Ken Taylor: Inflation taking debt's place as main worry for anxious investors

The coalition government has blamed this on the unusually prolonged severe weather prior to Christmas, but I think most people will be capable of drawing their own conclusions. The wrong type of snow might disrupt trains but surely not an entire economy?

I think this news is timely if not welcome, because it serves to counter the over-confident predictions that interest rates will rise in the UK in the near future. Indeed, bond markets have already priced in three jumps in rates by June prior to this news. Time will tell.

I have spent most of this week meeting clients and fund managers in London, where the atmosphere always allows a gauging of mood and current thinking. To counter this, however, I would also maintain that it would do economists, analysts and fund managers no harm at all to spend some time outside London in order to better appreciate the prevailing mood around the country.

The key purpose of engaging with fund managers is to try to make sense of what is likely to happen this year as far as markets are concerned. Sovereign debt concerns were unquestionably the main threat to investors last year, but appear to have been overtaken by worries about inflation.

We are currently experiencing cost-push inflation, and the real threat is that this moves to demand-pull inflation, where prices are forced up by wage demands. Should this transpire then our economy is in real trouble, especially if interest rates are increased. Some economists are of the opinion that fear of job losses will counter wage increase demands, but at a time when food, heating and fuel are all costing more, there is surely a real threat that workers will begin to demand pay rises. Again, time will tell.

This underlines the fact that nobody knows with any certainty what will unfold this year. I instinctively side with those who argue that the extent of our debt woes are sufficiently huge to virtually guarantee a severe market correction at some point. The trouble, however, is that while we continue to fret, markets continue to rise. It is often said that stock markets climb a wall of worry, and that certainly appears to be true now.

Perhaps some of the support for markets can be explained by the fact that achieving a real return on savings now requires a growth rate of about 5.8 per cent for a higher rate tax payer, at a time when the best headline rate on a deposit account is less than half this figure.

This is the huge dilemma faced by those who rely on deposit interest for their income; while bank savings offer the alleged comfort of capital security, they also guarantee a loss in the spending power of your money.Consequently, many are being forced to seek solutions that involve direct exposure to stock markets.

Having already stated that nobody has divine insight into future market returns, I should at least offer some thoughts as to what investors might expect this year. I believe that participating in the current equity rally is sensible, and should deliver satisfactory returns over the coming months. However, any investor must remain responsive to change.

The volatility of markets is highly likely to increase, so taking profits and admitting losses and taking the appropriate actions will be mandatory. This is not to encourage short-term thinking, but rather to move away from the traditional, defensive buy-and-hold mentality.

The principle to remember is that investors are by no means risk averse, but they most certainly are loss averse. This explains why at certain points, cash is the best option. Understanding and appreciating the difference is one of the fundamentals of successful investing, and also a key reason why too many make poor investment decisions.

If you are using the services of any adviser, I would suggest you ensure they understand this fact.

• Ken Taylor is director of Mackenzie Taylor Wealth Management