Benel Lagua l June 16, 2023 l The Manila Times
THE new rounds of inflation experienced worldwide are eroding the value of savings. Real return on investments equals the nominal rate less the inflation bite. Those who have banked on returns from their pot of assets find themselves challenged as the purchasing power based on returns have been diminished.
Central banks have been increasing interest rates as their main tool for fighting inflation. The problem of inflation these days is that they are basically supply driven, borne out of geopolitical fragmentation, the pandemic and aggravated by the tragic war in Ukraine. The costs of fighting inflation have thus become heavier. Interest rate increases especially in the US have dragged global markets. Banks are expected to tighten their lending standards as the interest rate hikes continue to tighten liquidity conditions. The shock will lead to higher unemployment rates and gross domestic product (GDP) slowdown.
The predicted lower output has increased the risk that the US economy will suffer from a recession in the next few months and for profits to fall. US stocks remain expensive, trading at high price-earnings ratios (P/Es).
The Philippines is doing better with first-quarter GDP growing by 6.4 percent. Our stocks are relatively cheaper at lower P/Es and earning reports of listed companies have been better than expected. Still, we cannot discount the effect of contagion and the slide of the peso to the P56 level. The risks remain.
With higher interest rates, investors will have to aim for higher expected returns. Philippines inflation for April has remarkably improved to a lower 6.6 percent. The downtrend is most welcome, but the absolute nominal rate will still put pressure on the investing public. Most analysts believe that while eventually the inflation rate would be tamed, it will still settle at a level higher than pre-pandemic levels. We will have a structurally higher inflation level, with its stickiness predicted to stay at the 4- to 5-percent level.
Investors will have to find real returns above this stickiness rate. Their portfolio would have to compensate them enough to maintain undiminished consumption levels in the future. This means mixing the investment mix and improving diversification efforts.
In the long run, equity investments have proven to be good hedges against inflation. There is a natural aversion domestically because our PSEI’s year-to-date gain has been miniscule. Notwithstanding, analysts are confident that unlike the US, we are not exposed to recession risk. And listed domestic companies continue to report profits.
One of the dire effects of higher interest rates is the growing impatience of investors. This leads to a bias for the short run and the more predictable results. There is, of course, nothing really predictable when it comes to investment returns. Just the same, immediate pain has shifted sights to the near term.
Another clear need at this time is to build a liquidity pool from one’s portfolio. The lessons of the pandemic opened the eyes of many to the need to have a clear portion set aside for emergencies and for unpredictable economic downturns.
This development does not augur well for innovation and pioneering undertakings that need time to generate results. Distant returns will be frowned upon even if worthy of support. Risks on technology and small startups will be viewed as being on the high side. This short-sightedness cannot be helped but should also be tempered. Investors with excess funds should not lose sight of the developmental need to invest in innovation and trailblazers.
The astute investor will not be blamed for the undue care in viewing risks. Rationale thinking tilts the preference for a mix of stocks and bonds that are biased toward the shorter term. Firms that are well capitalized, with enough foundation to repel the negative effects of volatility, will naturally be favored.
But the history of investments shows that one must still take the long view. It still will pay to invest in promising stocks. Investors should demand higher compensation for holding long maturity bonds. Diversification must be approached conservatively, outside of stocks and bonds, into other instruments including commodities and real estate. Warren Buffett once famously said, “If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.”
And if the long run will prove the markets right in the overall, index investing is still a good way for a large number of investors to at least make the average return. As finance history has taught us, it is difficult to beat the market consistently.
*** Benel de la Paz Lagua was previously EVP and chief development officer at the Development Bank of the Philippines. He is an active Finex member and an advocate of risk-based lending for SMEs. Today, he is an independent director in progressive banks and in some NGOs. The views expressed herein are his own and do not necessarily reflect the opinion of his office as well as Finex.