Sunday Supplement – 17/07/2022

Jul 17, 2022

*“There’s no such thing as bad publicity” *- Phineas T. Barnum

Welcome to the supplement as we gear up for the first ever 40 degree celsius temperatures in the UK. The current record, for those interested, is 38.7 degrees which was set around 3 years ago. Over 40 is a significant increase on that, of course. These headlines always get politicised immediately – all I’d note is that the Daily Express FINALLY got it right this summer, which keeps their record somewhere near the stopped clock – correct twice a day. It’s sensible to stay indoors if possible – and increase your typical water/fluids intake significantly. It looks like a 2-day aberration on current forecasts.

We’ve learned a few other things this week too. I refrained from getting involved in the Boris’ successor debate last week, partially because I wasn’t even sure he was really going, such is his “alligator blood” – now it is clear that the entire party is behind his gracious (or not) exit, and a new betting favourite has also emerged. Penny Mordaunt dominates the betting – political markets are notoriously volatile, and not always the very best at picking favourites and outcomes (Brexit, anyone?) with Rishi in second place. Tom Tugenhat, who has come across as a decent enough individual, of course cannot win – it is just the nature of the beast in these situations. For me, it speaks volumes that there have been some decent candidates from the back benches/without significant ministerial experience – it continues the narrative that Boris deliberately surrounded himself with lower quality ministers in order to reign supreme. As it turns out, you can’t just say things, you actually need to do them and a combination of weak leadership, lying as easily as taking breath, and trying to pacify all parts of the party and the public has been found out in around 3 years – a feather in the cap of the UK above the US, I’d say, in terms of the robustness of the system.

The counter to that argument of course is that it was an incredibly difficult 3 years to preside over. No-one can really argue with this – first of all getting Brexit “done” – which was a silly use of a past participle, let’s face it – anyone could tell you it was going to be an ongoing situation which would need a decade+ of managing through – and then the pandemic, which, overall, was handled reasonably well. You could outsource the credit for that quite fairly, I think, because the things that did go well were economic management and healthcare/the vaccine rollout; the big political decisions on lockdowns and re-opening were made on weak logic, badly timed and became more about politics than good sense and scientific fact.

Either way – he’s gone and a new era will be ushered in. The publicity side – it would be fair to say that the amount of coverage the Conservative party are currently receiving, and will do over the course of the summer (this is a MASSIVE bonus for the press and media over what is always termed the “silly season”, the slow news time over the summer months). Free electioneering? Yes, I would think so. We now know we will have a new PM on 5th September. Mordaunt ticks a lot of boxes – involvement in the forces at a time when there is active conflict in Europe and a war footing is much more important than it has been for 15+ years (if not 30), appears to have handled herself well when put under pressure and has shown a modern Conservative can allocute effectively the difference between trans rights and biological fact – she’s even already done the reality TV thing.

For the duration I’ve suspected Rishi’s riches would sit in the way of the entire project, and although they could be characterised by saying he’s “married well”, his pragmatism over inflation-reducing tax increases (absolutely the right thing to do, right now, especially in the way in which he has implemented them – regardless of their impact on my tax return…..) may be a little too pragmatic for a voter base primed towards populism by his old partner-in-crime. He’s not done yet, but is trading solidly in the 3/1 range giving him an implied 25% chance.

I heard a great challenge from a radio presenter early this week. Asking the labour party if they were embarrassed over the diversity of the candidates in the leadership election – unlike Boris’ band of blithering incompetents, these candidates do look to be the best currently available (without too many skeletons in the closet, of course). There was no sufficient answer given by the politician being grilled. I would take the positives from this – forget the colour of the party, the diversity on show here has been praiseworthy regardless of your political or ideological viewpoints.

Staying on politics, but to a more granular level, I thought Ben Beadle, chief exec of the NRLA, spoke fantastically well this week. Focusing on the drop in supply of rental properties of 250,000+ over the past 5 years, he outlined how important it is that the new PM reverses the tide of hostility against landlords. Some have commented this will be too little, too late, but there is now evidence which the government can choose to act upon or ignore. There are some HUGE implications for the whole sector coming over the next few months as September sees benefits and minimum wage set for 2023, and as we come towards the release of the 23-24 LHA allowances starting April ‘23, normally first sighted in public in January, some massive decisions will have to be made. I can’t be the only one seeing massive increases in rents (alongside increases in holding costs, interest rates, maintenance bills and the likes) and thinking that these ingredients have been being mixed for the past 7 years, and now we have the cocktail for the perfect storm.

The good news for tenants is that higher rents WILL attract supply into the sector. The bad news is that this will take time, and rents will still be high – but they would likely otherwise get higher still without new supply. It is the devil and the deep blue sea. The abnormally tight labour market is seeing affordability keep pace, just about, and using some of that buffer that exists on average (25-28% is the usual spend on rent ex-London/SE, with 33% being the metric and organisations like CAB and Shelter using 35% as their benchmark number). The danger is that the pace of rent growth is considered as a trend and supply then exceeds demand as the economy cools – but the time it takes to get rental properties online provides some element of protection on this front, and the fact that very few developments of what is truly needed – 3 bed semis – stack up and get delivered – mean that depending on your product, you will be well insulated from what will be significant volatility over the next few years.

We are still a couple of days away from knowing June’s inflation figures for the UK, although the US has released theirs and are still showing much more consistent and aggressive inflation than has been predicted. However, the markets are still suppressing 10-year US bonds under 3% – the 3-month/10-year curve inverted this week in the US, which is a classic “soon” recession predictor, although it has ironed itself out already. There have been thousands of inflation metrics dusted off, or invented, over the past 18 months – the “trimmed means” which were supposed to filter out the transitory bits are now off the charts in the US, higher than they’ve been since records began. The excuses are starting to run out, and the world is waking up to secular inflation, but not yet filtering through into much higher bond yields. I think this WILL happen, and not only that, I think when the cat is truly out of the bag, the markets will over-react. The spike we’ve already had, plus the massive struggle with service levels, is already now seeing mortgage rates at 4.5% on the 5-year limited company fixes – there is a little around below that, but very little. This has priced in the 70%+ likely 0.5% base rate rise in August at the Bank of England Monetary Policy Committee meeting – this is the big one, and we won’t see mortgage rates coming down any time soon. The smart money right now would a) wait for June’s inflation figures, next week and b) NOT rush to take that 4.5%. If the 30% or so chance of a 0.25% was to come in, there might well be a combination of applications being much slower for the lenders and slightly cheaper money than expected, briefly.

This just shows you how there can be many micro-decisions to make before making a significant decision. Super-cheap money, at the moment, is over. I wouldn’t quite read the eulogy yet – it favoured far too many of the sophisticated, at the expense of the unsophisticated, to be killed off altogether. Plus, it created a situation where there is a bloating of cheap credit in the economy, the withdrawal of which, if handled badly, will have gigantic economic consequences.

We remain in a situation where we are holding on to one positive piece of economic data. It is a big one – unemployment is still very low. This is artificial as I’ve discussed before because of the number of people who are out of the market but within the ages of 16-65 – 550,000 of them more than it was before the pandemic. Still, inject those people back in and unemployment is still under 6%, and that’s always historically been heralded as a pretty good number.

Indeed, the job market in both the US and the UK looks more resilient than was thought. And there’s room for wages to go up, especially if commodity prices do come back down – however, they simply remain incredibly volatile and reports of blow-off tops from early July have almost been completely reversed already. Wages are playing catchup rather than front-running the inflation/being the underlying cause. Another economic phenomenon we are not used to.

This is where paradoxes kick in. The stronger and longer this job market, the more fuel to the fire when it comes to inflation. The bigger the fire, the more extinguishing it takes. Read into that – the more significant and damaging the recession when the pace comes to a halt. The engineer of the soft landing – the next PM, and her or his chancellor, has an incredibly important job. Spending our way out of inflation has been pilloried this week – but again, this needs to be more nuanced. Spending on WHAT? As usual high level political statements are useless. Levelling up via infrastructure investments that have positive net present values is unlikely to ever be a bad policy, but has been underfunded and underutilised for decades in the UK.

Rishi’s tax rises need to stay (in personal terms) – simply to combat inflation – on corporation tax I am certainly more flexible, and don’t believe we have great data (the treasury will do, of course, because they have far more statistical power for politically charged questions like this). My view would be to maximise the long-term tax take – and heavily incentivize research and development, which we already do, but I think a review of that system would be sensible. The 50% rise in the number of people who will be in the higher rate tax bracket this year compared to 2019 shows quite how ridiculous the entire system is becoming – a combination of IR35 and wage inflation, of course – although all of those struggling have very little regard for those in the 50k+ bracket of course.

We’ve got an interesting summer ahead, and this week we also saw GDP figures for May vastly exceeding predictions (a massive 0.5% compared to the 0.1% predicted) – so again, the economy is running hotter than expected. Despite the jubilee in June it is now very reasonable to expect Q2 2022 to have been a positive one, meaning if the recession is near, the first time we will know about it will be February 2023, when December ‘22s figures are released.

The feeling right now is that there is an element of resilience in the economies of both the US and the UK which won’t be killed off easily. As discussed previously, the pandemic savings, on top of the feeling of missing out and losing time, that one commodity that money cannot buy (directly), is still driving consumption even in the face of a million headlines about just how expensive energy will be, come October. We are also seeing pledges to cut VAT at the petrol pumps from some of the candidates including the aforementioned front runner, to 10% from 20% (no time frame given or larger detail that I’ve seen so far) – Mordaunt is a self-declared “small state, low tax” Conservative so her success would mean some significant restructuring in the autumn budget, you would think – plus a fear (certainly at this end) that this would be paid for via austerity, the single worst policy decision of this administration since the changes were rung (relatively limply) in 2010.

The lack of plans to drive tax receipts forwards by growing the economy and increasing efficiency, which can be done more quickly than increasing productivity, always saddens me in these situations but of course the candidates are courting support with what makes the most headlines and gets the most MPs to back them. The system as it goes continues to be broken – the one candidate talking about longer time horizons, the aforementioned Tom Tugendhat, is the one that is more than a 100/1 shot, in that perverse way that always works out in these situations.

The backdrop to all of this is a Federal reserve that is tossing up between a 1% interest rate rise and a 0.75% interest rate rise (in that order, listening to the chatter coming from the US) – and a meeting of our own Central Bank which, as above, sees 0.5% as the most likely increase in rates. That robust economy takes more action to cool, and that can see rates go higher and brakes, when they do start to work, hurt harder. The irony of all this being spoken about around the hottest temperature ever seen in the UK, when the pain will bite with energy bills looking to go from an average of £1,300 12 months ago to £3,300+ in October as it gets cold, is tangible.

Almost all of the activity at the moment feels particularly short-term – a problem that is endemic in today’s society, but with the volatility welcomed in thanks to the pandemic, this is even more damaging. We seem to have learned very few lessons from the past 15 years, let alone the last 40. My fear is that this will lead us into scrambling for cover, and embarrassingly reversing a number of policies, whenever we do have a new PM. I’m yet to hear anything on who Mordaunt would appoint as chancellor, but this will clearly be my number one focus whenever the contest is decided. I can’t see austerity winning many/any votes as an immediate policy even if it is bumped back up the agenda – not before the election which is still slated for 2024, remember – so the true colours might take some time to play out. Time, as always, will tell us everything – moving at speed to secure rates is no longer my first order of the day, since that window has now closed – the record has changed to being ready for anything. If you haven’t already – diversify. Look at the tenancy types within your portfolio – how can you mix it up and protect yourself? How will your tenants cope with another 25% on inflation in relatively short order – this is the sort of stress test that needs to be considered at the moment?

More even than this – the market is rolling on despite sooth-sayings of doom – the best phrase I heard in the past week or so is that “the market has cooled from white-hot to red-hot”. I think this is accurate and is a much better characterisation of where we are currently at. Too hot to buy, still? Not for the deals that have fallen over, especially if they have done that twice or more – those are always out there. Great to sell in? Yes, there’s still plenty of time to cash up and get some fuel in the bank – in spite of inflation, holding some cash as part of your investment portfolio rather than nearly 100% gearing, as I know many have used over the recent past/decade with significant success, is a good idea.

I still feel the stock markets have downward trajectory from here, whereas the housing market will flatten off but is not guaranteed to fall at all, particularly from today’s pricing (there may be a wobble after it puts on another 20%+, for example, but sitting and waiting for that is a thankless task if ever I heard of one). I could easily be wrong – I have been wrong many times before, but then I take a lot of positions and am not shy of expounding them, so you would expect me to be wrong on a semi-regular basis. My feeling is that you still need a strategy that has an element of the “cockroach” to it – we cannot necessarily see everything that might go wrong before it at least starts to, but resilience will be the key to portfolios to get through the rest of this bout of inflation, and the near-inevitable recession that follows.

Soon we will wake up and it will be after 2025, and all will be well again. Promise? No, not really – but yesterday’s policy mistakes can hopefully be righted by a sensible solution to follow the bumbling buffoon’s best efforts (and looking back, I’m not really clear what they were in a proactive sense – perhaps unfair, again, because there was just so much to react to over the past 3 years).

I feel obligated to finish with some clarity – because I have been accused/called out for my relative bearishness in the past couple of months. I still believe property is the number 1 asset class in the UK that is accessible to individuals in any volume. I am still buying, and will not stop until there is a major landscape change (the sort that a Jeremy Corbyn might have architected, for example). My numbers are tight at the moment thanks to interest rates and expectations – for acquisitions that need improvement before they can be held/transferred to term financing. I’m seeing more opportunities than in 2021, and think that will be the direction of travel (from a very low base) for the next 18 months. I’m not particularly concerned about the general macro issues, because of the strength of employment – I have more concerns over my social tenants if the LHA rates do not get significantly revised upwards, although it looks likely that they will. The plan is to keep dodging the arrows, expand (by buying more than I sell, but am definitely actively selling some properties to cash in on this now-red-hot market as discussed), and continue to improve when it comes to asset management. One thing is for sure – just like at the top of the Conservative party, change is needed and the longer it takes, the worse the situation will get, for the tenant, before it gets better. Keep calm……..