TSI #18: The UK Odissey: what is happening?!
Oct 23, 2022Hello Stoic Investors,
Today we talk about the current situation in the UK and a new potential investing opportunity.
Since a surprising tax cut announcement last month, everyone in UK started to create chaos:
Politicians changed their minds every day,
The central bank intervened heavily on the market,
Investors got more and more confused.
These are our ingredients of 4 weeks of craziness in UK.
Why does this even matter?
Because any turmoil creates investing opportunities.
And so we will see how we can benefit from the situation.
So today we will talk about:
- What actually happened in the last 4 weeks in UK
- What we can expect going forward and how to profit from the situation
Let’s go!
1. What happened in the last 4 weeks in UK
Let’s summarize the story in 4 key moments:
1️⃣ UK Government announces tax cuts
On 23rd September, UK government announced a budget plan which included the biggest tax cuts in 50 years.
These included a tax cut for basic income from 20% to 19% and a higher income tax shifting from 45% to 40%.
It was immediately clear that these tax cuts would have mainly benefit rich people and corporations.
Even worse, the government was planning to finance the plan with debt.
£411 Billions over the next 5 years to be precise. It’s… A lot.
2️⃣ Investors are NOT happy with the plan
What do you do when you are not happy with a company you are invested in?
You sell!
And that’s exactly what can happen with nations as well.
If investors are worried about a nation growth, they sell their two main assets: currency and government bonds.
In UK case, they started to heavily sell the pound and UK government bonds (GILTs)
As a natural consequence, two things happened:
- The British pound hit a record low against the dollar & other currencies.
Why is that?
Andrea & Jamiee explained from @stocksandsavings explained it well:
A weaker pound is a big problem for a nation like UK, which imports the majority of goods & services.
For example, oil and gas are priced in dollars. If you can buy less dollars with pounds, it also means that you can buy less oil and gas.
In other words, it makes key goods & services even more expensive!
- As second consequence, the UK bonds were deemed riskier by investors. When an investment is riskier, you expect a higher return to “accept” to bear that risk.
Investors not accepting the higher risk sell off their UK bonds.
Investors buying the UK bonds will accept to do it only at a higher expected return to be compensated.
And so UK bonds yield raised from 3.13% on Sept 18th to a maximum of 4.46% on Oct 10th.
An increase of 1.3% in less than one month is crazy for a “stable” asset as a government bond!
3️⃣ The Bank of England steps in
Financial institutions were losing faith in the pound and the UK economy.
Therefore, the Bank of England stepped in to stabilize financial markets.
They can do so by buying the same UK bonds that investors were heavily selling - in order to counter that effect.
4️⃣ U-Turn from the UK government
After this huge backlash, the UK government scrapped the more controversial tax cuts benefitting higher income classes.
Together with the support of the Bank of England, they were able to partially reverse the trend:
- The British pound recovered to $1.13 (one month ago was $1.15)
- The GILT interest rate for 10 years bonds fell to 4.04% (one month ago was 3.13%)
2. What’s next?
Is everything back to normal?
Not really.
When a government goes back on its word, it’s a terrible signal for financial markets.
If big investors do not trust the decisions of a government, the related economy can suffer.
However, I strongly believe that the UK economy is resilient in the long term.
There are two alternative ways you can take advantage of the situation as investor.
And by the way this is true for investors in all countries, as similar interest rates trends are happening all over the world:
- The safe approach: taking advantage of the high base interest rate.
At the moment of writing, the interest rates offered by the Bank of England are at 2.25%.
This means that high yield saving accounts are now offering better returns too!
So I would look for these accounts and move my emergency fund there, to at least partially offset inflation while still having my money available.
- The riskier approach: invest gradually in national bonds for the long term.
Bonds are becoming more and more attractive this year.
If you are fine to keep these bonds for 10+ years, while getting a guaranteed return around 4% per year, this is the way to go.
Just keep in mind that interest rates are likely only to rise from here, so consider to invest your money in them gradually to capture higher and higher interest rates!
That’s all for today.
I know that this topic can be complex, therefore feel free to reply to this email if you have any question, I will be happy to answer!
