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Stimulant dispensed at wrong time

So, the Bank of England has cut interest rates, citing slower household spending and business investment. As something of a contrarian, I cannot help believe that a rate cut at this point in the economic cycle only intensifies the risk that rates will have to increase more aggressively in future.

I can understand the reasons the monetary policy committee may have for wanting to reduce rates. It is well aware of the sensitivity of the housing market and consumers to monetary policy and has no desire to let either category suffer unduly, especially as both are clearly starting to cool down. Given the renewed threat of terrorism, consumer caution is unlikely to ease in the short term. But UK interest rates are at long-term lows and the economy – not just in the UK but globally – is awash with cheap money.

This has had a range of effects, from the perspective of an income manager. Cheap debt has fuelled corporate actions, notably leveraged buyouts,mergers and acquisitions. Jupiter income trust has benefited from holding a number of these targets, such as RAC, Pillar Property and Mersey Docks & Harbour.

However, low interest rates have also led to extremes in asset prices, such as property and high-yield bonds. Bond yields are also extremely low for this point in the economic cycle, which has helped fuel the rally in equities.

Adopting a policy of falling rates risks reigniting excessive confidence at a time when many consumers should be repairing their domestic balance sheets. Given that many consumer-related stocks are coming back down to reasonable valuations, the timing does not seem right from an investment perspective, either.

Likewise, the housing market is showing signs of a soft landing, successfully engineered by the MPC, and does not need any stimulation at this point, in my view.

There is a further issue for income investors. With public-sector spending slowing and consumers looking overstretched, it is time for companies to start reinvesting for the future. There is a significant lack of fixed-capital formation in the UK now. This is not because companies are not generating enough cash to reinvest but because they prefer to return this money to shareholders through increased dividends or, alternatively, to buy other businesses.

Naturally, rising dividends are positive in the short term for income investors but there needs to be a balance between returning cash and reinvesting in operations.

A recent Item Club report pointed out that business investment levels have fallen at a time when there has been a strong recovery in company finances. Its conclusion is that the UK economy faces serious questions as to how it will wean itself off unsustainable levels of consumer activity and public-sector spending. It does at least believe that companies will soon start to sanction increased capital expenditure, which may eventually help to even the balance.

However, if monetary policy does ease off too soon, my fear is that a reinvigorated consumer sector will continue to mask a problem that needs addressing.

Nor do I think that inflationary pressures are off the radar, even if rate cuts do not reignite consumer spending. We all know about the continued strength in oil prices but other commodities are exacerbating the situation. Copper has also been hitting all-time highs recently. Cost pressures are there but are being contained for now.

However, I am broadly positive on equities. Corporate balance sheets are generally in good shape and, because many sectors are generating a lot of surplus cash, dividend growth remains strong, particularly in oils and telecoms. The stockmarket remains a more attractive home for investors’ money than any other asset class right now.


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