Sunday Supplement – 12/09/2021

Sep 12, 2021

Happy September Sunday and welcome to the supplement – a big thank you to all those who have reached out in the past couple of weeks and said how much they enjoy reading my efforts, it is good for the ego if nothing else! Much appreciated.

This week I feel that the theme is bounceback after holidays into a relative hive of activity, and so I wanted to talk a bit about the pendulums that may well be out there to swing backwards (and perhaps forwards again) over the coming months and years. It would also be impossible not to talk about tax and fiscal policy because of the recent tax rise that has been laid out, the politics behind all of that, and the direction of travel.

So, anecdotally to start with. A few deals have been around in the past week both “in-house” and also for those in my network. Some actions have been taken it seems. The odd repossession, and some relatively quick sales. Is this the floodgates opening? I doubt it. More likely a post-summer-holiday clearout – activity seemed that quiet in August that some kind of pickup was inevitable. Will it mean a busy September? Current feeling is not really. The stock numbers will be well worth monitoring and we will take another look at those last week.

Within the last couple of days there have been reports of (likely inevitable) lumber prices crashing. The peak was actually reached for the year on 7th May – it is the time this takes to trickle down supply chains that is the most interesting. The (slightly confusing) metric is Dollars per 1000 board feet – but nonetheless, the price at that peak was $1686. It is now $517 – almost at its low for the year, down 69% from the peak. The bottom over the last couple of years was $260 on April 1st 2020, nearly peak Covid panic. That in fact was the lowest price for several years, lower prices had not been seen since early 2016.

This is a classic “Covid graph” – I am sure there will be phrases coined. Impossible to really look into these things with true meaning, because the swing from $260 to $1686 in around 13 months is around a 650% increase – and then you have the 70% decline. Over the past 25 years, the biggest other “trough-to-peak” took about 2.5 times as long (Sept 15 to May 18) and was about a 160% increase, around a quarter of the magnitude. Effectively, around 10 times less meaningful that what’s happened this year.

It is legitimate to wonder why the price of wood hasn’t gone up MORE this year! It is worth remembering that in these scenarios, the price of the commodity often only makes up between about a sixth and a half of the final price of the finished item, ultimately. There are transport/logistics costs, retailing costs, finishing costs, etc. Of course, these have also been under pressure with shortages of workers at key parts of the supply chain, so have provided some of their own upward pressures of late! But, overall, this looks like a massive pendulum swing that may well still be on its way down. As compared to today’s price of $517, the pre-covid 5 year average was around $440, so things have been nearly normalized (but doesn’t mean it might not come down further).

The whole exercise is a useful lesson in where volatility is extremely damaging. There will be a small number of speculators who saw the trend here and jumped on early – but most actors involved in this market over the past year will not have done well. This level of volatility helps no-one. Constantly changing prices cause problems for all involved and rack up their own level of cost (economists like to call these “menu costs” and historically, this is why the fish prices (for example) would be on the specials board in a restaurant – or if they were on the menu, they would be on there as “market price” – too volatile to write down. When this becomes the case for staples, there is a large inefficiency and this costs everyone involved in the transaction. It is wasteful – unproductive – and unhelpful.

My analogy for this could be something like Covid testing to get back into the UK if you have been lucky enough to be able to leave the country – the system is very inefficient and has hundreds of companies popping up, trying to undercut the others (or, also, jump the queue by changing their names to ,.01 testing or similar, to beat the alphabetical algorithm) – none are able to emerge dominant, and from the consumer end, the prices have been high and the extra cost is punishing. This hasn’t hurt all the actors in the transaction of course, but the point is that the level of efficiency is relatively low compared to a stable market.

So where are the pendulums likely to swing? It depends on the path of the prices. Lumber before the massive peak in May this year had already charged up to $920 a year ago, and then back down to $496 within a few weeks before charging right up to that gigantic high of $1686. How do you run a supply chain in a major retailer of lumber in this situation? With extreme difficulty! There are futures markets at all but when seeing once in an “ever” volatility, it is highly likely that many businesses were not using these extensively (but perhaps now wish they had been). The realistic outcome that is being observed at many retailers is that sales were down as prices went through the roof (classic supply and demand situation) and also margins were squeezed, particularly on the way down for the price as amounts purchased at higher source costs then have to be sold after the price has come down, and could look expensive or be beaten by smaller, more lean operations who could get stock to the shelves faster.

The overarching point here is that the very aggressive swings are likely to be coming to the end, generally speaking (there is no guarantee in any specific market, of course) – although the impact working its way through the supply chain could still take several more months to play out.

So, onto taxes and fiscal policy. For those hiding under a rock, the discussion is around the hike in national insurance (and also dividend tax) by 1.25%. The actual incidence is quite a lot more than this – for example, if as has been assumed in much of the analysis thus far, the higher earners (above £50,284) pay 2% NI on monies above this; if this is also going up by 125 basis points, their marginal rise here is 62.5% more national insurance on their earnings above that figure! Cry me a river, those lobbying for income equality say, but without taking a position, this is really significant. Those with the broadest shoulders do pay the biggest burden absolutely, and of course they also enter the 40% income tax bracket at that point – so the “real” marginal tax bracket above 50k goes to 43.25%, and 48.25% above 150k.

“Nice problem to have” is the typical way to accept and get our heads around something which, as usual, we have no real control over (aside from leaving the country, of course, in search of a lower tax regime). Although, with inflation an active issue, and tax brackets frozen until 2026, some of this is really going to be quite punishing for many over the next few years. There have been arguments of quite how regressive this is – because those on lower earnings already pay 12% (and now 13.25%) up to the 50k barrier – 34% of UK households have an income above 50k but at an individual level that breaks down at around 15% on the last figures I saw having individual incomes over 50k. So the 85% will feel that, as they already pay enough, this hits them harder – and that is the social media emojis that I’ve observed over the past few days. People are angry, and labour are ahead in the polls for the first time. Labour vote against the tax rise and show some fight/backbone, and it has worked rather than the “war footing” voting with the government which has punished them. Will it be the start of a Starmer charge? It feels unlikely but there is one thing people don’t like and that’s higher taxes. Broken promises I’m not so sure have much currency after Covid and so many u-turns, but to have the Conservatives be the party to bring in the highest tax burden in the post-war era seems strange and unlikely.

Employers will also pay the tax of course – which helps to squeeze the amazons and googles of the world, to an extent – although per £ of revenue they employ far fewer people than almost any other business. There have been arguments that people might pay 3 times – in your own business as an employer, employee and then dividend holder. That argument is fallacious – because if it is paid via salary, it won’t be paid via dividend – and the simple choice will be to pay it twice in salary (which business owners won’t do, to themselves anyway) or pay it once via dividend, which will be the route that 99% of accountants advise the business owners to take!

So what is the quantum like here? The amount being bandied around is £12bn – from a GDP at around £2tn – around 0.6% of GDP. The entire GDP is not taxed of course (some of it is made up of Government spending – a huge amount of it at the moment), but it puts it into some perspective. Few things change, you would think, over 1.25% (or 2.5%, to some). However, taxation as a rule is disinflationary.

This is where we stroll across into the point around fiscal dominance. In the most plain terms, monetary policy is somewhat ineffective at this time and could well be for a decade or more. Rates are likely to stay close to the floor, although seem to have settled that the next move will be upwards. QE tapering is being approached very, very carefully worldwide in case markets are fragile or have “taper tantrums”. This leaves the government effectively in charge and leads to fiscal policy being a far stronger lever than monetary policy.
Fiscal policy is best characterised by “spending and taxing” and if we think about what happens in the real world in the face of a tax rise like this:

The real-world scenario – real wages have increased by around 2.5% annually since Jan 2020 (again, the Covid graph plague hits us here, but let’s go with it – this statement may well be inaccurate). The government basically takes all of this increase, and no more money is in the pocket for the difficulties of the past 18 months in real terms. The reality now though is that wages after inflation look higher than they have for all time, so the government CAN take this significant slice. It will, instead of being consumed (although we still have to deal with the low velocity of money argument) and leading to a potential crack-up boom in consumption spending, go into the government coffers. What COULD have been inflationary instead leaves the system and becomes figures on a spreadsheet.

The trend is not our friend, here, however. Mr Starmer has made a couple of sweeping statements about landlords in the past week and it is safe to say that if Labour were to win the probable 2024 election then more pain may be in the pipeline. However, he’s also talking as if there are no landlords in limited companies and is not an ideological leftist (in my view) compared to say a John McDonnell. Rachel Reeves who has replaced Annalise Dodds as shadow chancellor was not a Corbynista and even said this in 2013 when she was shadow secretary of state for work and pensions: Reeves proposed that anyone unemployed for two years, or one year if under 25 years old, would be required to take a guaranteed job or lose access to benefits. She caused controversy within the Labour Party by stating Labour would be “tougher” than the Conservative Party in cutting the benefits bill. She caused further controversy in early 2015 by stating “We [Labour] don’t want to be seen, and we’re not, the party to represent those who are out of work” – so, a dramatically different outlook to McDonnell, and perhaps Starmer’s chat of this week is merely political jockeying and appealing to generation rent. Very possible.

Those in limited structures by 2024 would, you would think, also be better served by the increasing involvement of large corporates in landlording, who will be lobbying much more aggressively and effectively than the current self-funded efforts (not as a critique to the NRLA and similar bodies, just as a statement of fact).

The direction of travel is interesting and dangerous though. This is the highest tax burden since the last highest tax burden (which was before this rise was announced)! There will soon be room for a “low tax” side of the Conservative party, pulling off a Donald Trump style approach to tax. Boris and Trump have similar philosophies around infrastructure spending but a seemingly different attitude towards the debt – the incidence of the rise not being 100% on the top 10% will upset some, of course, but for me it is an indication that Modern Monetary Theory and the “free money” taps of the past 18 months are not the only way that Boris and his cabinet look at the world, which is good to know. The spectre (or perhaps the illusion, if that is not overly sceptical) of solid fiscal management should serve them well if the electorate can forgive them.

Ultimately there is one thought and feeling “in anger” when a rise is announced, IF the economy can continue on an upward path and workers feel in a decent position (the much-mentioned feelgood factor) then we may see more Boris from 2024-29+ – those who have read Dominic Cummings’ thoughts on the matter (Boris will bail to get a cushy job in the vein of Osborne/Cameron et. al.) will have their own thoughts, but the counter to this is that Boris is a deeply competitive individual and has set his sights on outlasting Margaret Thatcher’s record length of term as the premier.

I still feel the party could turn on him on a dime, if the time is right to do so, but ultimately they want a winner of elections, which he has already proven himself to be. How will that feelgood factor for 2024 start to be engineered? Perhaps another tax rise before a cut in 2023? (Remember a lot of this doesn’t kick IN until 2023, which is politically risky you would think). There will have to be some kind of giveaway – there always is……

Until next week, likes shares and comments are always gratefully appreciated!