Inflation is eating up our savings
The dangerous illusion of ‘safe’ interest rates
By Thomas Meier and Christos Sitounis, Portfolio Managers at Mainfirst
The euphoria of global investors about the return of interest rates mirrors that of a desert traveller glimpsing a long-awaited oasis. Savings rates in Europe have climbed to a new high of over 13% - a level only seen during the pandemic. However, a change in allocation is necessary simply to achieve the sole objective of saving, namely the preservation of the purchasing power of assets.
Over the past few years, enormous sums have been poured into interest-bearing assets around the world, including record inflows into money market funds. Over the past five years, inflows have more than doubled. In the US. alone, more than USD 8 trillion have flowed into money market funds, with nearly EUR 2 trillion in Europe. In contrast to the more volatile equity markets, global investors have moved significant amounts of money into perceived safe havens.
Overall asset allocation shows that cash and deposits account for 41 % of household financial assets in Germany.1 In Belgium and the Netherlands, the share of cash and deposits is around 30% and 20% respectively.2 But they are not alone; the eurozone average is around 35%. Including insurance, pension and standard guarantee schemes in Germany – which for regulatory reasons are mainly invested in interest-bearing assets – fixed-income investments represent roughly three-quarters of financial assets. Belgium and the Netherlands have a better pension system with a higher equity ratio. If only bonds and life insurance are included, the ratio is around 45% in Belgium and 25% in the Netherlands.3 Savings rates in Europe have climbed to a new high of over 13% - a level only seen during the pandemic.
Dwindling appeal: a closer look at ‘safe havens’
Against the backdrop of ongoing global conflicts and results of the U.S. election, safe havens currently offer an attractive short-term investment environment. However, the interest rate turnaround initiated by the ECB and the FED, as well as ongoing disinflationary pressure from China, have significantly reduced their appeal compared to equities. Once again, investors face an investment landscape that, from a real(-list) perspective, resembles an illusion. For example, the ten-year German government bond yields 2.3%, while Swiss bonds return 0.4%. In real terms, after deducting inflation, an investor is left with 0.6% interest growth in Germany and -0.4% in Switzerland. A similarly bleak picture is emerging in the US.
Against the backdrop of weaker global growth rates, falling inflation rates and declining interest rates the investment profile is inadequate for real wealth preservation. In addition, inflation is likely to remain at a structurally higher level due to demographics, potential trade conflicts and the continued rise in commodity prices. Sooner or later, it will become increasingly clear to investors that, despite intensified saving efforts, a change in allocation is necessary simply to achieve the sole objective of saving, namely the preservation of the purchasing power of assets.
Time to change course
It is expected that, despite global conflicts, investors will shift some of their interest-bearing assets back into equities, particularly from money market funds and overnight deposits. These huge investment sums will face investment pressure to be deployed as central banks continue to ease monetary policy. This should benefit equity markets, and dividend stocks and funds stand to gain in particular. The conservative approach of dividend funds, combined with distributions that exceed inflation and interest rates, will regain appeal compared to the broader equity market.
Dividend funds: the path to sable income
Dividend funds offer the advantage of holding cash-rich companies, often from defensive sectors. In addition, most companies have restructured their balance sheets after the pandemic and adjusted their cost structures to inflation developments. Although market participants point to high equity indices, these are largely dominated by a few stocks. The current high market concentration of some stocks, especially in the technology sector, is represented in the US by the "Magnificent 7" and in Europe by the "GRANOLAS" stocks. We anticipate that economic normalisation in the US and Europe will broaden stock performance, benefiting battered segments like small and mid-cap companies (SMEs).
It's important for investors to consider a long-term allocation based on real, inflation-adjusted return expectations and not to give in completely to the illusion of nominal interest rates.
1 Source: Bundesbank
2 Source: Haver, European Central Bank, Morgan Stanley Research
3 Source: Haver, European Central Bank, Morgan Stanley Research
