. Possibly. But maybe growth stocks’ sensitivity to these shocks partly reflects the fact that those stocks became overvalued in the low-rates era, and the market knows it.Copper revisitedTwo weeks ago I wrote about copper, pointing out that everyone agrees that there appears to be a lot more demand for than supply of the stuff in the medium-long term (5-10 years from now, say). The green transition needs a lot of copper, but there are not a lot of new mines being dug and old mines are becoming less productive. I concluded that the shortage looks real, but I am worried about the elasticity of supply, about whether the green transition will really happen, and about the fact that structurally commodities are just bad investments.I was therefore interested to read an investor note Bridgewater published earlier this week, arguing the metals cycle driven by the green transition will not be like other cycles. The reason is that the green transition is a demand shock that everyone sees coming from a mile away. As a result, governments and companies are providing supply incentives, exploring substitutes, and investing in technology to reduce demand. So the price picture is not as bullish as it may seem for nickel, lithium, and cobalt. But copper is something an exception: “Copper has not yet seen the investment or supply growth needed to meet energy transition demand. Looking forward, it’s less clear that supply will be able to keep pace . . . structural shortages are possible around 2030 if companies don’t undergo greenfield investments.” Furthermore, copper presents the fewest opportunities to use technology to lower demand or increase supply.This reminded me of a line that Saad Rahim of Trafigura told me he uses when talking to government and corporate officials: “You need to worry less about the rare earths and more about the boring earths.” Still, Bridgewater doesn’t think sustained high prices are inevitable — just that to avoid them, new mines need to be dug, starting roughly now. Marcus Garvey, who runs the commodities strategy team at Macquarie, thinks this demand shortage will follow the pattern of previous ones: the market will find a workable supply-demand balance, but only after a significant price spike creates an incentive. “Who knows what the equilibrium price that will resolve this deficit is,” he says, “But we don’t just arrive at equilibrium. At some point you will overshoot it.”It’s not just new mines that a price spike would incentivise. He argues it is plausible that the amount of copper needed for an electric car could fall quite a lot — from nearly 80kg now to perhaps somewhere in the 40s — if the pressure was really on the auto industry to make it happen.Still, even with the possibility of a big move up in price three to five years in the future, investing in copper is not like owning a stock, he says. The history of commodities shows you can’t just buy and hold: returns on the big commodities indices have simply not been that good. That leaves investors in search of diversifying exposure to commodities with the complexities of the options markets. More on that from Unhedged in the coming weeks.One good readHere’s a hard job.FT Unhedged podcastCan’t get enough of Unhedged? Listen to our new podcast, hosted by Ethan Wu and Katie Martin, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on past editions of the newsletter here.Recommended newsletters for youSwamp Notes — Expert insight on the intersection of money and power in US politics. Sign up hereThe Lex Newsletter — Lex is the FT’s incisive daily column on investment. Sign up for our newsletter on local and global trends from expert writers in four great financial centres. Sign up here More

If 5.25 per cent represents a “new normal” for UK interest rates, what does this mean for income investors? The Bank of England has paused its interest rate rises but, despite signs of inflation easing, many economists believe higher interest rates are here to stay.For income investors, used to buying shares that deliver dividends or professionally managed funds and investment trusts that do the same, high rates available in cash present a challenge to their strategy. You may be asking yourself or your financial adviser: “What’s the point of being in equities if I can get 6 per cent, or more, in the bank?”At the time of writing, National Savings and Investments (NS&I) is still smashing the competition with two products for savers prepared to fix for a year: the Guaranteed Growth Bond offering 6.2 per cent interest, and the equivalent Guaranteed Income Bond, which offers monthly interest. The savings bank is 100 per cent backed by the Treasury, making it a great option for savers with larger amounts. The Financial Services Compensation Scheme (FSCS), for example, only covers up to £85,000 per institution, so those saving with larger deposits can enjoy further security through the NS&I.Among mainstream banks, Aldermore Bank offers a two-year savings rate at 6 per cent; with RCI Bank, you can receive 5.85 per cent over three years — the top rates available, according to independent data provider Moneyfacts.Meanwhile, savers looking for flexibility can turn to Shawbrook Bank, which this week increased the rate on its Easy Access savings account to 5.02 per cent for savers with at least £1,000 to invest. A monthly interest option is available too. Incredibly, 8 per cent is also available for savers who want to save diligently up to a maximum of £200 each month. Nationwide Building Society has launched a new regular savings account, the Flex Regular Saver, available to new and existing current account customers at this table-topping rate. When the “risk free” rate looks this attractive, you may also be asking if there is any point in taking a risk to diversify into other sources of income?But even at these high rates, cash has downsides. The consensus is that interest rates are either peaking or have peaked, so 6 per cent is unlikely to be available next year when the bonds or deals mature. So you’d either have to roll over into a lower-paying account, or start investing in equities again.Meanwhile, unless you’re in a cash individual savings account (Isa), where the rates are slightly lagging behind ordinary savings accounts, you’re likely to be taxed on savings interest over the personal allowance at your marginal rate. The best one-year fix on a cash Isa is from UBL UK at 5.77 per cent, The personal tax-free savings allowance now stands at £1,000 for basic- rate taxpayers and £500 for higher-rate taxpayers. And for these people — taxed at a marginal rate of 40 per cent — a 6 per cent return becomes 3.6 per cent after tax. That’s not even close to beating Consumer Prices Index inflation at 6.8 per cent.Of course, now the Bank has paused its rate rises, the top savings deals may quickly disappear. But if they go, there are other ways to get low-risk income.Ben Yearsley, director of Shore Financial Planning, says: “I have been taking money out of higher-paying accounts and putting it into gilts.” He is attracted by the tax-free nature of capital growth on gilts, many of which are trading under par, which means there’s a gain on offer if you hold them to maturity. “If the majority of the return is tax-free, you’re making more money on gilts earning 5 per cent interest than cash earning 6 per cent,” he says.But let’s consider what someone relying on income from their investments for many years into the future actually needs. They want to take as high an income as possible today, while seeing the original money invested (the capital) growing to match or preferably beat inflation. And advisers say the only thing that can do that for you is equities.It’s a case of having less jam today for more jam tomorrow. Yes, you can get a better headline rate on cash today, but you won’t see that improve. Equities, on the other hand, can give you an inflation hedge over the medium to long term.Take the City of London Investment Trust, famous for raising its dividend every year for the past 56 years by investing in UK equities. It has a dividend yield of just over 5 per cent, so not far off those savings accounts, and if you hold it in an Isa or a self-invested personal pension (Sipp), it would be paid tax free. The trust’s dividend growth of 2.6 per cent in the past year did not beat inflation. However, over the past 10 years dividends from City of London have risen by 41.2 per cent, while the cumulative effect of CPI inflation has been just 26.5 per cent.Investors in equities, or funds that invest in them, have to be prepared to see their original money fluctuate in value, and riding out downturns is never easy. But the dividends paid consistently from the investments are the reward for that.Plus, remember that a 7 per cent tax-free return doubles your money over 10 years. Charles Schwab, the US bank, projects US large-company stocks will return 6.1 per cent a year over the next 10 years, compared with 7.6 per cent for international large-company stocks. For UK equities, Job Curtis, fund manager at City of London, says: “I would see dividend growth being in the low single digits. Longer term, you can be confident of total returns of 7 per cent per annum.”Yes, income investors are spoilt for choice today. But I think the way to look at the current bonanza for cash is that you can finally earn a return on your rainy day money. Most people are advised to hold 6-12 months of income or outgoings safely in the bank in case of emergency. For some families, it could be a large sum of £25,000 to £50,000. And for the past 14 years, you couldn’t earn anything decent on that.Looking at the potential for cash rates to fall from here, even today’s chart-topping rates don’t feel a good option for the bulk of your long-term savings. You’d be missing out on the potential for inflation-beating dividend and capital growth from shares. For long-term income investors, it’s hard to see a reason to retreat from equities.  Moira O’Neill is a freelance money and investment writer. X: @MoiraONeill, Instagram @MoiraOnMoney, email: moira.o’[email protected]. The author has a holding in City of London Investment Trust More

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