Inflation: a horror story in the making

The UK economy, and its capital markets, stand on the edge of a precipice marked inflation. If that seems like hyperbole, consider how much is crucially dependent on today’s ultra-low interest rates. Swathes of British industry are being kept alive because debt servicing costs are so low. House prices, driven up by tax breaks, are being sustained by a mortgage price war among the banks. Awash with cash, they are fighting for borrowers who are categorised as “low risk” by the authorities.

Both public and private sectors are hooked on the drug of almost-free money. We are sufficiently addicted that we can somehow claim, with a straight face, that a Bank rate of 0.1 per cent is some sort of new normal, that money will always be available to tide us over, and besides, even if rates double to the dizzy heights of 0.2 per cent, it will make almost no difference.

This is dangerous nonsense, and if the Bank of England’s Monetary Policy Committee was truly independent, it would have started raising rates already to head off rising inflation, as its remit demands. In fact, it has not even stopped the last of quantitative easing, that device to disguise money-printing. A couple of the MPC members are in hand-wringing mode, but none has yet voted for higher rates. To an outsider, this looks very much like regulatory capture: the Bank may be nominally independent, but the treasury is in effect calling the shots.

It’s not hard to see why. The National Debt may be high, but the post-dated cheques will really only start to be presented next year. Should the cost to the government of funding its deficit rise by just one per cent, it will add £700m to the new borrowing needed, and a rise of one per cent would be only the start. Should the semi-captive buyers get spooked and strike, they might start demanding a return on their money that exceeds inflation. In the US, headline inflation has already passed five per cent, and forecasts here of more than four per cent are no longer dismissed as scare-mongering. This also has a knock-on effect on the cost of servicing index-linked debt.

The idea that this is merely a passing surge in prices before stability resumes looks more fanciful by the day. The most fundamental cost of all, that of energy, is rising strongly, and is set to go on up. Thanks in part to the dramatic cuts in exploration and production budgets forced upon the oil majors, “worldwide oil demand may match or exceed world-wide pumping capability, including OPEC pumping full out,” according to a study by Goehring & Rozencwajg. Grant’s Interest Rate observer describes this as “a bull market both great and rare.”

It would mark the end of the 40-year bull market in government bonds and its associated equity boom. Jonathan Ruffer, who can remember it starting, is confident it is over, although the precise timing of the turn is impossible to predict. His unlovely metaphor compares today’s financial position to “sitting on an open AGA with bare buttocks.” We are near the end of silly money “because events have conspired to close off any escape route from the impasse which the whole world faces. The inescapable problem is that of indebtedness.”

There are already some signs of nerves in the debt markets. The yield on the 10-year gilt is at a two-year high. At 1.07 per cent, it is still well below the rate of inflation, guaranteeing losses for long-term holders. The rule of thumb for corporate failure is that things get worse slowly, and then suddenly. You may not time the moment, but like Ruffer, you may be confident it will come.

Let others buy these shares

Collins’s first rule of investing is: do not buy a share that has been listed on the public markets for less than a year. Considering that any healthy stock market requires new companies to join, to replace those which fail or are taken over, this seems to strike at the heart of what investing is all about, especially after a bumper year that has seen £14bn raised in London so far. But the arrival of another business, while good for the market as a whole, does not mean you have to rush in.

In theory, the prospectus that must accompany an issue of shares is as comprehensive a document as a company will ever publish. In practice, there are well-paid advisers whose bonuses depend on a successful sale and who will stress that opportunities like this one do not come around often, hinting that the offer price may never be seen again. Above all, the insiders doing the selling know far more about the business than even the most detailed prospectus can tell you.

This week saw a particularly painful demonstration of that first rule. Just over a year ago The Hut Group came to market at 500p a share. Dazzled by the prospect of a British digital champion, buyers started the shares trading at 600p, and ran them all the way to 800p in January. This week, after a catastrophic day of the company failing to explain what the business was about, the shares have collapsed to 270p.

THG, as founder Matthew Moulding has renamed it, is a classic, if extreme, example of investors getting carried away with the prospect of something they don’t really understand, but are caught up in the excitement. For a gem of this genre, the prospectus for Aston Martin remains as classic as the cars. It implied that the dream brand would rub off on the shares. It didn’t. Floated in 2019 at the equivalent of £10,000 each (sic), the shares now cost £18.

The impulse that took some investors into THG, that they really ought to have exposure to technology stocks regardless, has helped foreign exchange transfer group Wise, cyber-security group Darktrace, and DNA sequencers Oxford Nanopore to healthy premiums over this summer’s flotation prices. All look like proper businesses with fine prospects. Not owning them might prove expensive, but if they are really that good, they will still be there to buy after the anniversary of their flotation.