Page 30 - DIY Investor Magazine | Issue 38

Aug 2023 30
DIY Investor Magazine ·
QD VIEW – DIVINING HIGHER INCOME IN AN INFLATIONARY ENVIRONMENT
The outlook for the UK equity market looks particularly depressed: inflation is stubbornly high, surprising many commentators who expected to see it tumble as energy costs wane – by Matthew Read
Higher inflation brings higher interest rates, which it seems,
will persist as the UK’s central bank tries to cool the economy. Bank of England base rate is 5% - its highest for 15 years – with commentators expecting a peak as high as 6.5%, bringing higher mortgage rates, and greater government borrowing costs; it recently sold £4bn of October 2025 gilts, at 5.668% - the highest since the Debt Management Office was established in 1998.
Already weak, UK finances are deteriorating, as government debt rose above 100% of GDP in June - the first time since March 1961, and the highest in over 62 years – and there are plans to sell £241bn of gilts this year, up from £139bn in 2022; there is much for people and markets to worry about.
PERSISTENT INFLATION – IN PART A PANDEMIC HANGOVER
One reason inflation has remained high relates to the pandemic, when some workers left the workforce permanently; this reduced the pool of available talent, sustained higher employment levels, and put upward pressure on wages. ONS says average weekly pay increased by 7.4% in the year to April 2023.
The finance and business services sector saw the highest growth at 8.3%, followed by construction at 6.2%, but some commentators think wage inflation may actually be higher and has not yet peaked. If so, an environment of higher interest rates may be with us for some time, something that investors in search of income, will have to adjust to.
REAL-TERMS EROSION OF SAVINGS
Higher inflation can be both a blessing and a curse for the income focused investor. Meagre in the post-GFC period, yields on bonds and savings accounts have perked up significantly
as inflation has risen. Some banks now offer 6% on deposits but, with inflation at 7.9% in the year June, savings are still being eroded in real terms.
‘THERE IS MUCH FOR PEOPLE AND MARKETS TO WORRY’ ABOUT’
DEBT VERSUS EQUITY
Investors have sold down equities to buy bonds, which makes sense given the returns that they have achieved. Bond funds have held up better than UK equity funds in the short term (0.86% over six months vs. – 1.64% for equity). Over 12 months, returns are comparable : 3.65% for bonds vs. 3.12% for equity, but over three years, UK equity income has provided a median return of 6.99% p.a, around two-and-a-half points ahead of debt at 4.48%.
Despite its near-term performance, debt is not necessarily a long-term solution – over 10-years, UK equity income has given you an extra 1.13% per annum compound and, in an inflationary environment, equity tends to outperform.