Will Britain go broke?

So it’s been a busy few weeks.
 

We have had what many are considering a 🦇💩 budget.
 

Since then, The Bank of England has warned of faster rate rises. One of the many measures of trying to offset the currency decline. The depreciation in Sterling will only add fuel to the fire of inflation, which for Central Banks at the moment is the only game in town.
 

With the UK being a net importer of goods, if we buy more goods than we sell and now we have to pay more for the things we buy, that will find its way into prices.
 

Just watch Martin Lewis’s description of the budget. Factually accurate and also the answer to: “Siri, show me a version of someone screaming directly from their eyes?”

Markets did not like the proposals of the mini-budget AT ALL. With the gilt yield spiking. Typically due to UK bonds being sold and supply increasing, or expectation of a high level of new issuance.

The price and yield move in opposite directions.  From the government’s standpoint, the issue of rising rates is going to affect future borrowing costs. Not ideal when you’ve just made some huge tax cuts which you'll need to fund through borrowing.

The most interesting and perplexing aspect is that we have the fiscal policy directly contradicting the monetary policy. The politicians are enacting measures to increase spending while the Bank of England trying to reduce this.

We have reached the COVID hangover. 🤕 Where spending and supply chains wake up to the morning after. It looks pretty grim. Rumours over the weekend of trouble at Credit Suisse. The sentiment is not good.

Risk is what you don’t see 🫣

Like many in finance have done this week there was a deep dive into the world of ‘liability-driven investments.’ These are the risk mitigation (hedging) mechanisms that some large UK pension funds use to match future liabilities. Anyway, they do this for reasons you can explore on a technical level here if you’re interested.

The impact of the gilt yield spike caused issues with the plumbing of how these funds manage liabilities. Worth reading this excellent piece from Frances Coppola on the REAL reason for the Bank of England’s gilt market intervention.

It is important to remember, that the Bank of England’s intervention was concerning. With defined benefit schemes the actual liability rests with the sponsoring employer and it is ultimately they who would meet any unmet liabilities. In essence, if BPs pension fund needs an injection of cash due to issues with the liabilities of the scheme. BP the company (the sponsoring employer) are liable to meet this. So both would have to become insolvent to risk falling on The Pension Protection Fund.

Morgan Housel in the Psychology of Money talks about how ‘risk is what you don’t see.’ No better example of this than liabilities-driven investment by pension funds. Not exactly the type of areas most are looking at.

Negative Events World Service (NEWS) 📰

Pension funds being liquidated had elements of truth, but the headlines were misleading at best.

The energy crisis was unfathomable for most individuals until the cap.

The job losses that COVID would have caused were truly catastrophic until furlough.

Subprime losses in 2009 would have caused the new great depression until governments stepped in and balance sheets were underwritten.

Our debt levels in the UK will increase, but we still have the lowest debt-to-GDP ratio in the G7.

For the sake of our personal, mental, financial and behavioural selves. We must not let ourselves get swept away into extrapolation. Extending each problem to its worst-case scenario and discounting our ability to adapt in the interim. Things are never as good or as bad as they seem. 

“I've had a lot of worries in my life, most of which never happened.” - Attributed to Mark Twain 

Make no mistake, I feel we have some tough times ahead, but we have to focus on what we can control. Our own personal and financial situation. Most of what we take from outside events we have no influence on whatsoever.

“You have power over your mind – not outside events. Realise this, and you will find strength.” - Marcus Aurelius 

What hasn’t changed

Every day the leaders and workers of the best companies in the world wake up to succeed despite these global challenges. This is what you invest in via globally diversified investing. Some companies will fail, and some will innovate and succeed. This is why we diversify investments.

The most dangerous words in investing are ‘this time it’s different.’

The aim is to be a rational optimist, understanding the reality that things can be both painful and difficult over the short term but still progress over the long term.

From here we have 2 simple options:

Option 1

We could abandon our plan, sell out of our investments in the temporary decline and buy back when they are more expensive.

Option 2

We understand that despite how painful these declines are, they are part of the journey which we exchange for the long-term return.

So no, Britain will not go broke. Things are never as bad or as good as they may seem.

Things are going to be tough.

Thankfully for the patient investor, so are they.