Sunday Supplement – 10/07/2022

Jul 10, 2022

“If you can keep your head when all about you are losing theirs and blaming it on you” – Rudyard Kipling, If

Welcome to the supplement. First up – an ask. I’m looking for a researcher. Someone who can populate a few data tables that are of interest, somewhere between once a week and once a month, for metrics of interest that I use from time to time in the supplement. Some are easy (and could even be coded/screenscraped I’m sure), some are more “brute force”. Anyone interested will get an insight into what I keep my eyes on, and why I do so – please send me a message if you fancy a go at this, or know someone who might do.

This week is another one of those weeks where I sit back and look in some wonderment at the markets, and this week I’m going to focus on the macro level and try and make some sense of the constantly updating story so far. I spoke to an experienced trader earlier this week and she told me that her feel is that there is more emotion in the markets at the moment, and for the last couple of years, than for a long time that she could remember.

That makes sense. I’ve mentioned the number of macroeconomic incongruencies a few times recently. The economy appears to be hanging in the balance, thanks to ravaging inflation, and within the past few months the world appeared to be waking up to that (this is a global phenomenon, not a UK-based one). For all the answers, all the commentators, all the analysis – the consensus is pretty clear. There is only one realistic way out of a bout of inflation like the one we are currently experiencing – and that’s a recession.

But, but, but – some say – this is not like the other times. “This time it’s different”. Well, to be pedantic, it is definitely different EVERY time we go into a recession, but to think that “we can say goodbye to the days of boom and bust” (Gordon Brown, remember him?) is a dream that you might consider to be hopeless, wonderful, or both – “This time it’s different” fits right into the same category in my view.

What IS different? Well, employment – that’s definitely different. We’ve entered a number of “new worlds” in the past 15 years or so, following the financial crisis. The era of truly low unemployment is one of them. Not for the first time – realistically, it is one for the economic history books rather than the memory of the readers, but unemployment is a luxury of an era which saw workers’ rights, the end of child labour, health and safety become a consideration all a part of a much larger supercycle – things of course that we take for granted these days.

There are, of course, other reasons for unemployment in a post-industrial economy. Automation is oft cited, but clearly is not hurting employment prospects too badly at the moment. Indeed, there are more vacancies right now than there are people willing to fill them – those who are declared or recorded as “Looking for work”, rather than studying, enjoying early retirement, or not available due to long-term sickness. Other reasons include geographical location and resultant opportunities, not having the appropriate skills or qualifications, and also the unemployment that results from the stage of the business cycle.

The last one is the most puzzling, of course, right now. What stage of the cycle are we in, you ask? Well, that is a doozy. An economy so high on the morphine of stimulus, which has dried up and cold turkey is being endured with relative pace (in the form of higher interest rates and the withdrawal of quantitative easing, also known as quantitative tightening). The last recession (oft forgotten) was just about 2 years ago. It is unusual to have another one so quickly – but not unheard of (1970s being the most recent example, but remember we narrowly avoided a double dip recession in 2010-11). The other point of fact is that the last recession was not a “real” recession that really meant any true pain at a macro level, it was completely padded over thanks to the stimulus shotgun from the now-ex-chancellor Rishi Sunak (Thank you for your service) and the soon-to-be-ex Prime Minister (Boris Alexander De Pffefel Flash-in-the-pan Johnson).

If we sit back and reflect from a distance, we know several things to be true. We do not have a magic money tree – except, we do, when it suits us, regardless of the political colour of the government (Modern Monetary Theorists would disagree, of course, and will do until they are proven wrong). A pandemic should not usher in an era of prosperity – I have written at length in the past two years of the typical fallout of pandemics (low return on capital for decades, a shift from the power of capital to the power of labour, lower GDP growth). Ultra-low interest rates and government stimulus cheques keep things going that the market would otherwise clear out in its brutal, uncaring way. A good typical comparison is the way the US handles things, but this time round, even the US dug deep to support the unemployed, and whilst there was no equivalent of the furlough scheme, there was significant support for the disruption that the pandemic caused. They “took their medicine”, but in stages, in comparison to the 2008 financial crisis, where the troubled asset relief program (TARP) was actually a money-maker for the government (unlike the UK bank bailouts, which have meant significant cost to the taxpayer).

So – we must surely be expecting a correction, and because the stimulus has been so significant, alongside unrivalled supply chain difficulties, the largest challenge to the just-in-time methodology that it has ever seen, an artificial feeling of safety offered by the government blanket that was thrown over nearly everyone, and geopolitical tensions at a recent high, including but not limited to Ukraine/Russia, it seems sensible to expect a significant one. Yes, the US has undergone an “Orderly sell-off” – the phrase that has described the H1 stock market in the US in 2022, more than any other, and is in a technical bear market, but there’s lots of scope to go downwards from here. Another 10% off from here would look very damning for the US, who are ahead of the UK in their cycle as they often are because of their less “fluffy” approach to “fixing” (read, constant tinkering) with economic problems.

However – the markets disagree. The reversals have been significant. I saw the phrase “reverse ferret” this week (credit – John Authers, Bloomberg opinion – truly spectacular commentator if you have not had the pleasure as yet), and it really resonated. A business partner of mine prefers to let the cat out of the bag…..the equivalent analogy being squashing the cat back into the bag, hissing and howling. Early this year the reality of interest rate rises bit home, and the bond yields started to ascend at a significant pace, particularly in the US. The US 10-year yield has tested 3.5% this year (a few weeks ago), from 1.17% just one year ago. A significant ascendency – but the reversal went all the way back to 2.7%, although 3% is the current number. The upshot of the bond movements is that the US is facing 30-year mortgage rates at 6% (remember, we are the anomaly when it comes to home loans – most of the western world fixes for 20-30 years, and some for 100+ years – although 50-year mortgages have been floated this week, which would see people inherit property and mortgages).

This 3-3.5% range is significant. 3% is back to 2018 numbers for the US – 3.5% is getting back to the beginning of the last decade. Returns from bonds have been limited, when considering inflation – but, of course, considering inflation today they look negative, depending on how long this lasts for (I don’t think anyone thinks inflation will be above target for 10 years, but perhaps I shouldn’t assume!). So they look about as bad in real terms as they have done for some years. This is, of course, what’s driving the price up – although there is always the TINA argument.

TINA says, there is no alternative. Funds, pension trustees, and the likes, have to allocate money somewhere. Stocks are volatile (just look at this year). Bonds are deemed 100% safe (when issued by the US government), because they never default. Apart from when they do, of course – e.g. Nixon, 1971, coming off the gold standard; 1979, where they were simply “late in paying”…. And they’ve been close in recent times, but of course, every time, they simply raise the debt ceiling.

So returns go up (in nominal terms) but are looking miserable in real terms. The reverse ferret, or the cat back in the bag, recently, has been the movement back down in bond yields. To translate this into my preferred sort of language, there are some very big bets going on at the moment. Some are betting that inflation is secular – that it will be persistent, and drive onwards. Why, when these fluctuations are temporary? Well, I’m in this camp, so I’ll expound my view.

Inflation begets inflation. Mick Lynch, who struck a few chords when he was all over the media a few weeks ago during the rail strikes, put it simply – put it just as the man on the street would see it. Wages are chasing prices upwards, not the other way around, says our Mick.

Andrew Bailey, governor of the Bank of England, disagrees – and was pilloried for telling workers not to ask for pay rises (that was the media reporting, which was somewhat distorted, of course). Mr Bailey knows that this is the only way to stop the spiral upwards.

However, neither have really gone for the true money shot here. Companies are reporting – quietly, but not silently – that they’ve never found it so easy to raise prices by quite so much. People are acceptant of it, is the report.

And they are acceptant – but acceptance alone is not enough. Willingness to pay is one thing. Ability to pay is another. Why do they have ability to pay if wages are having to chase prices (and in Mick’s defence, certainly in the public sector, this is demonstrably true and all this on the back of the 2010s, the lost decade for public sector workers)?

Back to our friend the stimulus. Households saved quite literally like never before. Fear is an incredible motivator. The ability to save was almost forced upon households who could not consume leisure activities, holidays, restaurants and other regular pastimes/multi-billion pound sectors of the economy (sectors that are, you’ll have noticed, struggling to re-open effectively).

So what’s wrong with this picture? Well, from a macro perspective it’s hard for the central bank and the government to control spending from savings, or dissaving as the economists like to call it. The money is there – and there’s a natural human tendency after somewhere between 18 and 24 months of either significantly restricted or totally curtailed freedoms, to say “Sod it, time to enjoy ourselves”. The bounceback effect? The released prisoner effect? Answers on a postcard for a better name for this phenomenon, please.

The reality is that this excess pool of money runs out at some point. On top of this, higher interest rates mean lower disposable income for all of those apart from the completely debt free. A significant number of households fit this bill, of course – around 35%, but that leaves a significant majority that don’t (and, of course, mortgage debt is not the only debt).

Murphy’s law would suggest this will happen at the worst possible time. Whilst we face (current best guess, 51%) further energy price hikes in October, which are guaranteed to take a further bite out of discretionary incomes for households and indeed businesses, July has seen some respite thus far with oil down 14%, and natural gas down 31% as I write this. That level of volatility alone is very dangerous, of course, and prices move upwards very quickly but downwards more slowly – hence why petrol is still showing at £2.00 mostly.

It would also be dangerous to call the top – who knows what Putin has left up his sleeve, for example? Things could get much worse before they get better.

But no matter – in the face of all this, the market is up 3% this week in the US (who seem to have the nearest-term problem, to me) and the bond yields have retreated more than 10%.

Bear markets are, of course, characterised by times like this. Traps – if it was easy, everyone would do it, right?

Aren’t you glad you stick with property, reading all this? Maybe not – more headlines this week on the “flood” of stock (which is relative to recent times, not normal times) – and also the prices coming off the top on the back of this. The numbers right now don’t support this – I’ve written about this at length in this month’s Property Investor News, including the data – and will be following it closely, and reporting back when we do see something truly significant.

The tide could well be turning, but such volatility is thankfully reserved for commodities and stocks….take a breath and enjoy the relative calm of property!

Until next week……..keep calm and carry on, it’s not just the British way, it’s the only way!