Virgin Media has been sending customers letters telling them their prices are going up. Really going up. This year they will are to rise 12 percent, and from April next year they are to go up by the retail price index of inflation — which is usually a good 1 percentage point more than the government’s official measure, consumer price index — plus an additional 3.9 percent. Every year.
That is audacious of Virgin, and irritating for hard-pressed consumers.
However, it is also a reminder of how sticky inflation can be: If everyone put their prices up by 5 percentage points more than the previous year’s inflation every year, how could inflation ever fall?
The latest Credit Suisse Global Investment Returns said that once inflation reaches 8 percent, and is front and center in the minds of all price-setters and wage negotiators, it takes multiple years to revert to target.
Thinking anything else is “overly optimistic.”
So, with inflation near or more than 8 percent in a large number of developed countries, what is an investor to do?
Buy equities — they are famously a wonderful hedge against inflation.
The Credit Suisse report — authored by Elroy Dimson, Paul Marsh and Mike Staunton — runs through the record. It is a good one. From 1900 to last year, stocks in the 21 countries with continuous records over the period have more than beaten inflation.
The US market has produced an average annual real return of 6.4 percent, while the rest of the world has seen a real return of 4.3 percent. It is good to know those kinds of numbers can be locked in.
However, there is bad news: There has long been a market rule of thumb that claims equities only like inflation up to about 4 percent. Beyond that, they do not like it at all.
It turns out there is truth in this. Dimson, Marsh and Staunton divided their data by years when inflation was in the top 5 percent, the next highest 15 percent — which saw average rates of about 7.4 percent — the 15 percent below that — 4.1 percent to 7.4 percent — and the 15 percent below that — still above 2.7 percent. Here, the results were rather different.
In the top 5 percent of high inflation years, equities fell an average of 9.6 percent in real terms — bonds fell 24.5 percent — and in the next 15 percent they managed a rise of a mere 0.7 percent.
Times of stagflation — which investors are right to fear — were nasty too: In low-growth, high-inflation environments, real equity returns were minus-4.7 percent.
These miseries might be about the inflation itself — creating loss of confidence and uncertainty— but the cure, rising interest rates, quite clearly plays its role, too.
For example, in the UK, equities have historically produced a real return of 0.7 percent during periods of rising rates, but 8.5 percent in periods of falling rates.
In the US, those numbers are 2.6 percent and 9.4 percent. In the main, whatever else is going on, rising rates leads to stock market misery — see all markets last year.
That said, there is also evidence that the cheaper equities are to begin with, the more likely they are to outperform in inflationary times, a thought that should immediately focus all minds on the UK market.
Twenty years ago, it was perfectly normal for investors to have too much of their assets in both equities and in the UK, but things have swung far too far in the other direction, investment company RWC fund manager Ian Lance said.
Most UK funds that consider themselves balanced, such as pension funds or wealth manager model portfolios, are likely to have only 10 percent to 15 percent of their assets in the UK equity market.
That reduction of equity exposure to the UK — and the relentless selling it suggests — “potentially explains why returns have been lackluster since 2000.”
Even when the FTSE 100 hit a new high of 8,000 last week, that represented a rise of only 15 percent since the late 1990s. The US is up 180 percent in the same period.
This makes little sense. After all, “one of the immutable laws of investing is that valuations and subsequent returns are inversely related,” Lance said.
If you have money in the US and no money in the UK, you are betting that this time it will be different — when it never is.
The UK also offers one of the few things — apart from gold — that really is a hedge against inflation: dividend yield.
The UK is not just one of the cheapest markets in the world, it is one of the highest yielding. The FTSE 100 yields 3.5 percent, but look inside and you can see the likes of Glencore PLC on about 8 percent, HSBC Holdings PLC on 4.3 percent, Rio Tinto PLC on 6 percent and Vodafone Group PLC on nearly 8 percent.
You might also look at the UK’s many “dividend hero” investment trusts, so-called because they have put their dividend up every year for at least 20 years, and have a good incentive to keep doing so.
Many offer yields over 4 percent. These yields are far from guaranteed, but they still offer a pretty good starting point for anyone trying to hang on to their purchasing power.
Equities might not be a perfect inflation hedge.
However, buy cheap and focus on dividends, and holdings should have some hedge about them. This is maybe why the FTSE 100 is outperforming the S&P 500 this year.
Finally, a note on savings. Before adjusting your equity portfolio, there is something even easier you can do to help your future self: Check the interest rate on your savings account.
There has been little point in bothering with this for years. Pennies do eventually turn into more, but it has been hard to drag up the enthusiasm to do the admin to move money around when the differential between offerings is 0.01 percent or less. It is now more like 2 to 3 percentage points, which should increase enthusiasm.
You can get a one-year bond from NS&I at 4 percent. Or you can really push the boat out and get 4.3 percent at Atom Bank. These are not numbers that are likely to beat inflation this year, but they could make a firm dent in it — in exchange for very little effort on your part.
Get started and you might be able to afford to keep your Virgin subscription, should you still want to.
Merryn Somerset Webb is a senior columnist for Bloomberg Opinion, covering personal finance and investment, and host of the Merryn Talks Money podcast. Previously, she was editor-in-chief of MoneyWeek and a contributing editor at the Financial Times. This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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