Spending Power

David Coombs, Head of Multi-Asset Investments, Rathbones

Soaring costs are starting to bite for households and businesses all over the world. Rathbone Multi-Asset Portfolios fund manager David Coombs discusses how it could affect investment and energy markets.

Along with the gut-wrenching devastation among the Ukrainian people that we are all watching with horror, the Russian invasion has set off a chain of consequences that have spread through many markets. These have affected investments, but they are also strongly felt in our everyday lives as well.

It’s starting to hit people already. My family and friends are talking about how much more they are paying for power, in a throwback to the 70s dads are turning the heating down and telling the children to put on another sweater.

This is a large rise in costs for households and it’s compounded by the simultaneous jump in the price of filling up the car. Of course, oil is ubiquitous for producing, packaging and transporting most goods, so it can have a broader impact on spending power too. I think the UK is most at risk from this slowdown, given the other issues it’s struggling through and its lack of strategic reserves and alternative options for generating power.

We were quite early – about halfway through last year – in getting concerned about inflation smouldering on for longer than many expected. To protect ourselves, we substantially built up our investments in commodities. This position has risen steeply in just a few weeks because of the huge and widespread rise in commodity prices.

Problems come from shadows

It’s the ripple effects of one thing to another that really cause the problems with investments, and these spiral out from the most unexpected places. You never know which card will fall first, and whether it will upset the whole house. Every crisis has an asset class that’s the fulcrum. In the 1990s it was emerging market currencies that crumpled after hot money pumped them up with debt and ran for the door. In 2000 it was the original “irrational exuberance” over internet stocks. In 2008 it was the unexpectedly huge parcel of pain that was wrapped up in supposedly risk-free pools of mortgage-backed bonds and the credit default swaps that insured them. What makes these singular problem points ‘crises’ is how far and hard their consequences spread.

While we’re definitely living through a humanitarian and geopolitical crisis – and a time of rising costs for families and businesses – we’re not in a financial crisis. However, you can see stress starting to build in the system, and this stress is most acute in commodities. Moves in the prices of commodities and their derivatives have been so large and violent that it’s hard to decide whether to increase exposure or cut it back.

Lessons learnt

Despite the risks, I’m reassured that the financial system is in a tidy shape. The world has been through a few existential shocks in the past couple of decades, which has taught central bankers and policymakers lessons that remain fresh. Capital regulations for banks, insurers and clearing houses have been bolstered, making them much stronger and able to deal with unexpected shocks. Also, these days policymakers are quick to act, greasing international finance and keeping businesses and households supported in times of unexpected stress.

I don’t think the spike in commodity prices will be a short-term thing. There will be ups and downs in spot prices that will roll on depending on the news of the day. But I think the most crucial change will be many nations completely reviewing their strategies for food and energy supply and security. The repercussions of this would last for decades. It could mean that countries accept higher prices to ensure they are getting their energy and food either internally or from solid allies.

Of course, this would mean much higher investment in Western nations to ensure they can extract their own raw materials and create their own food – and ensure that they can hit climate change targets and improve yields while doing so. As it has been since the dawn of mankind, better technology will be the answer to this conundrum.

Also, a wide-ranging reappraisal of the transition to renewables may be coming. Not the imperative of doing so – virtually everyone agrees on that. Instead, we may have a much better – a more realistic – discussion about how we wean ourselves from carbon-heavy power while keeping the lights on at a reasonable price. This undertaking is much more complex than we have all acknowledged. It involves stable international relations, thoughtful policies, a more cohesive strategy and massive investment in technology and infrastructure. This is welcome.