Savers could bear the hidden cost of the developed world's mounting debt burden as governments run out of easy ways to combat their leveraged balance sheets, Hugh Selby-Smith, co-Chief Investment Officer at Talaria Capital says.
Selby-Smith says the global economy is moving from a three-decade era shaped by globalisation, cheap capital and low interest rates, into a new era of political fragmentation and higher funding costs.
“The headlines are full of missiles, airstrikes and oil shocks, but the more important change for investors is happening in plain sight,” Selby-Smith says.
“Supported by falling interest rates, governments have accumulated substantial debt across developed economies to the point where further borrowing is limited and there is little political appetite to cut spending sharply or raise taxes significantly. That leaves one option which is rarely discussed openly, and that is to let inflation do some of the work.”
Selby-Smith says this is what investors call financial repression – when interest rates stay below inflation for long enough that cash and savings lose value in real terms, while the real value of government debt falls over time.
“If inflation stays above interest rates for a prolonged period, people holding cash lose spending power, while borrowers, including governments, benefit because their debt becomes easier to manage,” Selby-Smith says.
“In effect, what is happening is wealth is transferred from those who save to those who owe, with governments the major beneficiaries.”
Talaria says years of globalisation has delivered reduced levels of global poverty, lower prices for consumers and more efficient supply chains, but has contributed to wealth inequality, trade imbalances and public debt. At the same time, governments are focusing more on economic self-reliance and security.
Selby-Smith says in an environment where the gap between real and nominal growth is higher the market is likely to place greater value on businesses that are generating significant levels of free cashflow, where funding is tighter investors ought to place a higher value on getting paid back their investment faster.
Talaria continues to favour short duration, real assets, strong balance sheets and diversification. Over the nine months to March 31, real assets including gold, commodities and infrastructure have performed strongly, while short-duration bonds have outperformed long-duration bonds.
“Investors who expect the next ten years to mirror the previous decade risk being caught off guard. What worked in a world of abundant capital may not work in a world defined by competition for capital,” Selby-Smith says.
"The system is changing and so must investors. Those who recognise this early and prioritise resilience and value over speculative growth stories that we’ve become accustomed are likely to be better placed in the years ahead."
