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  • Writer's pictureInvestment Synergy Team

How to grow your savings in the light of inflation by investigating smaller firms

Updated: Jun 10, 2022

Economic woes make it hard to know what to do with your savings.

Mark Baker, the head of research at 5i Research UK, June 9, 2022 7:00 am (Updated June 9, 2022 7:01 am)

There are no silver linings in the UK’s increasingly cloudy economic skies. GDP is now shrinking, investment is down, the trade deficit is at record levels and productivity, the only true driver of better living standards, began to fall again in the first quarter.

Even the welcome gleam of record low unemployment is tarnished by a huge drop in self-employment and part-time working, leaving the workforce half a million smaller than pre-Covid.

Oh, and there’s inflation. A lot of inflation. With poetic irony, it’s now the highest since Do You Really Want To Hurt Me was Number 1 in the charts in 1982.

The UK is not alone, though by next year the IMF expects our economic suit to look rather more threadbare than our neighbours’ as the twin chills of more tax and higher interest rates whistle through the buttonholes. Simultaneously attempting to repair the public finances and tame inflation is bad news for living standards.

The inflation problem is the most pressing. It was shocking to hear the Governor of the Bank of England admit he was “helpless” since most of the pressure on prices comes from corners UK interest rates cannot reach – surging energy and food prices rippling through global supply chains. Second-round effects are on the way, however.

It is nevertheless grimly reassuring that old truths about inflation are finally reasserting themselves after a decade chronicling increasingly baroque “new paradigmism” of why it would never return, accompanied by ever more rococo policies to jolt a lacklustre economy to life.

Well, it’s inflation that’s alive and kicking now. Put simply, there is too much money chasing too few goods and services. Not only did quantitative easing flood the world with cash, but governments also competed to be the biggest spenders during the pandemic.

At the same time, the supply of goods and services fell off a cliff as the global manufacturing and trading system seized up, and as many workers have downed tools permanently and given up the daily grind. The war in Ukraine has compounded the supply shock.

Financial markets have been busily adjusting to a dose of the truth serum, too. Vast excess global liquidity sloshing around at near-zero interest rates in the last few years reduced the cost of taking risks. That pushed up the value of risky assets and encouraged speculation in frivolous nonsense like bitcoin.

Now there’s a reckoning. Crypto was first to crack. Far from being immune to inflation or other kinds of economic risk as its blinkered evangelists pretend, bitcoin and co have proven they’re very, very sensitive to rising risk aversion.

Bond yields went next as investors worked out how much rates have to rise to choke the inflation beast. Bonds issued by the riskiest companies or flakiest countries fell furthest in price in a welcome return of differentiation between the safest and most speculative options.

Equity markets quickly shrieked in fright at rising bond yields and duly marked down prices, hitting the jam-tomorrow tech stocks most – especially those like Netflix and Uber that may never produce any jam at all. House prices might be next. Meanwhile gold’s pedigree as a safe haven has had its mettle successfully tested, too.

It is hard to know what to do with your savings in such an awful environment. Cash does not provide shelter – deposits will lose nearly a tenth of their value this year in real terms. Ouch! Income stocks are often a good refuge when economic growth is absent and inflation is on manoeuvres, however.

Transaction data from Calastone, a large global funds network, shows that retail investors have cottoned on to equity income funds of late, having shunned them for years. Companies with strong cash flow are prized in today’s environment, especially if they can pass rising costs on to customers or actively benefit from high energy prices.

Shell, BAT and AstraZeneca are just a few that meet some of these tests and help explain why the FTSE 100 has held pretty firm this year even as the tech-heavy Nasdaq has slumped by a quarter.

Janus Henderson tracks global dividends and expects the world’s firms to dish out a whopping £1.2trn this year. Payouts have grown six per cent per year on average in the last decade or so, even despite the pandemic. Dividend growth is associated with capital gains over time, too, so it’s a have cake/eat cake option. As a one-stop shop, investment trusts are especially useful to income-seeking investors.

There are plenty that offer a diversified, global portfolio plus they can smooth the ups and downs in dividends from one year to the next to generate a steadily growing stream. Link Group’s forthcoming Investment Trust Monitor expects investment trusts to generate £1.92bn of income for shareholders this year.

Markets will anticipate the recovery before it comes and will start to hunger for a bit more risk before long. Smaller firms will be one place to look when that time comes. Recent research from the European Smaller Companies Trust, an investment trust, shows that smaller firms have grown their profits four times faster than big ones over the longer term, yet valuations have remained attractive. Rapid growth at low prices is a recipe for long-term gains.

In the immediate future, the Bank will raise rates further. It cannot contain energy and food prices, but it can head off a dangerous wage/price spiral, even though that will dent the job market.

It will be a bumpy few months and with no crystal ball it is quite likely that policy will overshoot, making the landing harder than it needs to be. Still, we should be relieved that more conventional monetary policy is right back in vogue and some of the more fanciful influences are on their way out. Coincidentally, As It Was is topping the charts today – a reminder that sometimes the old ways are better.

Investment Synergy - Hey big spenders, or money money money...... government spending, despite good intentions has consequences.

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