Savers are being hit by brutal forces

Allister Heath
IF you want to feel the full effects of inflation, try buying a bar of chocolate at your local newsagent, a sandwich near your office or even a shirt for work. It’s incredibly depressing. Prices have shot up. For savers and investors, the name of the game remains wealth preservation: how do you prevent inflation at a 20-year high, increasing tax and global uncertainty from wiping you out? Even hedge funds are failing to keep up, with many highly paid managers failing to deliver an acceptable return, as we report on page one.

This challenge is made even harder by the fact that capital gains tax, which this government increased to 28 per cent, is no longer indexed to inflation. This has introduced a deeply perverse and unfair bias into the tax system, which this newspaper warned about at the time. Imagine that you owned an asset for the past year that you manage to sell for a 5.6 per cent gain – the rate of retail price index inflation. In real terms, you are not better off; yet you still have to pay a 28 per cent tax on the capital gain above the tax-free threshold. You are paying tax on a meaningless inflationary gain, which means that the tax system has turned into a wealth tax, forcing people to hand over a chunk of their assets rather than a chunk of their gains.

So what can be done? History is of limited use. Looking back over the past 38-odd years, Fidelity, the fund manager, has calculated annual returns on different asset classes – bonds, stocks, commodities and cash – depending on the phase of the economic cycle, such as reflation, recovery, overheating or stagflation. Given recent events, the year ahead will most likely be characterised by stagflation, in the UK at least. Historically, under stagflation, bonds lost 1.1 per cent a year, stocks lost 14.9 per cent, commodities surged 29.6 per cent and cash lost 0.8 per cent. That pattern is pretty clear – yet unfortunately it is of little help. Commodities are unlikely to rocket next year; globalisation has broken some historical correlations; and equities would only lose this much in the event of a real Eurozone implosion or banking meltdown. There are, unfortunately no simple answers.

Gold will do well if inflation remains high and central banks continue to boost liquidity around the world – but the yellow metal’s recent woes were caused by investors being forced to sell out as a result of margin calls triggered by declines in other assets. Once again, a key traditional relationship broke down. Other commodity prices will depend on how well China and the US are doing; there is growing evidence that growth is slowing in China, with possibly traumatic consequences. Equities will continue to be all over the place – but stocks that pay a high dividend are likely to outperform.

Gilt yields could fall further thanks to QE, pushing up capital values – but that would merely further fuel a bubble that will eventually end in complete disaster. One story last night showed just how absurd and irrational the situation has become: Goldman Sachs has just sold $500m worth of 50-year bonds paying just 6.5 per cent interest. Yes, you read that right. Investors were so desperate for yield that they lapped up the issue. The cost of borrowing has fallen to absurdly cheap levels, and savers are the ones who are paying the price. Grim times.
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