Sunday Supplement – What flavour is this one?

by May 15, 2022

“There are different flavours of recession. You can get into some pretty dark scenarios pretty quickly.” – Mark Zandi (chief economist, Moody’s).
Welcome to the mid-point of May and the supplement continues with the topic that is gripping the news at the moment – recession. There’s been speculation this week as to whether we have entered a bear market in the stock market, certainly in the US, as there is a completely useless and arbitrary definition of a bear market – when the market is down 20% from its high. The number was 19.9% some time on Thursday this week – but, unsurprisingly, nothing magic happens at or on the 20% number. It is one of the more useless definitions.
One of the other arbitrary definitions – to an extent – is the definition of a recession. “Two consecutive quarters of negative growth”. It doesn’t take a genius to work out that if you have two quarters in a row of growth at -0.1% and -0.1%, and then growth of 1% in the third quarter, things probably aren’t too bad (by today’s standards, in a developed economy, anyway). The two quarters thing is almost always a moot point, because the average recession lasts about 5 quarters. As always though, we are cautious over the average, and that’s the point of today’s quote. There are, indeed, different flavours of recession.
I wanted to look back at some of the more recent ones to draw out what we could learn from them – and also to point out that none were the same as the last one, or indeed any of the other ones – our want to make things cognitively easier is sadly very difficult to satiate when it comes to economic predictions.
We’ve got quite short memories, and a particular flavour we’ve never seen before (Some kind of mixture, perhaps stracciatella, neapolitan or rum and raisin?) happened in 2020. It was different in a number of ways – firstly, it only lasted for the obligatory two quarters (in fact it was only two months). It sent graphs off the charts and did things to the figures that hadn’t happened for sometimes hundreds of years when of course the world looked very different. I’d wager that the memory of that recession wasn’t too bad for the vast majority of the population.
Before that we had the so-called “Great Recession”. A name riddled with schadenfreude. This lasted for 5 quarters – 2008 Q2 to 2009 Q2 inclusive. We did have four quarters of negative growth relatively shortly afterwards – but not in succession (2010 Q4, 2011 Q4, 2012 Q2, 2012 Q4). The quarters that bookended the Great Recession were minor adjustments (-0.2%, -0.3%) and the three in the middle were a lot harsher – -1.7%, -2.2%, -1.8%. A notable statistic from this was the unemployment rate rising to 8.3% in August 2011 – so what we learn from that is that unemployment can lag a recession, somewhat due to the employment protections that we enjoy in the UK versus somewhere like the US, for example – today we sit at 3.8% unemployment, an incredible difference.
Prior to that, we are back to the recession of the early ‘90s. Nearly 3 years (11 quarters) to get back to the GDP levels of before it started – so a longer shadow than the 2020 recession, despite the depth of it. Annual inflation was 9.5% in 1990, 5.9% in 1991, 3.7% in 1992. and 1.6% in 1993. Interest rates started that recession at 14.8% and declined to 5.9% by the end of it (the lowest rate since the late 70s, over 15 years before).
You can see a few parallels there, perhaps. Recession or no, in the upcoming couple of years, those inflation figures might be a fairly accurate predictor of the path we might be on (perhaps add 1-1.5% to them, best forecast as I write this) – so that would see us still not under target in 4 years time. If we don’t have a recession, it will be harder to control inflation – since there is no cure like demand (and consumption) dropping off. Note the dropping rate though, of course. Unemployment went from 6.9% to 10.7% – again, perhaps a fair estimate of the basis point movement that is possible if we do go into recession, although the Bank of England forecast a less harsh outcome for the job market with us hitting only 5.5% unemployment, subject to fiscal policy.
We will halt there, aside from picking out one more recession of interest.
The last time we had two recessions as close to each other as this next one might be to the last, was the mid-70s. There’s been lots of mention of this as the last time there was real inflation (people’s memories are poor – the early 80s had massive inflation in the recession that lasted from Q1 1980 to Q1 1981 and beyond that, inflation was “only” at 4.6% in 1983 after a surge). It’s worth putting the situation into context – because some of this mess, at least, was international events outside of the government’s control (much like the energy and specifically gas markets at the moment – I was blown away this week when I discovered that 40% of our electricity in the UK is generated by burning gas – presumably because “gas is cheap” although in real terms gas is around 1200% more expensive than it was between 1995 and 2002. 1200%!).
However, note the numbers. The interest rate was all over the place, from 9% to 15%, and the central bank’s strategy simply was nowhere near as good as it is these days. Some of that at least is thanks to the Bank’s independence from the government of course. Average inflation was 9.2% in 1973, 16.0% in 1974, 24.2% in 1975 and 16.5% in 1976 – and one thing we can say with some certainty is that we aren’t there – that is just ridiculous – 83% in 4 years. We are looking at a scenario more like 20-25%.
It is worth saying though, one other reason why I chose to highlight this one was not an effort to put those inflation numbers into context, but to point out the stagflation element – low or negative growth with high inflation (high = over 4% in this day and age, realistically, low growth = below 1% real GDP growth per year) – and also the industrial action point. What happens when inflation runs away – cost of living is squeezed.
Employers don’t want to up pay to the rate of inflation because they can’t manage to pass on all of the costs to their consumers – if prices don’t go up as much, then wages can’t go up as much. Employees, understandably, don’t see this as their problem, and in unionised workforces a few spirited characters will point out the overall unfairness in the inequality created by capitalism (still waiting for a better system, of course, but will be waiting for some time in my opinion) – and how the boss still has a nice car, etc. etc. – cue a strike or two or many many strikes.
Now – the game has changed since the 70s because the level of industrial action seen nearly crippled the economy. The monetarist school and Mrs T came in and won a few arm-wrestles – potentially sometimes by headbutting the opponent rather than pinning their hand to the pad – and things were brought back under control. But strike action is not unheard of and is just one of the many upside risks that exist in the upcoming 12+ months.
So – my economic catharsis is achieved for the week. My central point is that we can learn something from all of these recessions, but the next, whether it be this year, next or in a decade’s time, won’t look like the last, or the one from the 90s/80s/70s etc. There will be one – that’s one certainty. When is the hard bit!
Unemployment will go up. That much is one feature we can pretty much bank on (a repeat pandemic aside, although unemployment DID go up in 2020 of course). As so often, it depends on the position we start from – and unemployment mid-year is forecast to be at 3.6%. Incredibly low in the context of the previous recessions – and some of the problems created by juggling the statistics and the benefits systems in the 80s, and the unwillingness to sort them out during the 90s and 2000s, do seem to have been ironed out to the point where there is much less incentive to choose a “benefits lifestyle”. This is often an unfair characterisation, but when you’ve had a significant amount of first hand experience of the sorts of mentalities that are out there – thanks to local circumstances but also overseeing thousands of tenancies over the years – then even the objective have to call it as they see it.
And what then for property investors. We don’t care about recessions, do we? Well we should. We’ve got to consider our debt exposure – we face an incredible opportunity today, one that I’ve never quite seen coming in this way. Inflation at 10%, you can still borrow at 3% even in a limited company – on multiple properties – with rents rising at “faster than 3%”, let’s agree. This is a generational wealth protection and wealth creation opportunity. But I can’t say it enough times, that leverage MUST be fixed. It must be. Yes, rates could go up then down again if we go into any sort of significant recession (GDP contraction above 2%, let’s say) – but that’s no guarantee. I can’t emphasise enough that we are still in uncharted territory for monetary policy, and so I’d be reluctant to rule out a whole number of scenarios with significant risk.
This is why I am personally looking at the following ratio: Cash (at bank/available/cash equivalents, including pledges from investors):Fixed rate debt (consider the duration as well of course):Floating rate debt.
I have used a very aggressive ratio to scale the portfolio I have done in the past decade or so. That level of aggression currently isn’t justified. This formula, whilst not that pretty, is very important. Apply it to a couple of situations:
  1. Investor, no property at the moment, 100k in the bank. Ratio: 100:0:0 (this is a horrible ratio when inflation is 10%). Solution – deploy, sensibly, with a fixed rate mortgage, with as long a duration as fits/is sensible.
  2. Portfolio landlord, 20 properties, 100k in the bank. Ratio: 100:500:1500 (i.e. 75% of their debt is on a floating rate). SIGNIFICANT UPSIDE RISK in this setup at the moment. Solution – get some floating rate debt onto fixed rate, ASAP.
  3. Part-time long-term investor, 5 properties, 10k in the bank. Ratio: 10:200:200. Cash at bank is too low for level of debt – 20/1 (40/1 on total debt) looks like a very very high multiple to me at the moment. Solution – fix the floating debt, regear to release cash, or consider sale of one property or more.
Hopefully that is useful, and I will of course continue to update each week as the world in 2022 plays out! Have a great week all – and if you haven’t heard about our PIP Live event in June, the link will be in the comments – unmissable!