Opinions on a possible perfect storm

hallmark

An update, all eleven of the asset classes mentioned above have now fallen, most have fallen further than before.  Thus far at least, what's happening confirms my suspicions outlined originally: an everything bubble caused by insane money printing.

BND Total Bond $77.00 > $75.76

S&P500 4392 > 3753

Nasdaq 13351 > 11036

FTSE100 7600 > 7049

FTSE250 21100 > 18362

iShares UK Property £6.61 > £5.33

iShares EU Property £32.56 > £24.73

Bitcoin $40549 > $19464

L&G All commodities £12.59 > £12.21

iSHares physical gold £29.34 > £28.92

iShares physical silver £18.64 > £15.52

masonic

None of those falls you have indicated are anything out of the ordinary. Just the sort of falls you would expect to see happen every few years. You've not captured the woes of long-dated bonds prior to April in your summary above, obviously that was in the past when you started your thread, but is worthy of comment now the extent of the fall is evdent. This is the exception, as the asset class has fallen further than has been seen in over 90% of pull-downs. Bonds were without a doubt subject to such losses when interest rates rose. They were long considered return free risk prior to this.

I had previously pointed to towards understanding the difference between long and short dated bonds shortly after you started the thread. Even long dated bonds have fared ok since April, losing a few percent, with periods of ups and downs in between. Short dated bonds have pretty much flatlined. We are at or nearing the time where longer dated bonds could once again serve a purpose. Oil prices falling give the first indication of inflation starting to ease and recession becoming the next theme. This will necessitate an easing of monetary policy, which will tend to reduce interest rate expectations and drive up bond prices. The second potential cause of bond prices rising is a flight to safety if the threat of recession solidifies. This would mark the return of an inverse relationship between bonds and equities if we get to that point.

hallmark

I happily (well, unhappily) confess to having a poor understanding of Bonds.  Or at least to understanding what makes them go up or down, as the stuff I've seen doesn't seem to match what happens.   Here's a good example, perhaps somebody can explain this to me:

I expected inflation to take off a long while before most commentators or any central banks did, i.e. a couple of years ago (not saying this to try to sound clever, just to give context).  So I began to research inflation-linked gilts as that sounded like the perfect investment if inflation was indeed to take off.

A bit of research told me that inflation-linked gilts aren't necessarily good in high inflation: it has to be HIGHER than expected inflation.  OK I could understand that.

Here's the thing.  I think it's reasonable to say that since January 2021 inflation has been higher than expected.  And yet when you look, for example, at this inflation-linked fund over that timeframe, it's fallen from £216 to £184.   Not only that, in the previous 7 months it's fallen £246 to £184.



https://www.vanguardinvestor.co.uk/investments/vanguard-uk-inflation-linked-gilt-index-fund-gbp-acc/price-performance

I don't understand how an inflation-linked fund performs so badly during inflation that's not only high but also higher than expected.  What's the point of an inflation-linked fund in that case?  and in what circumstances would it actualy do well?

This is something I'd like to understand as obviously I'm misunderstanding something basic

Linton

hallmark said:

I happily (well, unhappily) confess to having a poor understanding of Bonds.  Or at least to understanding what makes them go up or down, as the stuff I've seen doesn't seem to match what happens.   Here's a good example, perhaps somebody can explain this to me:

I expected inflation to take off a long while before most commentators or any central banks did, i.e. a couple of years ago (not saying this to try to sound clever, just to give context).  So I began to research inflation-linked gilts as that sounded like the perfect investment if inflation was indeed to take off.

A bit of research told me that inflation-linked gilts aren't necessarily good in high inflation: it has to be HIGHER than expected inflation.  OK I could understand that.

Here's the thing.  I think it's reasonable to say that since January 2021 inflation has been higher than expected.  And yet when you look, for example, at this inflation-linked fund over that timeframe, it's fallen from £216 to £184.   Not only that, in the previous 7 months it's fallen £246 to £184.



https://www.vanguardinvestor.co.uk/investments/vanguard-uk-inflation-linked-gilt-index-fund-gbp-acc/price-performance

I don't understand how an inflation-linked fund performs so badly during inflation that's not only high but also higher than expected.  What's the point of an inflation-linked fund in that case?  and in what circumstances would it actualy do well?

This is something I'd like to understand as obviously I'm misunderstanding something basic

Why have inflation linked gilts fallen so much....

IL bonds are competing against normal bonds of the same duration.  If the inflation rate is expected to be higher than the current long term interest rates people could prefer to buy IL bonds purely for the greater gain.  This would push up the price of the IL bond.  Conversely if interest rates were higher than expected inflation IL bonds would be cheaper.  Market forces would ensure that the prices were set such that the gains to maturity would be similar.

Now here is a grossly over-simplified calculation which demonstrates what is happening.

Assume a IL bond  has a 20 year duration and long term inflation is expected to be be 3%. 7 months ago (end Nov 2021) the 20 year interest rate was 0.956%.  If the creation price of the bond was £100, this would imply a fair value cost of  £100 X 1.03^20/(1+0.00956X20)=£152 fot the IL bond. Note that inflation is compounded whereas gilt returns are not.


Now the 20 year interest rate is 2.5% and assuming the markets long term inflation expectation has not changed this implies a fair price of £100X1.03^20/(1+0.025X20)=£120.

So a 21% fall.  Which, bearing in mind my made-up figures and over-simplification, is surprisingly close to your 7 month fall of 25%.

Linton

PS this does demonstrate the dangers of market timing and trying to predict the future.

hallmark

So would it be correct to say that the longterm nature of UK inflation-linked gilts effectively makes them (despite the name) pretty useless as any kind of hedge against, let's say, two or three years of high inflation?

And conversely, they might actually do WELL in low or reducing inflation, depending on other factors?

newatc

About 18 months ago I decided inflation was going to become a problem and bought a sizable(for me) amount of Vanguard UK Inflation fund referred to. A few months later there was a thread on this subject when a knowledgeable contributor (I think Dunstonh) said these funds were more complex than generally understood and were not recommended for normal investors. 
The fund didn't sit well with my overall strategy and with that view expressed I sold it and placed the money elsewhere. 

Linton

hallmark said:

So would it be correct to say that the longterm nature of UK inflation-linked gilts effectively makes them (despite the name) pretty useless as any kind of hedge against, let's say, two or three years of high inflation?

And conversely, they might actually do WELL in low or reducing inflation, depending on other factors?

1) Index linked bonds do not attempt to provide a hedge against short term inflation.  That is not what they are intended for.  They protect against long term inflation and so are essential for such roles as paying DB pensions.
2) You dont buy index linked bonds "to do well".  If you want to do well you should buy equity or possibly some other more niche investments.
3) In my view UK IL bonds are not appropriate for most small private investors.   I believe US IL bonds could be interesting to a sophisticated UK investor since they are more readily available for  medium or short term durations and have been less volatile than UK IL bonds since US interest rates have been less volatile.

masonic

hallmark said:

So would it be correct to say that the longterm nature of UK inflation-linked gilts effectively makes them (despite the name) pretty useless as any kind of hedge against, let's say, two or three years of high inflation?

And conversely, they might actually do WELL in low or reducing inflation, depending on other factors?

It makes an index fund useless when interest rates must also rise from historically low levels (a huge relative change). It does not make shorter dated gilts useless, but these must be bought individually - there is no short dated index linked gilt fund.

There are two opposing factors:

1) Higher than expected inflation --> positive contribution

2) Higher than expected interest rates --> negative contribution

Which wins out depends on the duration of the fund (and for longer duration, the timing of inflation expectations vs interest rate expectations).

If you buy short dated gilts and hold to maturity, you get a fixed nominal return + inflation linking, which is what most people are looking for. The overall return would be inflation plus X% when held to maturity. X has been negative, but as interest rates rise, it has moved towards positive territory for new buyers of individual gilts. Many would have been happy to take inflation minus 2% when it was available a year ago with the benefit of hindsight that RPI would rise to over 10%.

An index linked gilt fund would have gained 20% in the period between Feb-Dec 2021. This would have been a period when inflation began to be anticipated and was well ahead of any central bank guidance on interest rates going up.

TonyTeacake

hallmark said:

To give a little perspective, I am 50s, own outright, and not posting with any agenda, as I don't honestly know the best way out of the situation we're in, all roads out look pretty grim to me so just interested in hearing other opinions.

My position is similar to yours.

I believe this rampant inflation is just getting started and is going to cause a major recession. We will see many people lose jobs which will lead to a huge housing crash. I don't believe this will play out overnight, but come winter, we will start to see major economic cracks. Due to all this money printing, all the markets have been on steroids for the last 2 years which is in no way sustainable. Injecting all of this money into the economy has created too much activity but it's not based on anything, this is why it is going to crash big time because the supply of printing money is finished and the economy is already slowing down. UK GDP figures are the worse out of all G7 countries.

BOE and the Tories cannot tame this inflation which they said was transitory (short lived) and now they have finally admitted it is way out of control. They are playing catchup and I'm certain like I've said before they will start being more aggressive in raising interest rates, the days of cheap borrowing are over as people in the UK have personal debts which have hit record highs which have never been seen before.

I believe one of the main reasons for Rishi Sunak resigning is he can see that the economy is heading for a battering and he doesn't want to take the blame, especially after the damage he has already caused with nearly 6 billion pounds lost to fraudulent claims and playing a big part waiving stamp duty which as greatly contributed to this housing bubble we are in. The government is falling apart because they all know we are heading for a disaster. 

This crash will be much worse than 2008.  It will be carnage.