«Means & Purpose» – Good money for a good life
Luke Sustala
You are reading an excerpt from the «Means & Purpose» newsletter. At «Mittel & Zweck» we want to put aside the very German tradition «you don’t talk about money» and talk to you about finances – and how you can shape your future with a good plan and the right tools. You can subscribe here. And here you can see what you’ve missed so far.
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But now to today’s edition. It’s about the stagflation – what it is and how you can protect yourself from it.
topic of the week
Financial self-defense against stagflation
For the first time in our lives, as young adults, we face a period of stagflation. The term describes a Period of high inflation and low growth.
Such an episode is no longer an abstract danger. This week, the most important German economic research institutes estimated in their joint diagnosis that Germany 2022 a “high and initially still rising inflation” have to expect. Inflation is expected to come in at 6.1 percent, according to the release, and growth of 2.7 percent is expected, driven by the post-pandemic recovery. In the event of an energy embargo, the inflation rate would even be 7.3 percent and growth just 1.9 percent. According to the economists, this forecast is still subject to a high degree of uncertainty – i.e. it could even be too optimistic.
High inflation, no interest
There is a big difference from the stagflation phase that our parents experienced in the 1970s, when two oil price shocks wiped out much wealth. Namely, that we start with zero to negative interest rates – that makes a huge difference. The last time inflation was so high in Germany, so were interest rates. The last time inflation was 7.5 percent year-on-year was in 1981, but long-dated government bonds then yielded over 10 percent a year to maturity (see chart).
We are miles away from that now. Long-term yields are rarely in positive territory, and there is no interest on savings accounts either. The European Central Bank (ECB), whose council met today, is also still a long way from normalizing interest rate policy – and thus no real help in protecting your savings from inflation. Despite the high inflation, the ECB is sticking to its expansive monetary policy (as reported by NZZ colleague Michael Rasch).
The vast majority of analysts are now expecting the first rate hikes to take place soon. However, there will be no positive real interest rate – interest rate minus inflation – for several years to come.
What you can do about stagflation
- Discipline instead of shock. In the phase of stagflation there are no more excuses. You need a plan for your finances. If you can put money aside, don’t just put it in an overnight rate account because it will devalue comparatively quickly due to mini-interest rates and mega-inflation. So: Set up a savings plan based on your investor profile and your financial resources. Implement this savings plan in a disciplined manner, with standing orders that turn your savings into a real investment month after month.
- Market power pays off, dreams of the future less so. Many analysts are recommending being a little more cautious with stocks these days – because stagflation is not an easy situation for companies either. But there are some who are better prepared than others: Those who have great market power and can pass rising prices for energy and other inputs on to customers, i.e. us, will probably be better able to defend their profitability. On the other hand, growth stocks in particular could suffer because their future profits are now being discounted at a significantly higher factor due to expectations of inflation and interest rates.
- Rely on real assets, not just pure paper. Equity ETFs, real estate investments and commodities such as gold offer significantly greater protection than nominal investments or guaranteed products in phases of stagflation. In view of the still extremely low interest rates, bonds are already under considerable pressure, but the extremely loose monetary policy of the central banks has prevented bond investors from suffering major losses on the capital markets until recently. An extreme example, however, shows the direction in which things are headed. The Austrian ultra-long government bond, which expires in 2086, has lost 43 percent (!) of its value since its peak in the summer of 2021. German government bonds have also fallen massively, and 10-year yields have meanwhile risen from -0.5 to +0.77 percent. Although this is far from compensating for the expected inflation, it is a massive increase in interest rates after years of falling interest rates.
- Mixing of raw materials is mandatory. As discussed in our gold newsletter, commodities are often an asset class that bucks the negative trend during periods of stagflation. Commodities therefore provide diversification – protection in the event that there should be significantly more negative inflation shocks in the near future and stocks and bonds then lose value at the same time. There are three options: physical investments, investments via funds or investments via gold mining stocks.
- Fix low interest rates for real estate. If you want to finance a property, you should do it sooner rather than later and also try to get a fixed interest rate. Because it can be assumed that interest rates for new loans will gradually go up. You should no longer bet on long-term low interest rates with a variable-rate loan.
The first phase of stagflation in fifty years would be a first for the financial markets, because central banks are literally starting from scratch. Uncertainty will therefore remain high in the coming weeks and months.
It is all the more important that you keep an eye on your own financial goals. It’s like a turbulent swell on the high seas. It is important to focus on a distant, stable target in order not to get seasick. Monthly fixed savings plans or other projects help to have enough equity saved for a property. What does not help: waiting for the ECB to raise interest rates quickly.
Here you can find more on the topic:
Thank you very much for your attention! If you have any questions or comments, feel free to reply to this email.
Good buy!
Luke