Financial resilience in 2023

Susannah Streeter: Hello and welcome to the Switch Your Money on Podcast from Hargreaves Lansdown - I’m Susannah Streeter - I’m the senior investment and markets analyst at Hargreaves Lansdown. And, as usual, I’m here with Sarah Coles, our senior personal finance analyst. And, Sarah – it’s that time of the year when we will have made and probably broken already quite a few New Year resolutions…Let me summarise where I’ve failed so far this year – my determination to run every day ended in the first week – unless you count running up and down the stairs every morning trying to get everyone out the door. And cutting down on my cheese intake – my excuse was that I didn’t want to waste the Christmas leftovers…I can’t resist a bit of blue or manchego – to cheer up the dull January days. And, of course, it would be wrong wouldn’t it not to pair it with a dash of red wine…

Sarah Coles: Well, that all sounds fair enough to me. You know, I’m a firm believer that you only start food-related resolutions when all the Quality Streets are finished. So, obviously, we’ve still got lingering strawberry creams so we’re fine for now! But this year financial resolutions have been top of the list for me, so my first resolution was to give up top-up shops – because you know when you go to the supermarket and you end up coming out with a trolley full of food. I’ll have to let you know how that goes, and how my family adapt to a week without coco-pops if I forget them.

Susannah Streeter: Yeah, muesli isn’t really that much of a substitute is it. Anyway, there are of course plenty of people who use this time of year to make financial resolutions – in our recent survey almost half of people said they were making financial resolutions this year – with the most popular to save more and spend less in order to build resilience. And that’s what we are focusing on in today’s podcast, our financial resilience, where we stand right now, and just what it means for the way we are going to save and invest in the months to come in an episode we’re calling Reading the Resilience Barometer.

Sarah Coles: We’ll be talking to Nathan Long, a senior analyst at Hargreaves Lansdown, who has been working very closely with the experts at Oxford Economics to build the HL Savings and Resilience Barometer. Nathan this isn’t just another survey is it?

Nathan Long: It definitely isn’t, it’s a huge piece of analysis, it brings together 16 separate measures from various official datasets and using modelling to build an overarching picture of people’s financial resilience. For example, from how much savings they have to whether they’re on track for a reasonable retirement income. It shows us where people are vulnerable, and the gaps in their finances. It’s also a model we can use to see the impact of big changes in the world around us. So, for example at the moment, the rises in mortgage rates.

Susannah Streeter: And our lead equity analyst, Sophie Lund-Yates is here as usual to tell us about some companies who have relatively diverse income streams to help increase their options as times get tougher. Sophie, there’s quite a mix here this time around isn’t there.

Sophie Lund-Yates: Hi, Susannah. Yes, everything from fast moving consumer goods to healthcare and a financial business.

Susannah Streeter: Thanks, Sophie, we’ll look forward to finding out more shortly. And Emma Wall, our head of investment analysis and research will be speaking to Daniel McDonagh, Head of European Portfolio Management at Pyrford International. And in a bit of a departure from our quiz, as a fresh start for the new year, instead we’ll be looking at one of the more unusual stats for the week.

Sarah Coles: But first let’s set the scene. We know that persistent inflation has been squeezing household incomes until the pips squeak, and that rapidly rising mortgage rates in the wake of the mini budget tightened the squeeze on anyone looking to buy a new home or remortgage. We also know that inflation in 2022 was led by increases in the price of day-to-day essentials. Food and non-alcoholic drinks continued to feed inflation - up over 16% in a year, while housing and household services were up almost 27%. It’s no wonder that the ONS found that six in ten people are worried about keeping warm at home and around three quarters are worried about the cost of living.

Susannah Streeter: A big part of the picture is that wages aren’t rising to keep pace with inflation. Inflation is running at double digits but average pay growth for state employees stood at just 2.7% in the year to August to October 2022, compared to 6.9% for the private sector. This problem has tipped over into waves of industrial action, with the transport network slowing to all but a standstill, with mass walkouts of rail staff and highways employees. It’s a precursor of more disruption to come with healthcare workers planning to cease work in protest again as the fight between public sector staff and the government intensifies. The stage is set for a pretty fraught year for industrial relations as unions bed in for the long haul and the government seem determined to resist demands, for now. And all of this is having a knock-on effect on businesses too. The pain of the hospitality industry is set to be prolonged, as town and city centres are set stay emptier for longer, which will be particularly onerous for the crucial lunchtime and after-work trade.

Sarah Coles: The pressure on our household budgets also means we’re changing our shopping habits, which is taking a toll on businesses. The ONS statistics showed that the most common response to rising prices was to spend less on non-essentials, with two thirds of people spending less. Meanwhile almost half were shopping around more and spending less on food and essentials. It means businesses are trapped between the ‘rock’ of rising input prices and the ’hard place’ of hard-pressed consumers.

Susannah Streeter: This feels like a good time to bring in Sophie Lund-Yates, who has been looking at companies with more options in tough times - specifically those with diversified operating models – so tell us more about this, what do you mean by that?

Sophie Lund-Yates: One of the benefits of a company which offers diversification is that these businesses can perform better over the long-term. Not being overly reliant on one product area or service can help smooth bumps in the road during tough economic times. Of course, as ever, please remember nothing is guaranteed. One area that can offer broad product diversification is big fast-moving consumer goods, or FMCG companies. These tend to offer a lot of consumer staples, sorry, my dog getting involved there, so aren’t too reliant on people spending discretionary income.

Susannah Streeter: It’s always good to have a dog on the podcast, Sophie. First up, tell us more about a US consumer giant that you’ve been looking at.

Sophie Lund-Yates: So, firstly I was looking at Procter & Gamble, which is US listed. P&G operates through five segments: Beauty; Grooming; Health Care; Fabric & Home Care, and Baby, Feminine & Family Care. It also has a lot of geographical diversification, with its products sold in around 180 countries and territories. The group’s brands include Herbal Essences, Pampers, Gillette, Fairy, Tide, Always sanitary products and a whole host more. The group’s biggest area by revenue is Fabric and Home Care, which makes up 35% of annual revenue. Last year, Procter & Gamble had total net sales of $80.2bn and operating profit of $17.8bn, giving margins of around 22%. By offering so many staples, revenue is a bit more reliable than some other businesses, and that helps the group pay dividends. Please remember that no dividend is ever guaranteed. As always, it can’t all be good news and the biggest challenge facing Procter & Gamble is the higher cost environment, or as we all know it, inflation. Ignoring the effect of exchange rates, first quarter net sales rose 7%, with the vast majority of this coming from price increases that it was passing on to its customers. That demonstrates that customers are willing to pay more for Procter’s famous and trustworthy brands. However, if inflation doesn’t start to temper, there will be a limit to how much the group can inflate its prices without seeing volumes drop further than the 3% dip seen recently.

Susannah Streeter: So interesting, we’ll be keeping, as always, a close eye on inflation. And what about banks, Sophie?

Sophie Lund-Yates: Banks can be a great way to gain exposure to different geographies. They tend to be economic bellwethers for the regions they operate in, meaning they have broadly tracked the ups and downs of the wider economy. If a bank has exposure to more than one region then in theory, one area can help pick up some of the slack when others are struggling. One UK-listed bank with major exposure to overseas economies is Standard Chartered. Standard is first and foremost an Asian bank, with Asia making up $1.1bn of the group’s $1.4bn quarterly operating profits. Within that though, the group also has hundreds of billions reliant on other countries across Europe and the Americas, and the Middle East and Africa, which adds diversification benefits. The other diversification benefit is the breadth of banking products Standard offers. It has large exposure to Financial Markets banking products like Macro Trading and Issuance services. There’s also Wealth Management and Transaction Banking in the pot, alongside traditional retail banking. This is a model we’re supportive of because it helps spread risk. It might not be a surprise to hear that at the moment, high exposure to Asia is causing some challenges. Non-cash impairment charges, relating to a weaker economic outlook, more than doubled to $227m in the third quarter. So, impairment charges can be when a value asset is written down, its value is lowered, or it can be provisions that are put aside in case a higher number of people default on their loans. More than half of this related to Standard Chartered's exposure to the struggling Chinese commercial real estate sector. Together with wider recessionary risk in Western markets means ups and downs are likely in the short-term – risk which has been recognised in a price to book ratio of 0.46, some way lower than the ten-year average and shows the shares are currently trading below the value of Standard Charter’s assets.

Susannah Streeter: And what’s the final stock you’ve been looking at this week?

Sophie Lund-Yates: It’s another trip back over the pond to the US, where I’ve been looking at Life Science and Healthcare giant, Danaher Corporation. Danaher designs, manufactures and markets professional, medical, industrial, and commercial products and services. Essentially, its various businesses offer products and solutions for everything from consumer packaging, drinking water purification, supply chain standards including checking the consistency of pharmaceutical products, all the way to scientific healthcare research and technologies. Honestly, I think it would be faster to explain what this company doesn’t do. These might not be the sort of essentials you and I think of, but they’re precisely the types of things big companies, pharmaceuticals, universities and medical schools need to pay for. That’s especially true in today’s more risk-aware and forward planning corporate cultures. The group has quarterly revenue in the region of $7.7bn, and underlying core sales were up 10% in the third quarter, which is testament to the essential and diverse nature of the business model. Danaher’s net debt pile of $19.6bn seems on the high side which is worth keeping in mind. The price to earnings ratio of 25.5 also suggests the market has taken the group’s strengths into account and has high hopes. Any shortcomings, like if the group were to miss analyst expectations, is likely to evoke a stronger-than-average reaction.

Susannah Streeter: Fantastic, thanks very much Sophie, some really interesting businesses there to watch in tougher times as consumers get more and more stretched. Those figures are from Refinitiv and are correct as at 3 January.

Sarah Coles: It’s also worth looking a bit closer at how we’re all being affected by the cost-of-living crisis – and perhaps even more importantly, at what the future holds in store. That’s something explored by the third instalment of the HL Savings and Resilience Barometer, published this week, so let’s bring Nathan Long back in, who has been getting to grips with the data, So Nathan, it paints a pretty grim picture of where we stand right now, but who is particularly struggling.

Nathan Long: Yes, the overview from the Barometer this time round is that our financial resilience has dropped markedly, with the average household score out of 100 dropping from almost 65 at the end of 2021 to just over 60 a year later – eating into three fifths of the boost we got during the pandemic from things like lockdown savings where we weren’t able to spend on the same things as we were before. But within this, there was a huge difference between higher and lower earners. Those on lower incomes were hit harder, because they spend a disproportionate amount of their income on the essentials - which have seen much higher inflation – we think at around 12% compared to around 6% for the non-essentials. The barometer looks at how much of people’s spending went on the essentials, and for low-income households, the burden of the essentials was far greater. At the same time, they were less likely to be sitting on any extra savings built up during the pandemic, so that when we hit the end of 2022, households with less income than average were actually in a worse financial position when it comes to savings than before the pandemic hit -compared to those earning more than average who continued to sit on a savings cushion. For those with no savings left, it raises the risk that this year will see more people on lower incomes taking on unaffordable levels of debt.

Sarah Coles: So, it does look pretty grim. And it’s not only those on lower incomes, there are other groups struggling aren’t there?

Nathan Long: Yes and there’s quite a lot of detail in our barometer, but a good example- we see much lower scores for single people – both with and without children – who are having to make a single income stretch further than perhaps 2 incomes in a household. Only 13% of single person households without children have very good financial resilience compared to 41% of couples with no children – so that’s more than three times the resilience. Some of the detail in the barometer also shows that people who make financial decisions with their partner tend to be more resilient than those who make decisions alone, so having a sounding board seems to help people find solutions during tougher times. We also know things are harder for renters and for younger households than you may expect, who tend to have less in savings and lower incomes on average.

Susannah Streeter: So that’s where we are now, but what about what lies ahead?

Nathan Long: Well the good news is that the squeeze is expected to be past the peak – so we think that happened as of now, so the future looks a bit rosier. The barometer looks at where spending becomes unsustainable – and forces people to either cut back, spend their savings or borrow a bit more, and while almost two in five people were in this position at the end of 2022, it’s expected to gradually fall back to just under a quarter at the end of this year. It’s still a significant chunk of people to be wrestling with their costs as we go into 2023, but it is going to fall back. The less positive news is that the squeeze we’ve had so far – and the squeeze that’s coming - all have a cumulative effect, so people who are struggling now may spend more and more of their savings or see their borrowing mount. Now, compared to before the pandemic overall we’re slightly better off – but those on lower incomes have less in savings than before the pandemic, and those on higher incomes have more. One notable trend is that we’re starting to see those on middle incomes feel the squeeze too, which has an impact on them personally – and of course an impact on businesses from how they have changed their behaviour too.

Sarah Coles: So, the barometer also lets you model the impact of external changes too doesn’t it? Like the rise in mortgage rates.

Nathan Long: Yeah it does. Those who need to remortgage this year face doing so at significantly higher interest rates, which is going to wreak havoc on both savings and debt. We’ve measured that their savings and debt resilience scores are forecast to drop by around 3 points. They’re also going to face far tougher challenges than people remortgaging after the end of the year, when we’re expecting mortgage rates to have fallen back, who are predicted to see their resilience scores drop less than 1 point. It also models the impact of falling house prices, although an awful lot will depend on just how far and fast prices fall. It’s not just going to affect people’s confidence and immediate financial position, it will also damage longer-term plans, particularly for working-age households, with the scores for being on track for a comfortable retirement forecast to fall 1.4 points for homeowners – compared to 0.2 points for renters. These falls are particularly striking among Gen Z and Millennial homeowners, who tend to have borrowed more to buy when house prices were higher.

Sarah Coles: Well, thanks Nathan that’s really interesting insight. I know more detail will be released on the impact of remortgaging on resilience later this year, so I hope you’ll keep us updated.

Nathan Long: Of course, thanks for having me on the podcast – I’d love to come back.

Susannah Streeter: Thanks Nathan. So, it’s now time to bring in Emma Wall now – our head of investment analysis and research here at HL. She has been speaking to Daniel McDonagh Head of European Portfolio Management at Pyrford International.

Emma Wall: Hi Dan.

Daniel McDonagh: Hi Emma

Emma Wall: So, 2023 - a new year and I'm going to ask you to get your crystal ball out as much as you can. It was a difficult year for markets last year, although the FTSE 100 did okay, the rest of the world, both equities and bonds had a very difficult time. No guarantees, but what are your expectations for 2023?

Daniel McDonagh: Well, it does feel quite bleak, doesn't it, going into 2023 and I guess the expectations are going to be somewhat dependent on, on how sticky inflation proves. So, the more persistent inflation is going to be, the longer, higher rates are going to have to persist when you include the fact that the monetary policy that we've seen towards the back end or, or the second half of 2022 acts with a lag. It means the full force of the current tightening cycle may not have been felt yet. It's going to take a while for those increased borrowing costs to fully work their way through an economy via refinancings and and re-mortgagings. Then the fact that we have incomes are also being squeezed at all points to a possible recessionary environment likely in in 2023. Having said that, we do recognize that the market doesn't always move precisely in tandem with the real economy. Um, it sometimes leads it and with China opening up, it will be interesting to see whether that's a, a good thing because it adds to aggregate demand or whether that's going to be negative for local markets because it's going to add the inflationary problem.

Emma Wall: And you've mentioned the dreaded R word there - recession. It's a difficult balancing act that central banks like the Federal Reserve in the US and the Bank of England here in the UK have to tread now, isn't it? Because they want to raise rates and keep rates higher to combat inflation. But of course, if recession does rear its very ugly head, then that's very difficult to continue to raise rates in a recessionary environment. Actually, the pressure then becomes on them to start cutting rates, doesn't it? So, what are your expectations around interest rates and how recession plays into that?

Daniel McDonagh: It does look as if rates are going to have to continue to rise because one thing seems pretty clear the battle against an inflation hasn't been won yet categorically. So, while rates will continue to rise, what has been noticeable in the last 12 months is that the enthusiasm with which rates are being raised by various central banks has differed. So, the Fed has been leading the way, it has been the strongest and most hawkish in that sense. That means probably that they have done a lot of their work already and may mean that they've got less to do in 2023. If you look at the European picture, both the ECB and Bank of England seems to have been much more reticent when it comes to raising rates. You can understand why - the economic conditions there look a lot more vulnerable and fragile. So, they will continue to do so. But the sense that we get is central banks really are doing the absolute minimum possible in Europe trying to get away with when the inevitable recession does come. That that doing a lot of the work for them in taking the steam out of the market in terms of how fast prices are rising.

Emma Wall: Now resilience is a sort of other R word for 2023 because we've got this challenging backdrop. You as a professional investor run a fund which has multi-asset, so you have lots of opportunities to go to different asset classes, to equities, to bonds, to cash in order to sort of balance a portfolio and really build resilience against whatever the market throws at you. Again, nothing's guaranteed, but that's the aim of the fund and it and it managed to do that through 2022 against a challenging backdrop. How are you now thinking about the positioning between those asset classes in order to weather whatever storm is coming?

Daniel McDonagh: Well, we were cautious throughout 2022 and that cautiousness is not going to go away, um, anytime soon. And I guess the way that manifests itself in the portfolios that we look after tends to be a very conservative positioning in both the equity and the bond side. On the bond side, that means having a low duration portfolio, so a portfolio of short, dated bonds that are not that sensitive to interest rate rises because we are expecting more of them, we want to insulate the portfolio from any damage that that does to valuations. So, you gotta be a bit discerning when it comes to the bonds in our opinion. On the equity side, we have seen a reversal in most equity markets, not all of them, but most in 2022. Does that mean that we are primed for a new era of, of significant growth? Not necessarily. You know, valuations seem to be certainly not at the bottom end of historical ranges and as we've already discussed the economic backdrop, it's quite challenging. So again, in the equity space, you need to be a little bit discerning and what we have chosen to concentrate on is what we would regard as quality, uh, equities. Now by that we are talking about equities with strong balance sheets so that they're not as exposed to the rising, uh, cost of debt as other companies might be. Companies that are high quality in terms of being able to have pricing power. So being able to raise prices, which is obviously much coveted in an inflationary environment. And that general defensive combination tends to hold up well if the economic and market financial backdrop is challenging.

Emma Wall: Can I quickly ask you about cash? Both from a professional point of view and if you don't mind a personal point of view as well, because for such a long-time cash was just not an attractive asset class. Now you can get, although it's not inflation beating, but three, four, even 5% on cash. I mean we have a savings platform at HL as well as an investment platform and some of the fixed rates actually are looking quite compelling, more compelling than they have done certainly for the last decade. How do you think about cash?

Daniel McDonagh: You're right in the sense that cash is usually seen as the, the poor relation in terms of versus equities or bonds because over the long term, certainly equities are what you would expect to provide, um, the bulk of investment returns for most portfolios. But in this environment, cash as you say, has the benefit of being able to give a positive nominal return if not a positive real return, which is more than can be said necessarily for both bonds and equities in, in a challenging stagflationary environment. So, from that perspective, you know, cash has its place in the portfolio and it also gives you a lot of visibility in relation to what you would get in a, in any given year which obviously is not necessarily the case with those other asset classes

Emma Wall: Dan, thank you very much.

Daniel McDonagh: Thank you.

Susannah Streeter: That was Emma Wall, head of investment analysis and research here at HL, speaking to Daniel McDonagh Head of European Portfolio Management at Pyrford International. Please bear in mind that these are the views of the fund manager and are not individual stock recommendations. You’re listening to Switch your money on from Hargreaves Lansdown. And now it’s time for our exciting new feature, Sarah, – the stat of the week. And while you may be expecting something striking from the news, we’ll endeavour to trawl less familiar corners of the financial world, and this week it’s a gem from the sales figures Aldi announced over Christmas.

Sarah Coles: Altogether sales were up 26% in December. Some sales were affected by huge inflation within certain categories – which helped propel cheese sales up 50%. But particularly notable was the rise in sales of crisps and nuts – up around 40% - which it put down to the fact the men’s football World Cup coincided with Christmas sales.

Susannah Streeter: Well, I think I supported all of those cheese sales, but it does seem that Crisps were the flavour of the month this Christmas.

Sarah Coles: I can certainly vouch for that in our house, although I can confirm that if you’re ever about to buy tortillas shaped as Christmas trees and flavoured with turkey and stuffing, then you’d be better off saving your money.

Susannah Streeter: It certainly sounds like it! And podcast listeners will know by now, we’re all about the Quavers in our house. Although, this time Santa didn’t throw 100 packets down the chimney, but we did manage to consume an awful lot.

Sarah Coles: In fact, I’ve been savings a Quavers-related Christmas Cracker joke for you, do you want to hear it?

Susannah Streeter: Go on, I’m not sure I can avoid it at this stage.

Sarah Coles: OK. How do you eat Quavers at twice the speed?

Susannah Streeter: I don’t know

Sarah Coles: You break them in half, so they’re semi-quavers.

Susannah Streeter: Oh no, that’s terrible. I think after that, there’s nothing else I can say, so that’s all from us this time, but before we go, we need to remind you that this was recorded on 9 January 2023, and all information was correct at the time of recording.

Sarah Coles: Nothing in this podcast is personal advice – you should seek advice if you’re not sure what’s right for you. Investments rise and fall in value, so you could get back less than you invest. Past performance isn’t a guide to the future.

Susannah Streeter: This is not a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment and investors should form their own view on any proposed investment.

Sarah Coles: And this hasn’t been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication.

Susannah Streeter: Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing.

Sarah Coles: You can see our full non-independent research disclosure on our website for more information. So all that’s left is for me to thank our guests Nathan, Sophie, Daniel, Emma, and our producer Elizabeth Hotson.

Susannah Streeter: Thank you so much for listening. Goodbye.