Investors Weigh Risk and Reward Amid Market Volatility and Shifting Fiscal Policies
As investors grapple with the implications of Donald Trump's recent US election victory and its potential impact on growth and inflation, a pressing question emerges: Is this an opportune time to shift from fixed-income investments to risk assets like stocks and shares? In an interview with Yahoo Finance Future Focus, Charles Stanley Direct chief analyst Rob Morgan offered his insights on how investors should approach this decision amidst market volatility and shifting fiscal policies.
Navigating Market Volatility: Fixed Income vs. Risk Assets
"There's been a huge amount of volatility in bond markets just lately," Morgan noted, referencing the market reactions following Trump's election victory on November 5th. Expectations of higher fiscal spending and tariffs have driven inflation fears, historically unfavorable for bonds. However, Morgan warned that the market may have already priced this in. "Bond prices have moved to reflect fewer interest rate cuts going forward," he said. "It is a bit of a case of whether the horses are already bolted in terms of a tactical move away from bonds and into risk markets."
Morgan emphasized that despite the recent rally in equities, fixed income still holds value, particularly for income-focused and cautious investors. "The value we see in the bond market, having had that move with yields in the sort of 4.5% region for government bonds, compensates quite well for the inflationary risk," he said.
Understanding Economic Trajectories: A Key to Investment Decisions
Morgan highlighted the importance of assessing economic trajectories when evaluating investment opportunities. If inflation doesn't surge as markets anticipate, bonds could deliver both a steady income and potential capital appreciation. For this reason, he advised maintaining fixed income as a core component of balanced portfolios.
"For cautious investors, or those who are income-oriented, fixed income is a good place to be," Morgan said. "Less relevant for younger investors focused on share markets, but crucial for balancing assets in a portfolio." This highlights the challenges of adjusting investment strategies in a volatile market, where the choice depends on factors such as risk tolerance, investment time frame, and outlook on the broader economic landscape.
The Role of Fiscal Drag: A Stealth Tax
Fiscal drag occurs when tax thresholds fail to rise in line with wages, pushing more earners into higher tax brackets. Morgan noted that this has been happening for a very long time, citing the UK's personal allowance and higher rate threshold as examples. "Let's take the UK tax bands as an example," he said. "The personal allowance has been frozen since 2021, as has the higher rate threshold of just over £50,000. As wages rise, and these thresholds don't, more people are paying higher taxes—a sort of stealth tax."
Morgan highlighted the long-term impact of this policy, noting that while only 3.5% of UK taxpayers fell into the higher rate band in the early 1990s, that figure now stands at 11%. This emphasizes the need for investors to consider the broader economic landscape when making investment decisions.
Navigating UK Inheritance Tax Changes
The recent Labour budget included a contentious measure: the inclusion of pensions in inheritance tax (IHT) calculations starting in 2027. This could double the number of estates subject to the tax. Morgan noted that this was a "bombshell" for people using pensions as an IHT shelter.
"The combined nil-rate band for couples is £1m, but with modest family homes and pensions, many will now find themselves caught by this tax," he said. Morgan offered practical advice on mitigating the impact of inheritance tax, including gifting, gifts out of surplus income, and more sophisticated techniques involving trusts or business property relief.
Conclusion
In conclusion, investors must carefully consider their investment strategies in light of market volatility and shifting fiscal policies. While fixed income still holds value, particularly for income-focused and cautious investors, risk assets may offer medium- to long-term gains. However, the choice depends on factors such as risk tolerance, investment time frame, and outlook on the broader economic landscape.
Morgan's insights emphasize the importance of assessing economic trajectories and understanding the role of fiscal drag in shaping market conditions. By considering these factors, investors can make informed decisions about their portfolios and navigate the challenges posed by a volatile market.