Sunday Supplement – “The greatest trick the Devil ever pulled was convincing the world he didn’t exist” – Charles Baudelaire

Mar 20, 2022

The greatest trick the Devil ever pulled was convincing the world he didn’t exist”—Charles Baudelaire
Welcome to the supplement, and firstly I have now achieved my life goal of working in a quote from “The Usual Suspects” into the weekly production! However, to be clear up front, this is not the same Devil as Baudelaire attested to. Nor is it indeed Keyser Söze from the aforementioned great film, one of the greatest ever (regardless of the activities or proclivities of one of the stars of the film). The Devil I speak of has two roles in today’s efforts.
Firstly – he is in the detail – and there’s plenty of that today.
Secondly – he is oft cited as the alternative when the other option is the deep blue sea.
That, it strikes me, is exactly where we are at the moment with the economy and the resultant property market and relative uncertainty. The further problems that waterfall down from there are firstly that there is just so much detail out there at the moment, and so many variables, that whilst we are used to an ever-changing world, the hard part to model is which side will win the armwrestle, and which variable is more important than the next. The second is that whenever we are talking about that choice between the devil and the deep blue sea, it is rarely if ever a bullish outlook for the near future.
I’ve often described inflation as the carbon monoxide equivalent to the economy. Unseen, slow moving, odourless – the silent killer. However, at a rate not seen for 40+ years, there’s actually plenty to see and plenty of noise being made. Direct pain at the petrol pumps for drivers. Energy bill forecasts concerning people significantly. What’s the result of all of this? Well, for those of us that don’t get a double-digit pay rise every year (so basically, everyone outside of those who own an excellent and robust business or series of businesses – or everyone who doesn’t want to do 10%+ more work every year), it hits us square in the pocket.
We then face a series of choices. Let’s put ourselves in the shoes of the average working person. We can’t choose whether to go to work or not without significantly negative consequences – but we can start to do what economists call looking for substitute goods or services. We could walk, bus, train or cycle to work (potentially). We could, as a stronger move, demand to work from home. Or we could move jobs to a job that lets us work from home (and if we do that at the moment, we might also be able to negotiate a pay rise, if our skills are in demand and we are a proven operator).
We can also to an extent change our leisure activities. We can walk to destinations rather than drive. We can stay in the UK to vacation rather than fly abroad (the cost of both is soaring of course). As the currency has strengthened (but only very slightly – trading range of the £ versus the Euro, our favourite usual holiday destination from the UK has been 1.15 – 1.22 for the past year, currently sitting at 1.19) the holidays have perhaps got a couple of percent cheaper on average, but with inflation a worldwide phenomenon at this time we cannot go somewhere that isn’t being hit by rising prices.
More extreme outcomes are that we cannot afford things. Heating the house – the bottom 20% are obviously suffering – although I would exercise caution, the bottom 20% will always exist (purely by mathematical definition) so we need to be quite careful when we discuss what that means. For the first time in many years, the percentage improvement of the plight of those on minimum wage, or working in lower-skilled jobs which have had wages suppressed as a result of globalisation, are better in comparative terms than large swathes of the middle class from a purely income point of view. However, this does not impact the wealth gap which has grown due to the policies enacted throughout the pandemic.
The bigger problem is that still, EVERYONE is suffering in percentage terms – it might hurt when one group is doing better than another but if everyone is moving in the right direction, as has largely been the direction of travel for the past 200 years and beyond, that is at least something. Those living in poverty these days (again by the percentage definition) often own or have access to things that make other commentators strongly criticise or reject the phrase. The direction of travel, measured not in years but in days and months, at this point, is the wrong way and there’s no point in being comparatively better off than your neighbour if everyone is suffering.
Why? Well, inflation caused by supply-side shocks to commodities and the entire economy, thanks to the pandemic. There has also been the small matter of a gigantic amount of money injected into the economy, some of it in a much more direct way than in the past. If you compare the quantitative easing of the early 2010s to the bounceback loan scheme and the furlough scheme, for example, and follow the money, you’d see a massive difference in where that money ended up in the economy.
The hoarding of cash at the time, due to the pandemic and overall fear gripping consumers, did not lead to immediate inflation. However, in the reflation of the economy once goods and services were back open, and a large percentage were willing to go back to the daily and weekly routines that they once took for granted before March 2020, this money was always going to find a way around the circular flow and start to pick up velocity, and stimulate growth. This was the idea, after all – that is why it was called stimulus.
Don’t mistake my writing above as a scathing critique – the overall fiscal policies enacted during the pandemic were, at short notice, in my view, nothing short of spectacular. We did not have modern-day evidence; we performed poorly in 2008-9 in response to the great financial crisis (this is not a political point – we also performed very poorly on that front in the coalition government of 2010-15 just as we did in the Brown administration). However, they were always going to have consequences, short, medium and long term, and we are living with some of them already.
The following policies including the tax hikes are at a high level potentially not good for the economy – but the national insurance rises are somewhat redistributive (which is what is needed, versus say putting VAT up to 25%), and with a real commitment to social care, the overall outcome for the populace should be positive. My personal ideological belief, taking my own £ in my pocket out of the equation, is that the government should set the rate of tax at the rates to maximise government tax revenue in the short, medium and long terms. Excess revenues would be used to pay down debts – “fixing the roof when the sun is shining” and then in times of need, debt could be used as long as it is being used to invest in projects with positive net present value. Whether those projects are delivered by the public sector, the private sector, or a confluence of the two is a matter for debate beyond the scope of the supplement (although I always enjoy having it and the counterarguments on all sides, with evidence from all around the world). If we retain the lowest tax rate in the G7, then overall, especially with access to our lucrative consumer market being that bit harder because of Brexit – we should be the beneficiaries of that position.

The problem is you can’t measure corporation tax receipts year to year – oft cited is the poor receipts in 2010, but that’s an utter straw man – losses are carried forward, and what happened before 2010? That’s not to say putting taxes up was the right idea at that point – just to address the classic critique. Generally, the administration since 2010 and what could have been described as the “Not Great Reset” (do you see what I did there?), has done well to progress taxation receipts. Good job, as Boris is very much a Big Government operator, much to the chagrin of the neoliberal Conservatives who are still big fans of the Milton Friedman inspired approach and monetarist economics, despite some of the failings in the system that have appeared as a result.
Big Government isn’t wrong by definition, in my view – but there is of course much more chance for waste in absolute terms (Track and Trace, anyone?). Accountability and sensibility are what is needed regardless of the governmental structure adopted, anyway.
So – that’s the devil of some of the detail. Back to the highest level of macro – the Bank of England recognised on Thursday that inflation was now likely to exceed their number in the February report of 7.25% – they will not detail this until the next MPC meeting in 6 weeks time. They also see a medium term deflationary environment due to economic activity slowing down – so they see GDP growth/economic growth at 1.25% or lower in 2024-5, thanks to this inflation and the likely policy responses – as rates go up, growth suffers, pockets tighten, consumer confidence goes down and they see unemployment rising to 5% from the current 4.1% in the last ONS report (February). Again they have not yet remodelled it and have another 6 weeks to do so, but the suggestion is that the unemployment rate will be above 5%.
Let’s hover on that last one for a moment. After all, that means 25% more unemployed people than there are today (solely measured on the governmental definitions, anyway). That’s some increase. And right now, we have 1 job vacancy for every 1 unemployed person, for the first time since records began. In theory (and it would only ever be theory) full employment is once again possible without the state being the employer of the majority of the workers. How can this happen? You might well ask yourself.
This is where we get a little bit technical and need to zoom out to the past decade or slightly longer. If I threw the words “Blair Government” at everyone, a large number would respond saying “War Criminal” or make similar reference to the Iraq war. This is the media-engineered response that has come to pass since the change of government in 2010. Very few would recognise the steps forward that the national health service took, for example, under the same administration (nor would they be able to tell you what they were, how it performed versus other administrations, etc). It isn’t headline-grabbing stuff, although it was good for the people overall (and really, should THAT not be the primary role of government?). If I threw the same challenge out to the Coalition of 2010-15, the media engineered response again I’d suggest would be some reference to tuition fees and the capitulation/failure of the Lib Dems to stick to their words and values. Few would mention austerity (perhaps because it started to bite more later in that administration and then under Cameron/May/Johnson before the last election), despite the wealth of academic and NGO material published on the matter and the policy critique in general. Even fewer would mention “QE” although this, Quantitative Easing, was a major policy tool enacted by the Central Bank under the watchful eye of the government.
What we do know from that past decade is that QE had a tendency to inflate asset prices, when there was limited reasoning for them to be inflating quite so much. What was effectively financial repression, with no returns on savings, and pension funds and the likes stuck with massive bond exposure being a requirement of their existence, led monies to pour into equities wherever possible trying to chase any meaningful level of returns, in turn pumping up equity prices.
To be clear, one other thing that came out of the Bank of England report in February was confirmation of the plan already laid out by the Bank to cut their bond-buying programme. There are currently nearly £900bn of government bonds (£875bn to be precise) and £20bn of corporate bonds owned by the Bank of England. The plan is to, rather than what has happened over the past decade, let them expire when they mature and return the money to the Bank from the Treasury, which is where it has gone, and “retire” it (or shred it). So, the reverse of printing money.
QE has been around for so long, since 2010, that because it was a temporary measure that ended up lasting over a decade (and it isn’t done yet!), it now has a mirror term for what is about to happen if this goes ahead as planned. That name is QT (Quantitative Tightening). The likelihood, going on other monetary policy tightening cycles (normally characterised by rising rates, which is also what is going on at the moment) is that asset prices will suffer (just as they benefited from QE) and bond yields will rise. The flow will reverse – out of equity and rotate back into bonds.
But there’s a problem. It is much harder to rotate back into bonds when inflation is sitting at 5, 6, 7, 8% or higher. You are effectively saying “we will lose money in real terms”. It will be a lot easier to lose more money if the stock market loses say 20-30% of its value, for example (much more likely in the US than the UK, but still very possible in the UK) however, so this is part of the aforementioned devil and the deep blue sea argument being faced by pension fund trustees, hedge fund managers, and the likes over the next few months and years.
There’s a chunk of the market that believes “yeah, right”. The best way to describe this story is as the one of the Boy who cried Wolf. The central bank, the BoE and also the Federal Reserve, has told this story over the past decade. Instead, in reality, as referred to a few weeks back as the graphic for this article, the amount of QE has gone up, up and up.
At a really simple level, you could be accused for thinking that when it went into the pockets of the asset owners and shareholders, it was deflationary – and when it went into the pockets of the people and the consumers – it was inflationary. There is of course an element of truth to this – the reality is that neither fixed the long term problems and both created their own long term problems which now we have to deal with.
So, a fair few are saying that the boy is crying wolf again. I was also in this camp – until I wasn’t. What’s changed? Clarity. The Bank of England is not keen on raising rates but is being forced into it at this time. There’s a “might as well” element to that as all this does is put us back on the same footing as the highest rate for the past 13 years. The economy is just about where it was – the pace of anything can’t be trusted thanks to the reflation that’s occurred since the economy re-opened properly following “freedom day” or whatever, last year.
The next rise is different. The one after that is different again. Uncharted territory. My overall feeling is still the same as it was at the end of 2021/beginning of 2022 – is this the year to fix the problems of the past 12 or 13? Probably not. The Bank of England is more committed to moving slowly than the Federal reserve (who, let’s remember, did get the rate all the way back to 2.5% before having to capitulate in the face of a falling stock market).
Now, we also need to make another distinction. The stock market in the US means more than it does in the UK. A smaller number of people and a smaller percentage of people own stocks in the UK. Also, the personal involvement in the US with your stocks in your retirement portfolio account, if you are sitting in the massive middle class there, is much larger – directly picking stocks is much more of a pastime. In the UK, we much prefer to use tracker funds or financial advisors, and don’t have that connection with capitalism that there is in the US. So, the Fed is more incentivized (or the government is keener) to manage the stock market with their policy.
However, I think both markets are in trouble. The US market has far more heat in it than the UK, with the UK market having had a Brexit discount baked in since the actual leaving of the European union. But both countries have a significant inflation problem right now, and that is the real step change from the past decade or so.
Inflation is the number one remit of the central bank – both stated and unstated. Failure to control it will lead to heads rolling – it is as simple as that. Targets are 2% (government set). Numbers that will be double digits, almost certainly, at some point this year and at 5%+ for several years to come, potentially, in the UK, do not evidence a very good job regardless of the reasons for it happening, or the spin that can be put on why it is happening.
How is inflation traditionally controlled – via the interest rate. That goes up, inflation comes under control – not a perfect correlation, but a logic that is not usually disputed. However, as already referred to, this is the time to dispute that connection.
The eagle-eyed will also be noting one other issue here. If QE is deflationary (and I should be clear, not everyone agrees with this argument) and QT is therefore inflationary, isn’t this terrible timing for QT? Well, yes it is, frankly. I can’t make sense of it, apart from to say that this particular cocktail hasn’t been tried for many years so everyone has forgotten how badly it tastes (bit like the Snowball at Christmas). So, am I saying get the taps back on? Not exactly. What I am saying is that if the Bank of England (and the Federal reserve) keep going until something breaks (the favourite critique of the central bank) then what will happen then is that the taps will go back on in a much, much larger way. They are attempting to control the money supply via stopping QE when what has influenced the money supply so much in the past 2 years is the direct stimulus or near-helicopter money (actual helicopter money in the US). That’s already out there and is doing what it is already doing, rising inflation.
Now, you throw energy prices into the mixer. That leads to MORE stimulus, directly, into the hands of people (a small tax rebate and a loan against your utility bill in October 2022). In 2023 at this rate there’s no way the people will be in shape to start paying this loan off and are much more likely to need another one (which will effectively be written off). This is blurring the lines between monetary and fiscal policy for sure. If it gets worse, that means MORE stimulus – do you see where I am going with this? A vicious tornado, upwards, which is always the way for inflation when it moves outside of its reasonable bounds and spreads.
So – that’s the problem, where is the solution? What is the deep blue sea here? Well, the old adage says “the best cure for high prices is high prices”. This is back to my argument at the beginning of the piece, and the substitute goods. Things get expensive, people can’t afford them, they can’t buy them, demand subsides and prices fall again.
Sounds so easy, doesn’t it? But what does it mean? When that high price is fuel for the car, or energy to heat the home, things considered absolutely staple requirements by many – and then it filters through into everything that is transported including food being much more expensive thanks to fuel prices, which truly is needed for life to exist – you have a very unhappy populace. What do politicians like? Happy people who will vote for them. It isn’t a long-term strategy to just keep relying on people not wanting to vote for the other guy (ref. 2019 election!). This is where that “feelgood factor” comes in.
None of this is meant to be alarmist. There is, of course, a massive increase in savings balances amongst the percentage of the population that have more savings than they do unsecured debt that has occurred over the past 2 years. This offers a buffer to the majority. But people aren’t necessarily as sanguine as all of that. They look at the direction of travel – are things getting better or worse? For the next few months, they are getting worse, until we get over the peak of this inflation.
There could be all sorts of consequences. The “Great Resignation” could be reversed as people realise that their retirement savings are no longer sufficient – thanks to inflation. Social unrest is a live possibility if those without assets realise just how much in comparative terms they have suffered over the past couple of years – regardless of individual responsibility versus the collective. Inflation could come down as quickly as it went up – which is definitely a live possibility – the problem is the point at which it stops coming down. We won’t know that for a good few months yet, and the likely destination is around 5 for the next couple of years, in my forecast (as an average).
So, that’s the devil of the detail at the top level. What are the likely consequences for investors?
In the shorter term, I am bearish on the stock market for the reasons stated. The central bank will rescue us! At some point, they will, but that point will be lower than those points have been over the past 12 years or so. Five times we bumped up QE to a higher level since 2009 – never once did it go down. Stocks may be allowed to take a 40% drop before the taps come back on in that sense, potentially (depending on a) whether I am anywhere near correct and b) if something else major doesn’t change).
Many commodities are all over the place already – it did strike me as strange that Oil touched back near its current “normal” market price just a couple of days ago (near $90/barrel) when the Russia/Ukraine conflict is ongoing. That seems too sensible and there is very readable, sensible commentary out there at $200 or even $250/barrel. But one that always fascinates the investor is Gold. Having closed at $2050/oz around 12 days ago, the price is closer to $1950 now but could have some significant legs on the upside. It started from a high base, which is why gains have not been as expected in the past couple of years – but there could be significant upside volatility and owning some as a hedge or uncorrelated asset might make more sense today than it has done for some time.
So what of hard assets in general and particularly property? Well, we need to get more into the detail here. Those holding assets which contain tenants on housing benefit – the squeeze is inevitably going to crush those on these sorts of fixed incomes. You’d be tempted to believe that the government will let this happen first before they take any action – next week’s budget might prove me wrong, but I doubt it. Rent rises will be theoretical and rent collection will be challenging (many would argue it already is, anyway, of course). This would also be true of pensioners as a rental group.
Those containing blue-collar working tenants – pressure will be less. What mitigation strategies might you want to use? Keeping tenants informed about heating costs and efficiency. Applying for any grants for low income households and energy performance. Investing directly in properties to improve the energy performance if they are long-term holds. Their wages are rising and for those that are upwardly mobile in their careers, whether they be blue collar or white collar, it is always worth remembering that people tend to earn more money as they get older but top out at around 55, as they either look to take fewer commitments or a less stressful job. This is likely the safest group to be housing at this time.
The white collar middle class – mostly homeowners of course. Those who are not, particularly if they are not because they live right until the end of their money each month, are likely to have problems ahead. Those who cannot budget (and this applies to each tenant group of course) will be seriously punished for that in the months ahead. Take a close look at spending and bank statements, and don’t be expecting large pay rises for this tenant type in the current market.
HMO – you will need to control your bills as effectively as possible. Fair usage clauses may well need revisiting. Investing in the property with energy efficiency measures, if you are set on it being a long term hold, are an absolute must. Check your paybacks – there are fewer better places to put your money at this time. If they are not long term holds – it is still a fantastic market to be selling them in, and I’d consider that (and I’m a long term holder saying that!).
Serviced accommodation – expect prices to move up across the board. The base cost of providing a bedspace, getting a cleaner there, even down to the wifi – is all screaming up. If costs go up 15% and prices only 10%, margins get tighter. Again excellent bills control will be needed and remote management devices will be worth their weight in gold.
Is it still worth investing in property? Some will no doubt be asking themselves that after reading all this. The answer is yes – you need to look at your alternatives at this time. Take larger risks to potentially lose money in equities, or commodities. Pay more tax on income that you crystallise or get from other sources. Sit with cash on the sidelines waiting for the crash that may well still not come, even based on what I’ve said today – a swift turn in monetary and fiscal policy (see April 2020!) can very quickly change the course of a situation. Will the next few years returns, adjusted for inflation, be memorable in years to come? Absolutely not. Even keeping pace with it is a fairly good target right now.
The flip side of the inflationary situation, of course, is that if wages do get forced up to keep pace, house prices also keep climbing. And climbing. Debt inflates away and in the long run, there is a nominal rise in prices over these next few years that IS memorable. That in itself will provide a new challenge, because that will start to look like a bubble – inflation or no inflation. And when the wind does change and the inflation works its way through because of a bust – the fall will be more painful.
More on future house prices next week – this is enough for this week, well done if you made it to the end……the devil or the deep blue sea?