Sunday Supplement 25/10/2020

Oct 25, 2020

The Sunday supplement took a break last week whilst recovering from the business retreat! Always an awesome week of the year but so very draining…..and I had less time to keep plugged into the economic news whilst on the retreat too!

Today is more a zoom-out on something I’ve been researching and keeps it “macro” as we look towards 2021.

There are some eventful times ahead and the key message I’ve been talking about inside property circles and our PIP community is the volatility that definitely lies ahead next year. Let’s look at what we know:

Stamp duty holiday. Scheduled to end on March 31st. Every chance of an extension or more likely (IMO) an overall reform but currently a cliff edge exists which has pushed the market upwards, with some of the indices rising at the fastest pace for many years.

I wouldn’t get too carried away. The ONS is the one to follow and they are showing a relatively mild increase thus far in pricing. In reality a lot of deals are falling apart thanks to ever changing news and circumstances – markets hate uncertainty and that’s the one thing we have in huge volume this year.

Volatility offers opportunity for the most skilled. It means being calm under pressure and sticking with fundamentals.

Commercial property transactions have increased significantly. Why? Because there are willing buyers and willing sellers. Who has got it right? Not sure as yet! But at this time as we enter a mega-low-yield 5 years with inflation likely, i would suggest high-yielding well diversified assets are as well placed as they have ever been, if not better.

We know that cheap credit pushes prices up faster than anything else. Forget the disruption to new stock that has been observed and created this year……factor that in and the mix shows a very clear set of ingredients for prices to continue rising over the medium term.

I’ve also spent some time looking into the overall economic position as this is also a cause for concern for some. “Something has to change soon”…..or does it?

All the rules are on the table to be bent and broken….and that’s without even considering the brexit negotiations (or lack of them). Traditional measures are at all time volatility highs and/or supposed red lines or breaking points. But nothing is breaking yet……

I like to look at Japan as there are significant similarities with the UK. I have done so for Covid comparisons (the major difference being mask wearing being normalised for at least a whole generation, followed closely by hygiene standards/hygiene’s place in everyday society) because of the demographic similarities, geographic similarities and also based on population quantum. These are equally if not more valid for economic comparison and also Japan has been a live experiment for a little over 30 years of low interest rates and 25 years of QE.

Has this led to particular issues?

For savers it has. You can only survive based on brute force (I.e. saving more money), working for longer or taking more risks with your investments. Japan has a savings culture it is often said, but things like pandemics mean that even consumption-heavy economies like the UK see a massive increase in savings (and where our consumption is a larger part of the economy the bigger savings would be more largely magnified). The actual percentage of UK gdp that is consumption is 62%, compared to 55% in Japan. The government spending and investment proportions are remarkably similar between the two countries so the balance is made up by net imports.

Households are running a larger cash balance at the moment and this makes more of an impact the larger the percentage of the economy that relies on consumption.

What have we also seen in Japan? The central bank owns a gigantic 70% of the government’s debt, the infamous JGBs. The rest are owned largely in Japan too by risk averse institutions, it is a closed shop situation which to an outsider or beginner looks like a ridiculous situation (and you could argue that it is!) But insiders refer to this as the Widowmaker trade because you are likely to go bust before JGBs find a true level in the market.

By contrast the bank of England owns about 35% of the UK gilts (up from 25% a couple of years ago) and similar to Japan about 45% is owned in national institutions. The other 20%+ is owned internationally and those payments flow outside of the UK economy. This is because the UK has a much more attractive policy for foreign investors and Japan historically have actively tried to keep foreign investors out, no doubt not least because of their frosty overall relationship with China.

That capital inflow in general, combined with the much more expansive immigration policy in the UK, has potential to mean the UK won’t face the same fate as Japan by definition.

So what is that fate?

Productivity is low as measured economically. This sounds nonsensical to those who know that the Japanese stereotype is to work extremely long hours, and work very hard. This is because of how productivity is measured more than anything else. Incredibly low unemployment (under 2.5% before covid reared its head and still under 3% at this time) plus the long hours mean that Japan are penalised from the metric’s calculation. Productivity increases however do have a strong correlation with long term gdp growth so there are a few counterintuitive solutions that Japan have addressed over the last decade e.g. working fewer hours. This has washed out in very low GDP growth since the top came off the nikkei in the late 80s.

They also have ultra low inflation and have had to battle deflation on and off for 25 years. This is undesirable when carrying so much debt.

Their debt as a percentage of GDP is forecast to go over 250% thanks to Covid despite the Western world believing that 90-100% is a critical range (although Italy and Greece are well outside of this too, but they are not economic bedfellows that many would want to be keeping).

Uk debt is around 100% of GDP at the moment by comparison.

So are we likely to gravitate back to low unemployment, and “enjoy” low inflation post-covid? With ultra low interest rates? I’d say 2 out of 3 are extremely likely, the inflation one is the one that is not so clear cut. There could easily be an unstated objective to make the debt erode thanks to inflation, but this could be risky and it seems more likely to me that we will battle inflation rather than deflation in the next 5 years. However these other factors will have a significant drag on inflation so perhaps I am concerned about nothing! We should have at least some mitigating factors meaning we are not fighting deflation which is much more damaging than inflation because of what it does to consumption and consumer behaviour aside from anything else.

All this sets the stage for 5-10 years of house price growth, in my view, although the current market has gained too much too quickly with no fundamental reason to do so. This would be in real terms, something not often talked about i.e. After inflation. It can easily be forgotten that in the 2010s a large slice of the UK (40%+) did not see house prices increase at all after inflation, even if they went up nominally. So there’s room there – those areas tended to be in the Midlands, North, Scotland and Wales.

It also sets the stage for the breakdown of some of the underpinnings of economics. For years the monetarist school has clashed with the keynesians….monetarists like small governments and low tax bills, keynesians prefer higher government spending and fund that with higher taxes. But that was in the days before the magic money tree (MMT) or modern monetary theory as it is known.

The logic and the little-pointed-out

kicker is that with interest rates so very low there is an exponential increase in the size of the debt that can be carried. This is a key metric around the servicing of any debt, if we accept that the debt should be paid back (or in reality, the appearance that the debt might be paid back one day might be more accurate). The debt servicing cost to the UK currently is around 1% of GDP (“old world” metrics were keep it under 3%). The surplus could of course be used to repay debt in the future (the UK in the recent past has coped with up to 7% of gdp going out in interest payments).

Pursuing this policy actually also means lighter taxation (assuming inflation is the missing piece) although sales taxes (VAT) would be desirable to raise prices (but politically unpalatable or at least tempered by a tax seen to tax the wealthy). So the tax rises that many see as inevitable I think will be more political than anything and the core policy will be to try and pursue a level of inflation above the bank of England 2% target.

So if you don’t pay much or anything to borrow – and print your own money anyway/buy your own debt – why would you not borrow to do any sensible infrastructure investing (for example)? The theory could see a golden age of investment – IF covid can be moved past relatively quickly. There will never be a better backdrop than a big majority and an electorate with an appetite for government spending….and indeed this was the plan if you refer back to the march budget and the quoted 600bn of infrastructure spending that was planned for this parliament. I for one would support it wholeheartedly… long as the whole world keeps playing th fiat ponzi game.

That cat came out of the bag a little bit recently when it was revealed that the government had already retired 150bn in bonds that it owed the bank of England… simply did not pay that 150bn in capital back and it was quietly removed from the books…….a clear attempt to see what the reaction would be. Part of the reaction has been a credit rating downgrade but what else? We will need to watch future bond issues to check appetite and see if the risk premium changes…..

Interesting times ahead – make sure to follow the page for more updates and all members can catch up with our content via our online repository which has tons of content to watch “on demand” at a time that suits, alongside our dedicated Facebook and WhatsApp groups.