Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
WHAT happens in markets can often seem detached from real life. You’re unlikely to notice much impact from the Japanese bond market on your everyday goings-on, unless you’re pretty into your investing.
Unfortunately, few of us are able to escape the pain of a rising oil price. This is one asset whose movements are felt across the globe and where price volatility leaves its mark on everyone, whether you care about the world of investing or not.
How does the oil price affect me?
For most of us, our principle point of contact with the oil price lies in how much we pay for our petrol. As you’re probably aware, petrol ain’t cheap right now. Prices rose by 3.4p in July, marking the ninth monthly rise in a row. The RAC says that a driver filling up a 55-litre car now pays £11.47 more than they did a year ago.
Petrol prices are now at their highest level since 2013.1
No one likes paying more for their petrol, but unfortunately the story doesn’t end there. A rising oil price affects you in other ways too.
Oil is still the beating heart of our world’s economies, providing the bulk of the energy we use to drive our cars, power our businesses, heat our homes, and so on. When companies see a rising oil price add to their own costs and sap their profit, they may pass on some of the pain to their customers.
Take a supermarket that imports its food from across the world, sorts it in a warehouse and then distributes it via a fleet of lorries and vans to local stores and houses. The same black gold underpins every step of the process. If oil prices rise, that supermarket may choose to raise its own prices to compensate. Suddenly it’s not just petrol you’re paying more for - it’s your weekly grocery shop too.
In this way, oil and consumer price inflation often share a cause-and-effect relationship. It’s not an exact science, but history shows that where one travels, the other usually follows. Rising oil prices are like a hidden tax hike for businesses and, potentially, consumers.
What can you do about it?
Oil is driven by good old-fashioned supply and demand. After drying up at the start of the pandemic, consumer demand for oil shot up as lockdowns began to ease and economies rebounded. That process still has further to go, meaning demand is likely to continue rising over the short term.
The supply side of things is a little more complex. The world’s oil supply is largely controlled by OPEC (Organisation of the Petroleum Exporting Countries). When lockdowns ground the world to a halt at the start of the pandemic, OPEC decided to cease oil production to prevent the oil price from crashing further.
With things now reopening in parts of the world, OPEC has agreed to gradually relax production curbs in order to maintain a balance between demand and supply.
But OPEC’s cautious approach has drawn the ire of some - a member of the Biden administration earlier this week called on OPEC to boost production or else “risk harming the ongoing global recovery”.
This won’t be a simple story. Variants threaten to derail economies’ recoveries and so weigh on the oil price. Fears over the Delta strain have contributed to minor price falls in recent days. But, so long as the demand is there and OPEC remains cautious, prices will continue to climb overall.
Fortunately, oil is only one piece of a large inflationary jigsaw. Consumer price rises in the US and UK appear to be cooling, suggesting fears that we were moving into a new age of ultra-high inflation (à la 1970s) may be overblown.
Instead, investors should prepare themselves for a period of subtler price rises. Rather than blowing your money out the water, these have the potential to creep up on you like a stealth tax.
For those looking to keep ahead of that, certain assets can cope with inflation better than others.
The principal losers are cash and bonds. The rock-bottom interest rate levels earned on cash right now will be unable to keep apace with price rises. That will diminish the purchasing power of your cash over the long term. Similarly, inflation risks eroding the value of the fixed interest rate you earn on bonds.
Equities, however, tend to perform best in an environment of moderate inflation. Anything around the 2-4% mark would fit comfortably within the “goldilocks” bracket that’s just right for equity prices - not too much inflation, not too little. The Bank of England expects inflation to rise to 4% this year before edging back down toward the Bank’s 2% target.
Certain alternative assets can help too. Infrastructure may not be the most obvious port of call, but often the underlying cash flows in an infrastructure fund are linked to inflation. This means that when inflation goes up, so could those cash flows. That’s the thinking behind our Select 50 choice, the FP Foresight UK Infrastructure Income Fund.
It’s not all bad news for bond investors. While most bond funds suffer at the hand of inflation, inflation-linked bond funds actually benefit. The interest you receive on these bonds is linked to the inflation rate, as Adam Skerry, manager of the ASI Global Inflation-Linked Bond Fund, explained to us back in April.
Knowing how to protect your portfolio can help even through periods of moderate inflation. That’s not going to make it any easier to cough up at the pump, but it may help you keep your savings on track.
1 - RAC, August 2021
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. The Foresight UK Infrastructure Income Fund uses financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. The fund also uses currency hedging. Currency hedging is used to substantially reduce the risk of losses from unfavourable exchange rate movements on holdings in currencies that differ from the dealing currency. Hedging also has the effect of limiting the potential for currency gains to be made. The fund’s investment policy means it invests mainly in units in collective investment schemes. The ASI Global Inflation-Linked Bond Fund invests in overseas markets so the value of investments can be affected by changes in currency exchange rates. This fund also uses financial derivative instruments for investment purposes. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Due to the greater possibility of default an investment in a corporate bond is generally less secure than an investment in government bonds. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.
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