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We are seeing the beginning of an easing cycle in monetary policy. Many now ask how far might interest rates fall and what those falls might mean for our economies. Yet, for me, the more interesting questions are longer-term. To be precise, there are three. First, have real interest rates at last made an enduring upward jump, after their secular decline to extraordinarily low levels? Second, has the valuation of stock markets ceased to be mean-reverting, even in the US, where mean-reversion had long seemed the norm? Third, might the answer to the first question have any bearing on the answer to the second?

In answering the first, we have one invaluable piece of information — a direct estimate of real interest rates for the UK provided by 10-year index-linked gilts for just under 40 years. US Treasury inflation-protected securities provide comparable information for the US, but only since 2003. These match each other well between 2002 and 2013. Since then real rates have fallen notably lower in the UK than in the US. The explanation must be the regulation of UK defined benefit pension plans, which has forced them to fund the government at absurdly low real interest rates, at great cost to the economy.

Between their peak in September 1992 and their trough in December 2021, UK real rates fell by more than eight percentage points. In the US, they fell by more than four percentage points between their peak in November 2008, at the beginning of the financial crisis, and December 2021, after the pandemic.

Two things happened: a long-term decline in real interest rates and then a sharp fall triggered by the global financial crisis and the pandemic. The longer-term decline must in large part reflect the impact of globalisation, notably China’s huge excess savings.

Yet the recent rise in real rates has not brought real interest rates back to pre-financial crisis levels: today, they are 1.5 per cent in the US. These are modest rates. Estimates by the Federal Reserve Bank of St Louis (using a different methodology) give real interest rates of above 2 per cent in the 1990s in the US.

We have some reasons to expect real rates to go even higher. After all, they are still not all that high. Fiscal positions are stretched, notably in the US. There are the investment needs of the energy transition to fund, too. We have also moved from ageing to aged societies. This will tend to lower savings and raise fiscal pressures in high-income countries and China. Global turmoil will also raise spending on defence. This suggests that further increases in real rates are plausible. At the same time, ageing societies will tend to spend less on consumer durables and housing. This would weaken demand for investment. Moreover, as the OECD interim Economic Outlook notes, global economic growth is not widely expected to pick up strongly.

On balance, it is hard to have a strong view on future real interest rates, in either direction. Yet one might still have a view that inflation is set to return, perhaps as a result of soaring fiscal deficits and debts. That would show up as higher nominal interest rates if (or when) confidence in the ability of central banks to hit inflation targets started to erode. They have contained the recent price upsurge. But inflationary pressures could very easily return.

Now consider equity prices. What have today’s higher real interest rates meant for them? So far, the answer is: very little. If we look at the cyclically adjusted price-earnings ratios (Cape) developed by the Nobel-laureate Robert Shiller, we find that in the US both of the ratios he currently uses are close to all-time highs. The implied cyclically adjusted earnings yield on the S&P 500 is a mere 2.8 per cent. That is just one percentage point above the Tips rate. It is also much lower than for any other significant stock market.

“Sell”, it seems to scream. Needless to say, that has not been happening. So, why not? Today’s earnings yield is, after all, almost 60 per cent below its historic average. One answer, lucidly propounded by Aswath Damodaran of the Stern School of Business, is that the past is not relevant. Certainly, he is right that backward-looking valuation ratios have been a poor guide to future returns, at least since the financial crisis. We cannot know whether this will remain true. Yet it is not hard to understand why he has jettisoned the past in favour of forecasts of future earnings. But the future is also highly uncertain. It is not difficult to imagine shocks able to disrupt markets that are far worse than the recent ones.

What we do know is that the margin between the real interest rate and the cyclically adjusted earnings yield is very small. It seem safe to argue that prospective returns from owning US stocks are unlikely to come to any large extent (if at all) from revaluations, given how highly valued they already are. Even the current valuations must depend on a belief in the ability of earnings to grow at extremely high rates far into the future, perhaps because existing (or prospective) monopolists will remain as profitable as today’s tech giants (now including Nvidia) have been.

This is essentially a bet on the ability of today’s US capitalism to generate supernormal profits forever. The weakness of other markets is a bet on the opposite outcome. If investors are right, recent rises in real interest rates are neither here nor there. In sum, they are betting on the proposition that “it really is different this time”. Personally, I find this hard to accept. But maybe, network effects and zero marginal costs have turned profitability into “manna from heaven”. Those able to collect it will enjoy their feast of profits forever.

Real interest rates? Who cares? Soaring inflation might be another matter.

martin.wolf@ft.com

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A HOMEOWNER was ordered to flatten their garden after raising its height to peer over their neighbour’s 6ft fence.

An argument broke out after the offender piled dirt to create a terrace which caused a “significant degree of overlooking”.

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The resident, who lives in Dinas Powys in Wales, laid artificial grass over the raised bed for a barbeque and summer house – all the same height as their patio doors.

Furious by the lack of privacy, the neighbour complained to the local council.

Council staff paid a visit and were not impressed with what they saw.

The Vale of Glamorgan’s planning committee found that the height of the garden had been increased by 600mm and would need to be lowered by 300mm.

However, the resident refused to flatten their garden and instead submitted a planning application.

It was denied by the council, who deemed the change to the garden and the infringement on their neighbour’s privacy “unacceptable”.

A Vale of Glamorgan Council spokesperson told The Sun: “Every planning application is different with each considered on its merits.

“In this case, it was decided that the development would involve and unacceptable loss of privacy for a neighbouring property so the application was rejected.”

Whilst the majority of councillors on the planning committee agreed that the garden’s height was inappropriate, Cllr Christine Cave said the decision was “hypocritical “.

A former primary school in the area had portable homes erected through special planning powers.

The temporary accommodation was passed for Ukrainian refugees, but the councillor argued that they were tall enough to see into people’s gardens – like the raised garden.

“When we made the site visit [to Eagleswell in Llantwit Major] and we actually asked why the ground had been built up and why the buildings could then be overlooking into peoples’ gardens. 

“This seems a bit hypocritical to me here, that the council have done exactly the same on a much grander scale with huge overlooking of peoples’ gardens and now we are being told it is not permissible.”

Vale of Glamorgan Council allowed the development of the site at Llantwit Major through what is known as permitted development rights.

The planning powers are usually used in an emergency, but the scheme must eventually get planning permission within 12 months of the construction starting.

The council’s planning committee voted to allow the 90 units permission to remain for a minimum of five more years.

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Greggs shrugged off slowing sales in the past quarter, which the UK bakery chain blamed on violent riots and poor weather, and said its appeal to cost-conscious shoppers would endure even as inflation eased.

However, shares in the food-to-go retailer — which continues to expand rapidly as its popularity has soared in recent years — still fell 6 per cent on Tuesday as sales growth slowed in the three months to September 28.

“We had the riots, and we know that in some key shopping locations the public decided to stay away from those locations for a period of time just because of the unrest that was taking place,” chief executive Roisin Currie told the Financial Times. The UK experienced about a week of anti-immigrant and far-right violence from late July, as masked men attacked hotels housing asylum seekers and mosques while clashing with police.

She added that the “wet and damp weather of the British summer” as well as uncertainty over the general election had weighed on trading in July and August, but that it had recovered in September.

Like-for-like sales for company-managed shops were up 5 per cent in the 13-week period, a slowdown from a 7.4 per cent rise in the first half.

Currie said she was confident that 2025 would be “better than the preceding two years” for Greggs, which grew significantly amid the cost of living crisis, as consumers will stick with its products such as the popular sausage rolls even when they have more disposable income.

“Customers, through the cost of living crisis, have now just become more savvy,” she said. “Even when you might have a bit more cash in your pocket, you want to choose where you spend that.”

“We’ve probably got more customers who maybe came to us occasionally previously, but are [now] more frequent consumers, and I believe that behaviour will stay,” Currie said, adding that new products and opening into the evening were broadening the chain’s appeal.

She added that the easing of inflation including food commodities would also relieve cost pressure on the business, even as wage costs continued to grow.

Data published by the British Retail Consortium said UK shop prices fell for the second consecutive month in September, with the 0.6 per cent contraction the lowest rate in more than three years.

Currie’s bullish comments come as Greggs gears up its expansion. The Newcastle-based group is set to open between 140 and 160 new stores this year, after adding 145 in 2023.

In 2021, Greggs set out a plan to double its sales by 2026 and to have “significantly” more than 3,000 shops in the UK. It currently has 2,559.

Shares have surged over the past year, rising 28 per cent before Tuesday’s fall. Clive Black, head of research at Shore Capital, said the third quarter was “weaker and also more volatile than the management would have expected”.

“Greggs is undoubtedly very well placed when times get tough”, which has been the case over the past few years, Black said. “As inflation falls and living standards rise, is Greggs as well positioned as some others? Probably not.”

For income investors, there are typically three legs to the stool – the yield, total return and a stable, or growing, dividend stream.

Key to a successful strategy above all else is generating a real yield, ensuring income is not eroded by inflation over time.

Prior to the global financial crisis of 2008, when interest rates sat comfortably higher than inflation, this real yield was relatively easy to achieve.

Over the decade that followed, however, the economic environment reversed, with interest rates languishing below inflation, meaning cash held in the bank, and accordingly asset prices, lost value in real terms.

As long as rates remain above inflation, income investing once again looks more appealing

Subsequent rounds of quantitative easing suppressed yields on fixed-income assets and investors were forced to look to more growth-oriented assets.

Today, however, the picture looks very different. Inflation and interest rates have crossed over once again, with the former sitting below the latter. This creates an environment more favourable for both yields on bonds and equities.

While it is hard to say with certainty how long this will last, as long as rates remain above inflation, income investing once again looks more appealing.

In the case of fixed-income yields within the UK market, those available from both gilts and corporate bonds fell drastically in the aftermath of the financial crisis.

Income investors no longer need to look to riskier areas of the market to secure the same yield

However, with the base rate as it stands today, the economic backdrop is much more supportive of fixed-income yields. This is because fixed-income securities adjust to cash rates given the additional risk involved in investing in them.

The implication for income-seeking investors is that they no longer need to look to riskier areas of the market to secure the same yield. Instead, it is possible to remain in the relatively safe areas along the capital-risk spectrum.

In contrast, yields from equities have been relatively static over the last decade, as fixed-income yields dropped off and then subsequently rose strongly.

Yields from the UK equity market today stand at around 4% and at around 2% for global equities due to the dominance of the US, which has typically paid lower levels of income.

The outlook for dividends has been steadily improving, with strong gains posted year-on-year

But that is only part of the story.

Another major element to the overall picture is dividend stability. Dividends took a significant hit during the pandemic – in the UK to the tune of 40%, in part due to UK banks being forced to suspend payments and the impact of travel restrictions on oil companies’ profitability, both fertile sectors for income investors.

Since then, however, the outlook for dividends has been steadily improving, with strong gains posted year-on-year.

Indeed, in the first quarter of 2024, some 93% of dividend paying companies globally either increased their payouts or held them steady, demonstrating the robustness of these businesses as a source of income. Even firms considered high growth stocks – the likes of Meta and Alibaba – started to pay a dividend, albeit from a low base.

The combination of these elements means it is now possible to secure much higher levels of yield without incurring additional risk.

Investors might consider adding some spicier funds to the mix offering exposure to high yield debt, or equity strategies that employ an options overlay

Nonetheless, it is important to blend income styles with strategies that reinvest dividends to secure the compounding effect, thereby producing an attractive total return complemented by more defensive approaches focused on more stable or growing dividend streams – stocks that are sometimes referred to as bond-proxies.

These may lag in more exuberant market conditions but their return profile tends to be steadier, with the added attraction of offering some downside protection.

Finally, investors might consider adding some spicier funds to the mix offering exposure to high-yield debt, or, on the equities side, strategies that employ an options overlay to enhance income, albeit by sacrificing some capital appreciation.

The implications for income investors, typically those in or approaching retirement and therefore needing to replace a salary with an alternative source of income, are important.

Earlier this year, the Financial Conduct Authority’s review of the pensions freedoms introduced some 10 years ago found income portfolios had been largely neglected for such individuals.

While annuities are once again looking attractive as a means of delivering a baseline level of retirement income, a much broader range of natural income generating solutions are now coming into play that sit above that, helping to ensure that, in retirement, the financial liabilities linked to funding a comfortable lifestyle can continue to be met.

Daniel Pereira is investment manager at Square Mile Investment Consulting and Research

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It was perhaps unwise of Edward Gardner to warn the audience that they were in for an evening devoted to child murders, suicide and death. Probably not many of them had thought about that when they bought the tickets for the London Philharmonic Orchestra’s opening concert of the season.

Despite the conductor’s apology this was not an evening of doom and gloom. The presence of Joyce DiDonato provided season-opening glitz and a neatly-devised programme brought together infrequently-heard works by Samuel Barber and Berlioz, leading to a Beethoven symphony.

There is an opportunity waiting for somebody to champion the music of the postwar, neo-Romantic composers. Barber’s compact orchestral showpiece, Medea’s Dance of Vengeance, combines a mastery of atmosphere worthy of Hollywood with mounting excitement, ending with Medea slashing at her children with a knife. It makes an exciting opening number and deserves to be heard more often.

Compared to that, Berlioz’s La Mort de Cléopâtre, though wildly original, is a lot less violent. DiDonato has been performing this “scène lyrique” a lot recently and its writing for the voice suits her vocal range and dramatic instincts to near perfection. Her French is good and she has plenty of vocal colours at her disposal, the half-fluted, almost quavery top notes with fast vibrato an effect that was sparingly used here. Magisterial, intense, vulnerable, and living the role as she sang, she was a Cleopatra to remember.

Gardner supported her as though his baton was hard-wired to Cleopatra’s nerve endings. The LPO played superbly for him, as they did in a strongly-propelled performance of Beethoven’s Symphony No. 3, energised by the swift speeds and valveless trumpets of the period instrument movement. The funeral march, picking up the “death” theme, dug deep. ★★★★☆

This week also saw the start of English Touring Opera’s autumn season, as it prepares to set out across the country from its starting-point at Hackney Empire. It will take two fairytale operas on tour, Judith Weir’s concise, sinister Blond Eckbert and Rimsky-Korsakov’s more sentimental treatment of The Snowmaiden.

The latter is quite slow-moving, but should appeal to those who like Russian seasonal folk legends. The story is similar to Dvořák’s Rusalka, a coming-of-age tale in which a folkloric maiden longs for human love, but is destined to melt if she experiences its heat.

Olivia Fuchs’s production warms to its theme as it goes on. At the start, the designs by Eleanor Bull look modestly conceived for touring purposes, but through imagination and subtle lighting they radiate magic in the closing scenes. By that point Ffion Edwards’s Snowmaiden, presented as an Alice-in-Wonderland figure, is also floating crystalline top notes. Rimsky-Korsakov’s music, rather thin earlier on, blossoms with the once-upon-a-time radiance at which he can excel. Katherine McIndoe sings well as the rival Kupava, Edmund Danon creates a character of depth from the anti-hero Mizgir, and conductor Hannah Quinn does well to get sounds of some Romantic depth from a small orchestra thin on strings. ★★★☆☆