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Watch out for inflation in 2018

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Summary

Our latest weekly investment update reveals how inflation could really hit investors this year

2 min read

Inflation down but not out

As part of our investment outlook for 2018 – Investing Through Disruption – we highlight inflation as a key challenge for investors this year because of its corrosive effect on the spending power of cash and the value of low-yielding bonds.

Since deposit rates for cash and the yield on government bonds in most developed economies is lower than inflation, investors with substantial holdings in either will find the value of their wealth steadily eroded and their spending power diminished.

Over the last two years inflation has, for the most part, surprised markets by staying low. We expect it to bounce back up a little in the US and Europe this year, while it has so far peaked at just over 3% in the UK. A revised inflation figure for the UK is expected this week but, whatever it is, the damaging effects of relying on cash and government bonds remain.

Our outlook, published this week, highlights how we look for ways to overcome this in our investment strategy.

Monique Wong, Multi-Asset Investment Manager at Coutts, says: “In our search for inflation-beating returns we favour segments of higher-yielding bonds like financial credit – yielding over 5% – and emerging market debt. More broadly, the combination of the economic growth backdrop and valuations favours equities, where dividend yields are solid – 4.2% for the UK’s FTSE 100 – and earnings are growing.”

Investing Through Disruption identifies our investment convictions for 2018 and five key challenges we think will define the investment landscape in the year ahead. It also looks at emerging trends that could affect our clients’ long-term wealth, such as technology and inequality.

“Since deposit rates for cash and the yield on government bonds in most developed economies is lower than inflation, investors with substantial holdings in either will find the value of their wealth steadily eroded.”

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A merry Christmas for retailers?

There has been a wave of Christmas trading announcements from UK retailers showing a mixed bag of performance. The festive season saw upbeat trading at John Lewis and numbers above expectations at Next, but profit warnings from Debenhams and Mothercare.

At Coutts, we have very limited direct exposure to the UK retail sector. Low consumer confidence – largely due to inflation outstripping wage growth over the last 12 months or so – has seen people spending more cautiously and profits from retailers fall.

With relatively less cash in their pockets, consumers are increasingly resorting to credit, according to the Bank of England. Data up until the end of October shows total unsecured consumer credit rising consistently and reaching over £205bn. This is another cause for concern when it comes to the retail sector as those depending on credit may need to adjust their spending in future to service their debts.


Europe’s success story continues

There were further reminders this week of why Europe remains one of our preferred regions for equities.

Eurozone industrial production rose 1% in November, ahead of expectations, and the region’s unemployment rate fell to 8.7% – its lowest level since 2009.

Also, the German economy grew by 2.2% in 2017 according to the country’s Federal Statistical Office, its fastest pace in six years and its eighth consecutive year of growth, European equities were among 2017’s best performers in sterling terms. We believe there is still room for prices to rise as the pick-up in economic activity supports consumer spending and increased investment by companies. At the same time the European Central Bank has indicated that any monetary tightening will be gradual.

Past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.

About Coutts investments

With unstinting focus on client objectives and capital preservation, Coutts Investments provide high-touch investment expertise that centres on diversified solutions and a service-led approach to portfolio management. Our investment process is as disciplined as it is creative – ensuring tailored solutions with robust results.

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