Sunday Supplement – 16/05/2021

May 16, 2021

Sunday brings us another supplement and various markets have had an interesting week. What we know at the moment is certainly that Covid is a) not over and b) not boring.

We have to remember that we have lots of traps as human beings that we can regularly fall into. A book I first read around 10 years ago now is incredibly helpful if you want to have an idea of behavioural biases that we can often be susceptible to is “thinking, fast and slow” by Daniel Kahneman, containing a summary of 30 years of research which Kahneman conducted with Amos Tversky, and the output is worthy of a Nobel prize winning economist.

One such trap at the moment would be that the pandemic is all over. Not that I’m suggesting the virus is not under control in the UK – numbers show that it is. Worldwide cases are down 12% this week, UK cases are up 8% but the likelihood of outcomes as bad as over the past 14 months has been dramatically suppressed by vaccinations. There is some scary chat around the Indian variant, and the SAGE meeting notes don’t make for good reading – but they are full of worst case scenarios for obvious and good reason. Case numbers will be rising over the next few weeks that’s for sure. Less than 100 deaths per week from Covid in the UK for the past 2 weeks is a milestone worthy of celebration.

However, being overoptimistic would be foolish. But this is not the end, even if it truly is the beginning of the end. From an economic perspective the disruption has been like nothing seen before in most of our lifetimes, and this is being borne out in commodity pricing. In short many commodity businesses run on a lag time – they have to forecast demand and then, if we use the example of mining, determine whether they are going to need to operate next cycle or not. You can imagine the thoughts in February/March/April 2020 – if you recall 90%+ of the western world was expecting doomsday with all sorts of terrible forecasts. Property prices lurched downwards – briefly – (although this was because very few transactions took place and many buyers took the opportunity to pull out or adjust purchase pricing).

The result of that was not mining/cutting/producing/planting etc. Those decisions are having an impact now and a lot of the readers will see the parallels with property prices:

Demand went up when it was forecast to go down.

Supply is much shorter because of these decisions made.

Economics has had a challenging 15 years since around the time the financial crisis was coming around, but one thing that is exceedingly unlikely to ever break down is the relationship between supply, demand, price and equilibrium.

You can imagine we need to get into another cycle to reset this. This could be next year……..and commodity prices have gone through the roof.

In the real world what does this mean? Fence panels up from 15-20 quid to 30-35 quid. Really hard to get certain things at any price! Procurement (which many builders are not great at – not a criticism because they have enough on their plates – they trust their regular suppliers) is a skill in short supply. Our experience is that materials can be got hold of but it may be a long stint on Google and/or 15-20 phone calls to get what you could get 18 months ago at the click of a button, costing not only 20%+ more but also hours in time too.

This has likely consequences. Bankruptcies, half finished projects, itchy lenders – and, as always, opportunity and misery dance a twisted dance. Look out for these in H2 2021 and beyond, this has at least a year to play out.

Indeed it is wise to think that we may easily have another 15 months of complete disruption if we accept we are 15 months in to a pandemic response thus far. That needs to shape your thinking. We need to have a dose of economic reality.

The Bank of England report quarterly on monetary policy and May’s report has as yet not been examined in depth in the Supplement. I’ve referred to it over the past year with interest, because mostly I haven’t agreed with it – or, more accurately, I have not agreed with the pace of it. Upon examination, the time I thought would come has finally come. The pendulum has swung too far.

The Monetary Policy Committee (the people who set the base rate and the level of quantitative easing) is, as you can imagine, largely a group of pretty cautious economists. They do have the odd firework in the box – Andy Haldane is an incredibly talented economist and has a touch of the maverick in him (perhaps this is why I’m such a big fan). But I don’t agree with Andy on what I understand his current position to be – I think he’s falling into one of the Kahneman traps referred to above and is being overoptimistic. I think quite a few people are. I’d like to develop that point a little.

Haldane has been the one publicising the savings balances in the UK and just how much they have improved. He also believes and is certainly quoted as talking about the rubber band that will snap back as all of this is deployed. I’m feeling differently about this.

At the core I think we could agree the following without creating any controversy:

With the majority of the workforce on PAYE the following has happened in the past 15 months:

1) some have been on furlough throughout

2) some have spent an extended time on furlough

3) some have worked throughout and earned the same or more money

4) some have taken temporary or permanent pay cuts as output dropped

5) some have lost their jobs and dropped into the benefits system which has been temporarily enhanced.

6) most have seen their cost of living go down because of “enforced saving” – with pubs and restaurants closed, and commuting devastated (and the extra spend that goes along with the office “lifestyle”), that money has stayed in the bank.

If you read some of the literature about habit forming, most will mention the 3-month mark. I.e. it takes 3 months for new habits to form.

With the recent pattern of lockdowns it is very clear that new habits will have and have been formed.

Thus, will this incredible amount of savings that have been made (on average) suddenly be deployed?? Some are being deployed as we speak into the housing market, as mania and panic sets in in some parts of the country. Hamptons published figures this week suggesting that 41% of their houses have attracted 3 or more bids this month which is a really significant number.

However, will people just go out and spend spend spend? Does the rubber band just snap back like that? I think not.

If you believe the pandemic is under control in the UK, then it might be an appropriate time to talk about scarring. This was raised briefly last year but I’ve heard very little since then. I don’t really want to concentrate on purely economic scarring, which can and will be covered in the longer term by the supplement as it unfolds, but on behavioural and habit scarring.

I believe consumption patterns have been disrupted like never before and will take a similar amount of time to come back to “normal” (remember that word) which won’t be some kind of revolutionary “new normal” but nor will it be what it was in 2019 – it will be somewhere in the middle of the two. This sees a more protracted recovery over the next 5 quarters or so.

I believe that return to air travel for the “grey pound” will be slower and the industry will continue to suffer this year regardless of green list good news, with it being 2022 before healthy figures are posted. If this is correct then staycations will do exceptionally well.

I believe that household spend on pubs and restaurants won’t reach 2019 levels until late this year.

I believe that outdoor experiences will do well for the next 18 months although you’d have to factor in the long term weather forecast – not at the moment they won’t!

I believe that health-related industries will have an excellent decade on the back of this.

The thread pulling together all of the above is time. Many people reclaimed time that they didn’t believe they had. This begets patience and consideration which there didn’t seem time for in the 2019 world.

This, though, is a pendulum. Some will come out of the traps at 3000mph. One thing we know about behaviour and biases is that some people tend to try and compete with others/”keep up with the Joneses”. My favourite stat to back this up is the increase in bankruptcies in the immediate neighbourhood of a lottery winner. Mr and Mrs X get a new car and some people want one. So the early whippets will attract some tailgating and that will help to be a driver, but I don’t expect to see 7%+ growth figures by the end of this year – I think we’ve now overshot and got too optimistic.

The other notable figure from the MPC report is unemployment. I’ve been the proverbial broken record on this for around 9 months now saying that furlough was doing a good job and figures would be nowhere near as bad as expected. From memory the predictions were around 9.5% unemployment when the penny dropped for me. In just 3 months the BoE have revised their 2021 Q2 unemployment forecast down from 7.7% which was (I thought) ridiculous down to 5.2%. There is talk of topping out at 5.5%.

This is incredible and the difference is quite literally orders of magnitude. However I’d bet “overs” on 5.5% (think 6 is nearer the mark) because there are so many supply side shocks yet to come.

As always the headline metric is flawed – many can have “a job” but it is below their qualification level or desired job or, perhaps more importantly, their number of desired hours per week. So the phenomenon of underemployment can be difficult to see in the figures, but will show itself in terms of output and GDP growth.

There’s also been probably the strongest case of overemployment in the past 14 months as there has been for many years. Not widely recognised as an economic phenomenon I’d posit 2 types to consider – the first is persistent. Many will have heard of the Peter Principle (even if not by name) – colloquially, “you are promoted to your level of incompetence”. Buckles in line of duty may spring to mind.

The other type has come about because of the pandemic. Firstly, the extra hours found by simply not travelling have been employed productively by many business owners (also driven, of course, by the fear of going out of business). Fear is a brilliant short term motivator but has scarring impacts in the long term on health, productivity and ultimately will lead to early retirement and burnout.

Secondly, some businesses and whole industries have opened and grown at 5 or even 10 times normal pace. This overemploys all of those involved and provides a productivity boost (more on productivity when more up to date figures can be scrutinised).

So there’s more than average to get lost in the figures. In simplistic terms though – there will not be as many liabilities on the income statement for the treasury as they were expecting, and there will be more income, thanks to these improved and much more realistic figures.

However…..if I’m correct on spending and it is more sluggish than many would like, then the velocity of money will not pick up. Despite the commodity crisis (not a crisis yet, but the alliteration pleases me, and it might yet develop of course) this would see shorter term inflation stay a bit lower.

It seems these days I say inflation more than I say risk! However it needs a further mention because of news coming out of the US – and we can use the US here as a great bellwether, because they did allow unemployment to rip whereas we chose the European style “look after the worker approach” – so they are further into the cycle than we are.

They also have had 4 years of a president with a relatively notorious attitude towards his creditors and he took that forward BEFORE the pandemic which is why the national debt has blown up like it has in the US. Of course, if a republican can do that then a democrat can spend more (particularly with control of the house and the senate). And that democrat seems nearly hell-bent on doing just that.

They’ve also got some very bad short term inflation figures – over 4% year on year. No cause for panic here because the base year was near-deflationary at some points (2020 of course) so the bigger picture is what we need to look at. And that’s where I’m a bit stuck, to be honest.

A quick jargon-buster – the breakeven is effectively the market’s opinion of inflation in x years. So the 5 year-5 year breakeven puts the yield of government bonds with a 5 year maturity next to the yield of government inflation protected (or index-linked as we prefer to say in the UK) 5 year bonds – the difference tells us what the market expects inflation to be in 5 years time.

The 5 and the 10 year are the most often quoted, but there can be any breakeven as long as there is a bond of the equivalent maturity of both types.

The US 5y5y B/E is at around 2.5%. This is saying the market’s best guess for inflation in 5 years time is 2.5%.

The UK equivalent is at around 3.55%!

The UK, in context, is known for having slightly higher inflation than other Western economies. Some of this is because of the level to which we import goods as sterling continues its very long term trend of retreating from back when it was the world’s reserve currency (a distant memory of course). However, the UK figures are still very flat (although not in construction as discussed!).

Where we also have heat, of course, is “shelter costs”. So – rents are rising on new tenancies. Big time. There’s less stock (size of the PRS is down 3% year on year). There’s more demand. Little discussed thus far is the extra room needed for working from home but as that becomes a longer term reality (and most jobs I believe will go hybrid) – even if only 2 days a week from home, if you are a couple you likely need an extra bedroom, or a garden room, or a reception room or something. This kick up the chain combined with the known shortage of 3+ bed properties means that you need to go deeper into the data to understand what’s going on.

On top of this, the longer term trend has been towards larger properties anyway and now this is also including outdoor space (which has been a declining trend right up until the pandemic has snapped that off).

However, other homeowners are seeing the same as the government…..the cost of renewing debt is down thanks to easy credit markets, lenders desperate to lend to make up for a disappointing 2020, and historically low interest rates.

Commuting costs were 6-7% of the basket before and may only return to being half of that.

I’m doing more research but I’m surprised the US economy is more bearish on inflation than the UK one – however we do need to consider recent form in that at least in the US they felt confident and tried to get the interest rate up to around 2.5% (that all unwound before covid anyway though), whereas in the UK our highest base rate since 2009 is 0.75%, so that may well be being factored in.

2008 and the response was so much better in the US than the UK that perhaps I’m still in shock that this time round the UK response looks superior. Time will tell of course.
I’ll draw to a close but have to make yet one more broken record observation. Early this week I saw someone asking what had gone wrong in the world of crypto as his holdings had “tanked” because they lost 3.2%.

This was before Mr Musk and his latest gamesmanship.

Bitcoin lost 17% after “that tweet” and that’s real volatility.

Be cautious. Many people got in for small money relatively recently and have done great in percentage terms but it is beer money. Those who get in now for big money – or those who decide that their small money should now become big money – are the ones likely to lose their shirts. It is speculation, it is gambling, I’m pro-gambling because I’m pro-freedom of choice, but don’t bet more than you can afford to lose, and when the fun stops, stop. I can see people with quality track records in property posting their emotions all over their Facebook feeds and it is a bit sad, to be honest. Be careful out there folks…..mania is upon us.

Keep your head while many around you are losing theirs.

Until next week – as always please “smash the like button” – I love the shares and also the comments, thanks for making it to the end!