Sunday Supplement – 23/05/2021

May 23, 2021

Sunday – widely recognised, of course, as the greatest day of the week! And not just because of the supplement, although hopefully it helps.

Our collective enemy at the moment is noise. Not the “environmental health” kind, but the data kind. It is just so very difficult to know what to listen to – I wouldn’t confine this to economics, social media, or anything – that does just sum up life in 2021. Reading graphs, eating data, looking at year on year trends, quarterly trends – I asked the question yesterday, “What is the base level?”. Trends mean very little without context, although arch-traders would likely disagree with me.

In fact, some of the wizards of trading would say that the trends you can’t explain are the most powerful ones and the ones that are most worth following. Something to consider if you are involved in fast-moving commodities, in things that can be liquidated very quickly – to liquidate property quickly, you almost always need to take a significant financial haircut, so applying a lot of traditional stock market trading logic to property is quite dangerous. Instead, property traders tend to be self-taught, and the most often observed transferable skill that I’ve seen is experience in sales-heavy environments. Throw in some other talent such as a background as a qualified or chartered property professional, and some understanding of how the human psyche works, and you are close to the total package.

For those of us mere mortals who take a slightly more sedentary approach – or perhaps I should call it – buy fast, optimise, hold long, sell high (HODL maybe, for the crypto fans) – there is one massive skill that is so relevant this week that is vastly undersold. Spoiler alert – it really isn’t sexy. But the stuff that delivers the returns rarely is. The sexy developers burn twice as bright but seem to burn out 4 times as quickly. The true pedigree is alligator blood – hanging around, every environment, every twist and turn, every market, every fallthrough, every disappointment. A friend and business partner has his tongue firmly in his cheek when he describes himself as an overnight success of 30 years, but there’s so much truth in that.

So what is that skill? It is best encapsulated by a famous Rudyard Kipling quote from the poem If–: “If you can keep your head when all about you; Are losing theirs and blaming it on you.” I’ve seen plenty of that this week. Lost bombs on crypto? Blame Elon Musk. I’m by no means his biggest fan, but start with the mirror, folks, I’m afraid. At least learn a lesson if you have lost money. The real tragedy here would be to lose money AND not learn anything. My favourite of all time, “Uncle” Warren Buffett, the Sage of Omaha, encapsulates this slightly differently and of course has more of an investment focus: “When you buy an investment (stock, in his case) plan to hold it forever”.

What does that achieve? It sets your mentality correctly. Crypto destroys it because in theory, all these people are getting rich quick! Then you are missing out, FOMO sets in, and the carnage begins. Bad decisions – people put in spots they’ve never been in before, not realising the volatility that brought things up so quickly acts so much faster on the downside. Chasing losses. Every single part of the gambler’s fallacy comes true before their eyes.

Does this mean you HAVE to hold every property or investment forever? No, absolutely not. Reviews are an incredibly important part of a long term investment strategy. The one single quality of Uncle Warren’s that I’ve tried hardest to emulate is to maximise the probability of significant success. My argument would be that in a million possible universes, Warren Buffett has a great life, a great pedigree, and puts himself in an incredible position without taking a lot of risk in over 99% of them. Look at the other famous billionaires – and tell me that they share that same quality? I think not. In some worlds, Warren would be a little-heard-of investor who has no public profile and $800 million to his name. His life wouldn’t be a lot different. In some, he would be the first trillionaire.

That’s what needs to be learnt from. Despite endless gurus spewing mindless BS about your mindset, it really is the anchor from which everything comes. You need significant strength to do what others won’t or don’t want to, surround yourself with the right people, ignore the wrong people, and make good decisions, consistently, day by day. Not easy. By no means do I position myself as someone who has “cracked it”. But – back to mindset – every day is a school day. I love learning and education is one of my highest values – both for myself, and for everyone. Why otherwise would I take a view, post critical responses on social media to often get sharp or troll-like replies – and write 3000-4000 words for a Sunday morning each week! Your values are embodied in what you do, not what you say they are. What you say they are is just marketing.

Before I move off my high horse, and while Uncle Warren is front of mind – another great Buffett secret to success (that of course, is not a secret, thanks to the number of interviews, biographies, etc. etc. that there are out there) is very relevant here. “Most news is noise, not news.” This is no joke, and after a week like this, is well remembered.

I’ve also been asked whether I’ve “invested” (I take exception to the use of the word here – there is a very fine line at the best of times between investment and gambling, and it has been breached here!) in crypto at all. The answer is no. I’m solely a voyeur and a learner at the moment. But I will say this much – at some point in the following months, I will be thinking about starting. Not via direct investment, or any of the somewhat convoluted schemes – because I’ve heard some sad stories this week about people losing money to hackers, and then of course you have to look out for the fraudsters/small time ponzi scheme players – but via an ETF – there have been a few indices launched early this month by the S&P – one for bitcoin, one for ethereum, and one for both – I will be looking at a more diversified basket but only betting (sorry, investing) via an ETF operated by a global player via a tax-efficient wrapper!

So I’ve no dog in the fight (or should that be no doge, for the aficionados?) – I got tired a few months back of posting warnings about the bubble, and called the top far too early (although I didn’t actually call the top, I just told people to be careful) – and just 2 weeks ago posted warnings all over a thread on one of the property forums when 80% of the replies were telling people to take their £20k life savings and punt it on crypto – a classic sign of being near the top of a market before a big blow-off. “When the taxi driver is giving you stock tips, get out of the market”.

This is the frustrating thing. We’ve seen it all before. If you want to look at someone who has a spectacular knowledge and also application of economic history, then look no further than Ray Dalio. And still, he definitely doesn’t get it right every time. But this stuff is more about avoiding events that can blow you up than making money every day, hour, week or year. That’s what gets missed. Very few people don’t want to get rich quick – but the path to do so, aside from anything else, takes an incredible amount of luck. Back to my million possible universes and Warren Buffett – in how many of those is Elon Musk vying to be the richest person in the world? In my view, only a small percentage of them.

OK – so crypto is done to death. But so what? Why is it even getting airtime? Well, aside from the inevitable lessons about bubbles and downside risk, it is wise to think about where the money has gone.

Back to Buffett once more. He and Berkshire Hathaway are realistically the enemy of the broker. The broker wants you to transact, whatever they broker for you. This is straightforward self-interest and also a simple rule of business. A really good mortgage broker will give you great advice across a portfolio, because they understand the longer game – customer acquisition is hard and expensive, and if you have your broker stepping in as part of your overall financial strategy, you will ultimately transact more and offer more opportunities for that broker. That’s joining the dots and is a thinking at a level that many are not capable of.

If you sit on your hands, the broker has had their fees, and they are getting nothing. But on the other side, there is no money leaking out of the transaction. The 1%s here and there can be the difference between a good long-term portfolio strategy and a great one. I hesitate to mention the British Cycling Team and Dave Brailsford these days for a few reasons, but the logic still applies. If you can get 1% better on a regular basis, then the miracle of compound interest will have a gigantic effect on your edge, and ultimately, your returns.

My point here is that the transaction costs in Crypto are incredibly high. No-one balks at it when things are moving up 10% a day and ridiculous numbers like that. But it is like the casino…..have you ever been and played, or seen someone else play roulette? What happens when they hit a number with a lot of chips on it? The casino slips in a few larger denomination chips, and pays as much as they can in “colour” as they call it – so all the colour can go back on and stay in the machine. The broker effect when the transaction costs are so high is the same for Crypto – so an awful lot of the money swishing in the system has gone to the brokers, and platforms. That’s business – they are charging what the market will stand.

So, significant leakage to the platforms. What about the rest of it? I’ve now heard 5 different independent stories from 5 people about crypto megastars/big winners that they have met. All 5 had liquidated the majority of their holdings over the past month and were going to plough the proceeds into investment property. In one instance this was over £50 million.

What those 5 people did was brilliant, of course. They were early adopters when people like me were struggling to get around the idea of investing/gambling in something without intrinsic value. They rode the waves, but most importantly, somehow they saw the top, or near the top. They were realistic. They hit the big number at roulette with a “beast”-style bet (my misspent youth once again shows its true colours) – I learned this phrase from a large payday loan provider CEO who loved to gamble big money at the local casinos, one chip on every bet possible (straight up, splits, corners, streets, 6-lines) and then hitting that one chosen number (8, black, in case you are wondering). More importantly, when those people hit the beast, they walked away….some completely (for now), some just mostly.

So, some profits that ultimately in a few months time will look like they came from air, will be in the property markets. More demand! Uh oh. However – I’d wager there will be at least as much supply from people who’ve got themselves into trouble and need to sell assets to pay margin calls. I’ve heard a few stories of people trading on margin this week who don’t understand margin – and that’s incredibly expensive and dangerous. Big volatility down, quickly, means that people are likely to get smacked in the face. A reminder of the old Mike Tyson quote “Everybody has a plan until they get punched in the mouth.”

As an aside, I do wonder what the anti-money laundering (AML) treatment of all of that will be like! And as for the HMRC investigations – CGT is due, ultimately, as it is on forex, unless betting is used as a “shield” (forex traders tend to use contracts for difference or CFDs to avoid capital gains tax – I am not even clear if the same or similar has been available for crypto) – but there will be a very profitable seam of investigations for those that have made over their annual CGT allowance from Crypto. HMRC have already hired another 1000 investigators which is “nothing to do with Covid” (ha ha) but I’m sure the recent bull run will not have escaped them. This usually means more disposals (and/or more remortgages, bridges and personal loans) as the unexpected catches up by January 31st, 2023. If you’ve made decent coin (see what I did there?) and not looked after your tax, do it before they do it for you, if you take one thing away from today!

So – has this influenced me feeling a touch bearish (yes, I am)? Not sure. I was feeling it before all of this really kicked off, so I don’t think it is related at all. I’m just open-mindedly carrying on listening to lots of YouTube content on economics (I know, rock and roll, right?). I heard the best deflationary argument (to be clear, that is after a period of inflation – that this commentator insisted would be transitory) this week that I’ve heard for at least 6 months, which I will quickly summarize, and then translate to the UK:

QE has largely been deflationary. It has held down GDP growth and inflation rates and stifled “proper” investment. There are shortages at the moment in many markets which are leading to inflation and also temporary demand spikes (the position of the commentator is that aggregate demand, on the whole, will not hold up – because the underlying economy is so weak). Prices will correct once supply shortages ease. The competitive nature of markets (especially commodities) will look after that. Once stimulus has worked its way through the economy (been gambled on Crypto/on RobinHood) then a lot of the household savings balances will be kept just where they are. People will remain cautious for a long time post-pandemic.

The first bit I didn’t agree 100% with and I think it misses the larger fiscal policy backdrop (this is UK relevant now particularly). Policies of austerity were the suppressors and the architects of the flat as a pancake 2010s in my view – and the view of some large apolitical or right-leaning economic think tanks and international organizations (e.g. the IMF). QE was a secondary part of that and of course has led to significant asset inflation. It has also created a fairly significant issue in countries like the US and to a slightly lesser extent the UK who depend so much on a healthy stock market to give consumers confidence (and money) – and fund pension obligations etc. With a bigger state (more governmental control/central planning), the stock market is not so important. So what’s the problem? The problem is that when QE unwinds and cheap money is no longer, the stock market will experience a really significant selloff. This has been seen by what are called “taper tantrums” in larger and smaller forms – the wording and emphasis of everything that comes out of the central bank influences the markets significantly. A taper tantrum is when QE is scaled back and the stock market sells off, aggressively.

There definitely is temporary demand at the moment – you would expect the pent-up part to work its way through. I also know a lot of people that are sitting on more cash at the moment than they otherwise would because they have not been able to find deals – this works its way through in a 3-12 month lifecycle (or even longer for development). The supply constraints are also likely to go the other way, simply because so many suppliers don’t understand the pandemic and its impact, and the pendulum almost always swings back too far. This would be early 2022 or late 2021, in my view.

If both those things happen at the same time, the see-saw swaps positions and the bearish headlines will start. The thing that definitely resonated is what is effectively the velocity of money argument – still lots of people I know who won’t go abroad this year, and won’t be spending what they have hoarded (or accessing the cash in their newly-inflated houses that they own). A slice are still considering the winter and believe there may be another lockdown then – and I think will only be convinced when we get there and it doesn’t happen (colours to the mast on that one!)

My view is that a long, hard, drawn-out psychological battle will take time to get over. Habits take 3 months to form (broadly) as I’ve said before. We’ve had plenty longer than 3 months. You have to look at so many things – the age of the people that are relevant to your business/asset/chosen investments. Their spending power and how they’ve been impacted – what sort of pandemic have they had? They might want to go out and spend but haven’t got the job or the money!

So this means caution, and it means volatility. You can buy in this market at haste and repent at leisure. I still feel early July sees some chains fall apart, and some more deals. Massive refurbs will soon stop being attractive as even the slowcoaches get the message that a) materials are up 15%+ and b) you can’t always get them even if you will pay for them! That ultimately forces the price down of the building/asset/land.

So where does that all leave rates? Well, in a deflationary or limp inflationary environment (The UK “benefits” – and I think it is a benefit – from a long-declining former global reserve currency situation which is unique to the UK) rates stay on the floor. For a long, long time. However, asset prices also stay pretty slumpy and rents also don’t move forwards. Wages stagnate. No growth, much harder to pay down the “War debt”. Not good, overall.

To be clear, though, I’m yet to go away from the inflationista side of the equation. I am questioning my role as a secular inflationist, though – this feels a lot less likely to me than it did 2-3 months ago. A lot also depends on fiscal policy – as I have said before, Boris is the Antichrist to austerity – he wants to spend money on big stuff with his name on it! I don’t see this as a bad thing as long as it isn’t “bridges to nowhere” – the antiquated infrastructure of the north of England (and much of the midlands) means there should be plenty of sensible projects before there are too many red herrings, but Boris has form in the Red Herring department too remember, if you examine some of his failed projects as the Mayor of London.

So this inflation could be transitory. Ultimately, though, I have respect for the markets – peak inflation prediction for 5 years time came on 7th May in the UK, and we have calmed a very small amount since then, about 4 basis points or just over 1% – the expectation is still 3.5%, which is too high. This doesn’t fit with a “transitory” stance. The 3 year is at 3.2%, the 4 year at 3.36% – the 2 year is at 3.07% which I believe the bank would swallow, but will be watching closely.

Let’s bear two other things in mind too. One is more worrying than the other. That’s the plan to actually get out of this rates hole. And I don’t mean just a base rate increase – I mean getting back even to 2.5% which has long been the BoE mid-2020s target (pre-pandemic). I don’t see much of a plan or a way to get above 1% as we speak – I see a need to do it, potentially, but a real Hobson’s choice and there is now lots and lots of form in the economic history books about what happens when Central banks crank rates too fast and too soon (the reality is, before the independence of the BoE).

The other issue is that 3.5% is actually what I think the Government would want (I first mentioned a range of 3.25%-3.5% as desirable a few months back) but the fear of that level is a breakout to the upside, because that could be very dangerous indeed. So they could flirt with it, but not NOT take action if they approached it, in my view.

I am maintaining my position that they will not act as quickly as would traditionally be the case. However, there will have to be a rise at some point as they have to reload the gun. Boris’ desire to invest will have an inflationary effect – and austerity is utterly out of the window. It’s the Tories, so there will be continued faux pas around some causes that will capture the hearts of the nation and it will still be on the Marcus Rashfords of the world to set them straight – but until things really are “over” in the minds of the very most bearish, and SAGE is no longer hitting the headlines, the brakes are unlikely to go on.

What does this really look like? PROBABLY (I’ve moved from definitely) no base rate rises until the end of 2022. A road back to 0.5-0.75-1% at a bit more pace (by 2026 though, most likely, because some of the sluggishness in the economy put forward by the deflationary argument does hold some water in the UK). After that – well, who can say? Will Boris still be in charge – I find it unlikely. If aggregate demand stops being stimulated by such an active government, will a “small state” party/leader of one of the traditional parties be at the fore?

Will the chunky investment in infrastructure (rather than the multibillions invested/gambled/wasted on track and trace) do its job, quickly? That’s unlikely – it is normally a longer term investment.

Is a really sudden uptick from here likely in terms of interest rate or inflation expectations? Possibly. There’s really significant tail risk at the moment in the economy. At the moment it is difficult to discount any prediction that doesn’t contain overtly false assumptions in it. The US had some horrific jobs figures last week, but further investigation reveals that there are elements of a “pandemic hangover” – many people, and of those people mostly women, rightly or wrongly, as the chief bearers of childcare dependency which bled into home schooling, still could not seek employment as recently as mid-March, so are unlikely to have been hired and working by April, in all fairness – we need to stop quite often and appreciate the pace of change that’s been going on!

What does it mean? Fixing debt at these low rates still looks attractive! The downside on rates has disappeared, we can say with 95%+ confidence that we won’t be going negative (black swans aside), and ultra-low savings rates have not discouraged savings at all – the lack of things to spend them on but more importantly the fear created by the pandemic has meant that it is more about storing something than the return you get on it. Return of investment rather than return on investment, and inflation is the biggest silent killer of all, economically – people can hear about it, see it, read about it but it isn’t every day, or week, or even year sometimes – it just ploughs a hole through badly-invested or non-invested cash piles over the course of 5 years and longer time horizons.

Are trackers therefore very dangerous? Well, with the price of any insurance (and ultimately, that is what a fixed rate is) there is usually healthy margin for the insurance provider. However, with these continued tail risks, it might start to look like unusually good value. I’d be looking at 80% fixed 20% floating right now if I was deciding today, versus more like 60% fixed 40% floating if I’d answered that question 3-4 months back. (I’m quite conservative, small c, so 50% fixed 50% floating would be an “all in” bet for me on falling rates.)

I realise that even by my standards this has turned into an epic tome – so I will save a couple more snippets for next week, and just want to say as usual, thanks for the likes, reads, shares, comments and particularly if you disagree PLEASE comment because I work quite hard to read and listen broadly across the spectrum of news/noise and economic commentators, and I always learn something from those with slightly different or completely contrary opinions! Until next week………