Supplement 020723 – H1 down

Jul 2, 2023

“Buzzsaw gone, Dynamo down, but the stalk isn’t over till the fat lady sings, and the very last criminal…Fireball, report to wardrobe at once. Fireball, you are wanted in wardrobe.” – The Running Man, 1987


Welcome to the Supplement everyone. Half a year down and it is inevitably time to review goals (if set per calendar year), lament over predictions, and most importantly of all look forwards. One thing that lasts long in my mind is my comparison of 2023 to “treacle” back near the start of the year, and whilst the media prefers to use the word crisis wherever it can (I can’t even be bothered to tot up how many crises we have supposedly had thus far), treacle it is.


As per the new format I’m going ahead with the bullets up front, although I’m going to number them for the purpose of the NEW audio version which I’ve managed to get online with the help of a colleague. 


  1. Flat markets are times where skills really shine
  2. Excuses for inaction will never lead to excellent results
  3. There’s cash out there and that’s one real difference from previous doldrums – but just how much, and what direction is it going in? 
  4. It is perfectly possible for other asset classes to outperform property over the next 12 months. It’s not guaranteed nor is it likely that any major asset classes will outperform it over the next 10 years – what is your time horizon?
  5. So few people understand reinvestment risk – so there’s more on that this week
  6. One of the doves leaves the Monetary Policy Committee that sets the interest rates – her outgoing commentary is interesting
  7. The Zoopla report highlighted last week has some airtime, including 42% of properties trading at a 5% discount or more to asking price – highest since 2018, but remember this is asking price, so some more context around that. 15% are trading at 10% or more off the “original asking price”… what?
  8. 5-year swaps have drifted very slowly higher this week, touching 5% at points – a 20bp drift upwards in the UK 5-year gilt this week and 4.7% has been tested – a fairly high watermark historically – the mortgage rate outlook remains bleak for the very near term
  9. If you haven’t fixed yet, and haven’t got a rate locked in – you still need to wait, in my view
  10. A quick synopsis of the logic of interest rates HAVING to go higher than inflation to conquer it


So – commencing with the flat markets. 2019 was a flat market, and was lucrative for our operation. The lack of movement, and the lack of momentum, and also the lack of volatility combined with some particularly low interest rates, made it a happy environment to trade in. Why? Well, enough flatness to sit on the fence and do nothing – that takes some buyers out of the market. That’s helpful. Some still paralysed over the fear of Brexit, what it would or wouldn’t be, and making ill-informed predictions of how it would change the housing market (on that front it has done very little indeed, on a nationwide scale anyway). When returns are not exciting, all the recreational money dries up, and they leave it to the professionals – that’s the really juicy reason, to be honest. When the taxi driver isn’t buying buy to lets, that’s a good time – not a bad one.


This feeds into inaction excuses. You shouldn’t be seeking optimum entry points or exit points. They should be largely staged, and accepting that the returns are a long time coming in this game. So much of your returns will be tied up in capital growth – untaxed until crystallisation – that not selling is very attractive indeed, especially when wrapped within a limited company. Timing the top, or the bottom, is a fool’s errand. What will you do when outside of the market? Are you a world class bond, forex or crypto trader? No, you aren’t. Neither am I. That’s why you are reading or listening to this, and I’m writing or speaking it.


I see lots of relief, often, when inaction looks best. If you feel stressed, at any time or market condition – take a break. Doesn’t need to be an expensive holiday. A 30 minute walk without a mobile phone is a fabulous break – and highly recommended for that matter. In reality though, fabulous deals were done in 2004, 2005, 2006, 2007, 2008, 2009 and 2010 – and every year before or hence. They may have looked a bit different – sure – but tens of thousands of them were done – or more!


The big difference oft cited at the moment between now and 2008/9 is the volume of cash that is out there on the streets, in the pockets. Corporate aggregate net cash holdings went from £20bn to £109bn (yes, £109bn) from 1st March 2020 to end July 2021. Figures are hard to come by for today’s number. Households still save around 8% of their disposable income (on average) in 2023 – not as much as the great figures of 2021-22, but still well above the anaemic 5-6%s of 2016-19. This is expected to continue into 2024 at loosely the same number.


Now in 2008 people still saved around 8% of disposable income, and this went up to over 10% and nearly 12% as the financial crisis played out – people save MORE in times of trouble, because they are more worried, effectively. Household net worth in 2021 in the UK was £11.8 Trillion (the last year for which there are figures); estimates for 2022 are that another half trillion went on those figures from 2021. Comparisons to 2011 were around £7 trillion, so a 68.5% growth in a decade (not bad). There sure is more money, but it mostly appears to be in the hands of the corporates rather than the people. However, the figures are quite robust – in general, the only way is up, as Yazz would say.


We’ve now got to get into reality, and short-termism – the downside of even attempting to invest in stocks. Prices go up and down more on emotion than they do on fact – earnings still drive prices but price-earnings ratios at these sorts of levels in a time of “normalising” interest rates (if that’s what it is – if) – and resi property, for once, isn’t the top performing asset class at the moment. Cashflow is difficult, and prices are moving sideways/downwards. That’s before you start on inflation. 


But you don’t invest for a few months. You invest for the long term. Anyone who owned any property by 1st March 2020 and has curated it with a modicum of skill has still achieved a fantastic return since then, and in a 12, 18 or whatever month trappy, sideways or slipping market, will still have achieved an acceptable return by 31st December 2024 (to pick an arbitrary date). 


It’s the decades (or similar) that you need to think about. The gurus, or furus if you prefer, will tell you that property doubles every 10 years. It’s hogwash, of course, although there are plenty of 10 year cycles where this happened, or better. The recent cycles and the “new world” tend to be different – there were limited parts of the UK where this happened between 2010 and 2020, for example; definitely the exception not the rule.


Still, until the crystal ball, and because of the high frictional costs of buying and selling property, the vast majority of us will be better off sitting on it, and doing our level best to eke out a workable return. The market is adjusting at the moment – and you see what happens. Rents are inflating in a similar way to the way that inflation has worked thus far in this uptick cycle. Let me explain.


Rents started moving because of stimulus, and supply-side shocks caused by the pandemic. Just like other prices. However, inflation gets endemic and then the cost of the supply of rental stock goes up massively (because interest rates go up significantly) and the tsunami continues, fueled by different reasons. The market keeps going up, and inflation in wages and prices mean that it can keep going up. The returns required to hold a property – the balance between capital value and yield – are racing forward in favour of yield at the moment, which has been a rare phenomenon for some time. Capital growth has oustripped yield dramatically in 2020-2022 and the balance is starting to come back – the market clears itself, in the end, and is ruthlessly efficient at doing so.


Still – this year, plenty are looking and making what – on the face of it – is a rational decision. Invest in a shiny new savings account at 5% (gross). Or – pay down a floating mortgage debt that has hit 9%, or 10%, or similar. Let’s dive into those a little, and what’s called reinvestment risk – because people have short memories, or learned little about this in the first place.


Welcome to 2005, if you follow my flight of fancy. Resi property isn’t for you (yes, suspend belief for the moment) although you’ve paid the mortgage off, and are still at work on a comparatively voluntary basis. Let’s say you are 63. You’ve got 300k in the building society – one of the lucky ones. You get a nice, juicy 4% bond fixed for 5 years, and decide to retire. 12k a year, per year, without touching the capital. Private pension bringing in the same money, let’s say. State to kick in soon at 4.25k per annum (yep, really). £28,250 pre-tax – massive. £22,672 was the median earnings. Great position – bulletproof, right? Not the lap of luxury.


Fast forward to 2010. Pension has trickled up to £5k per year. Private pension has taken a kicking due to being in the stock market, and sensible drawdowns have halved to £6k per year. You go to renew the building society bond – and there you are, offered 1.5% for 5 years (and little do you know, it gets worse every time you renew, for the next decade). £4.5k per year from that, and we are down to £15.5k pre-tax; median earnings have moved up to £26,234 despite the crash and instead of being 25% ahead of median you are now 40% behind. Let alone the fact there’s been inflation over that 5-year period.


THIS is reinvestment risk. It’s great seeing what you can get now, but what happens when you can’t replicate it in the future? That’s why a historically inflation-proof (or at least, inflation-mitigating) asset can be massively helpful. I see property returns in 3 ways – discount, yield, and cash flow.


Discount only happens once – on the way in. The majority actually pay a premium – because stamp and legals and mortgage arrangement fees easily add up to 6-7% on a property – but the logic still holds up. If that’s you – that’s the cost to play. Cash flow happens every month, and can be aggregated – as long as it is there – pertinent commentary at the moment. Capital growth happens over time and is either accessed by refinancing, or crystallising all those gains upon the sale of the property (and paying the associated taxes at that point, too).


Today – discount might not be where you might want it to be – although remember, there’s great deals in every market. We are still agreeing purchases at nice prices, and although we’ve sharpened the pencil to reflect the likely doldrums in pricing over the next couple of years or at least lack of capital growth, that discount needs to make up for the lack of cash flow there might be to boot. Over 5 years+, we remain very confident in our own operation.


Look instead at the paying down debt option. If you are unfortunate enough to be paying 9%+ at the moment on a floating rate mortgage, let’s address the downsides first. It is frictionally expensive – a new replacement loan, when it comes, will have fees associated. There might be early repayment charges. So, the 9% return isn’t 9%. Also, there will be tax implications – debt is tax deductible. So the net position might not be that 9% for a couple of reasons (although if you invest it at 5%, you are likely creating tax that end, so the tax point might be moot, depending on circumstances). 


The upside though – if you are au fait with the fast finance market, you can release that capital very quickly if a deal comes along. It is not far off being as useful as cash, although raising small amounts is fraught with issues, so do bear that in mind. Lower gearing as costs go up is sensible, although expect your return on equity to be temporarily very low (certainly below inflation). I’ve revived that 70s phrase a number of times – who can lose the least, at times like this, in real terms?


Remember though, when you hear people who are “sorted” because interest rates have (relatively temporarily) touched 5%, coaching them on reinvestment risk is sensible.


I thought I would also refer to the end of the tenure of Silvana Tenreyro on the Monetary Policy Committee for the Bank of England this week. Her second 3-year term as an “external” on the Committee has come to an end, and she’s done. She’s voted against rate rises since rates hit 3%, so she may well be a darling of many supplement fans – she believes, effectively, that we need to wait and see the effects before raising rates any further.

This is, frustratingly, such a textbook answer. Dr Tenreyro is far more academically qualified than I could ever dream of being, of course. But she’s wrong – and I’ll tell you why. She hasn’t appreciated the importance of managing the international money markets, despite their incredible reaction when Liz “The Iceberg Lady” Truss presented the Kwar Krash budget with her chosen chancellor. This isn’t the stated policy of the Bank – of course – the remit is to control inflation – but to ignore this secondary order effect is not to do a good job as an MPC member, I’d suggest.


This is the thing. Should you do what the textbooks tell you is right – what a lifetime of research tells you is right, based on economic history and econometrics? Even if those who control the price of fresh debt to the UK government simply expect “action” of a positive nature, regardless of whether it will actually work or not? THAT is the question – but just as a major part of the role of a CEO these days is to manage the stock price, so that the company can continue to attract inward investment, thrive and go forward, one major role of the committee is to project confidence that they know what they are doing.


“Right” or “Wrong” is the incorrect focus, though. It’s quite the claim that this is the wrong course of action. It’s more accurate to say that Dr Tenreyro is likely correct about the correct marginal rate for the base rate of interest at this time – we have been tight enough for this economy for some time. The likely path, in her eyes, is that the rate has to come down relatively quickly in a relatively embarrassing loosening of monetary policy because the noose has been too tight for some months; however, we might not actually see this for anything up to another 18 months. Such is the nature of monetary policy – and before then, and during that period, a lot is still bound to change, and play out.


“I would expect loosening will be needed to meet the inflation target. And the more we raise rates now, the earlier and faster we will need eventually to cut rates,” she said.


Eh? How can loosening be needed to meet the target? Well, she thinks that inflation will cave in soon, and that it will fall not only to target, but below it, and so rates will need to come back down relatively swiftly in order to square this circle. Good news – if you believe that. More good news, she’s got a PhD – which I don’t have. Bad news maybe – I don’t agree with this directly, although there’s no time frame on these comments of course. The stubbornness with which inflation will resist these rises is likely to be highly resilient, in my view, and I am sure I am putting more emphasis on managing the gilt yield that she might well do. As I said – interesting.


Her commentary did nothing to calm the 5-year swap rate, and the 5-year UK Gilt. Rates drifted upwards another 0.2% or 20 basis points this week, with the swap touching 5% at points, and the 5 year touching 4.7% alone. This is a precursor of 7% rates on 5-year fixed rate mortgages (including the arrangement fee) and that feels pretty horrible. 5% rate with a 10% arrangement fee, anyone? Not yet I hear you say, but many more weeks at this level – and that looks perfectly possible – and we won’t be far off.


GDP was up 0.1% on the first quarter and 0.2% on the entire year. The Nationwide house price index was down 3.5% on the year, but up 0.1% on the month in an unexpected piece of news. June seems to have been a more resilient month than expected, despite the interest rate news developing for a good half of the month. UK Business Investment was also far more robust in Q1 than was expected – much of this is more fuel to the interest rate fire, as things still look stronger than anticipated – and indeed this speaks as to why the bond markets have moved the way they have this week.


It isn’t time to be fixing any mortgages yet, nor is it a week coming up to look forward with anticipation as to new rate releases based on swaps. Perhaps some of the lenders with large cash reserves, keen to earn a margin on it, could steal a march by releasing a best-buy product, but, in the face of limited competition, they don’t need to work too hard to get to best-buy without compromising on margins.


I wanted to bring things to a close with some commentary around interest rates “having” to go higher than inflation in order to conquer inflation. A couple of shaky graphs from the 70s tends to be the logic for this economic identity – which is not an identity, and has no grounding in fact. As discussed last week, our key core metric to watch right now is core inflation, rather than CPI. Germany vs Spain bore this out incredibly this week; Spain’s CPI (the headline number) came down to below target at 1.9%, but its core inflation remained up at 5.9%, after a peak in early 2023. Germany’s headline number was 6.4% – far worse on the face of it – but actually the core inflation was 5.8% (still their equal peak in this cycle, but lower than Spain’s).


CPI versus base, lagging, is not much more useful than a solution to the escape room after the time has run out. Base should lag CPI, but not necessarily at the same level. That’s just the nature of central banking – relatively slow moves, after events have happened, to reset expectations about future events happening (or not). Worth revising this bit, Mr Bailey…..that’s why this week’s image sets 22 years of base rate versus CPI, so you can see the “correlation”. 


We need figures back in the 70s, 80s, and 90s I hear you say! Well, I agree – but CPI was only first wheeled out in 1996. Not ideal for backtesting.


So we end the week a little inconclusive, with still some signs of relative green shoots for the UK macro picture. Economic growth of 0.2% is a bit of a swizz if population growth in the interim has been around 0.34% of course, per capita we are worse off, but recession still looks months away if it is happening, and treacle continues to be the order of the day. Remember to polish your soft skills, get your game faces on and most of all…..keep calm and carry on!