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A Review Of Current Risks Part 2

I’m still trying to get my head around what’s going on in the world and more importantly where things are going, so I can act accordingly with my investment strategy. I wrote up an article a couple of months ago outlining the current risks as I saw them, but I think it’s time to review that and think about which risks are important to my strategy.

I think the current risks remain, which can be broadly categorized as inflation (resulting in recession) & wealth destruction. Ultimately I’m looking to mitigate the risk of being unable to repay my hefty mortgage due to increases in OCR / mortgage rates, while keeping my investments if possible. Let’s look at the cause of each and whether things are going to change.

Wealth Destruction

This is being caused by the falling stock market and falling house prices. The fall in the stock market is caused by fear of inflation. The cause of the house price fall is possibly due to government policy enabling people to build more property and (more significantly) restricting banks from lending.

Inflation

Causes of inflation are mainly around COVID and war, but may also be affected a little bit by the “wealth effect” from being at the end of an investment boom in property and shares (less significant). The concern is that inflation will increase costs and decrease consumer demand, which will decrease profits and maybe cause a recession.

Things affecting inflation are numerous:

  • Oil and food price increases from the lack of supply due to the Russian invasion of the Ukraine. This will likely persist for years.
  • Deflation of the value of cash resulting from money printing during COVID lock-down. It seems unlikely that this will be wound back.
  • Shipping cost increases, possibly caused by increased oil costs and labour supply issues.
  • Wage inflation due to lack of supply of labour. I’ve not understood this one until recently when chatting with a friend, who hypothesized that it’s not that companies are demanding more labour because of demand on their company; rather, employee output has decreased, so employers need to hire more people to do the same jobs that they had before. My friend believes that employee output has decreased because of COVID measures and attitudes. I.e. If an employee is sick, all healthy contacts may not be able to go to work (you can lose a whole department to that). Additionally attitudes towards taking sick days have changed: Managers are happy to allow days off without question and employees are willing to take a day of due to the slightest suggestion of a sniffle. I believe this is likely to continue until job scarcity causes employees to value their jobs more, which may happen if there’s a recession.

Wage inflation is an interesting one, because while it’s a bad thing for business costs, it seems to be the only thing keeping people spending (holding up the economy) during this time of increased costs and financial risk from increases to the OCR.

How Can Inflation Be Stopped?

Conventionally, inflation is stopped with monetary policy; specifically increasing the OCR. However, as long as people’s salaries keep going up, they’ll keep spending more because interest rates will be less of a factor for them. Therefore OCR increases cannot solve this problem without causing a recession.

The only other way I can see wage inflation stopping is if people’s attitudes towards COVID measures change and productivity increases. The idea that we all need to work more to reduce our salary is ironic. I feel that this is an unlikely scenario.

Predictions And Actions

Clearly it all boils down to how central banks across the world handle the inflation. It seems as though the options are:

  • Continued inflation and the economy ticks along until COVID attitudes and measures relax. Possible hyper inflation (my feeling is that hyperinflation is unlikely).
  • Recession caused by high OCR (mortgage cost increases)

My focus will be to keep an eye on the rate of increase of OCR vs the rate of wage inflation, which will be used to help decide whether or not exit my more liquid investments. In terms of my income, I will try to be the best, most valuable employee I can be (so I keep up with the wage inflation) in a company that looks like it will be robust through a recession (so I can keep my job). I will continue to try to exit my largest private equity position so I can clear all my debt and become financially independent. I will try to reduce my debt by paying more of my salary into my mortgage and become slightly more frugal if things look like they’re taking a turn for the worst. I may consider selling more liquid shares to reduce my debt risk, as information presents itself.

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