“The truth will set you free. But only when it is finished with you.” – David Foster Wallace, American novelist.
Welcome to the Supplement everyone. Those regular readers and listeners will know I get relatively obsessed with the Bank of England meetings. I have the vital statistics and postcodes of all of the members of the monetary policy committee. I regularly slide into their DMs. OK, those claims are not true – but that’s a play on the fact that this week, once we get through the macro headlines regarding the BoE meeting, I want to talk about the truth in this market – the truth which no-one dares speak.
After that “truth bomb teaser” (TBT), those who follow my socials will know that I predicted a hold by 6 votes to 3, and, indeed, it came to pass. I’m not one to make the most of a prediction like this, and like to keep it quiet……well, that’s not really true either. But again, this was an easy one to predict.
So – why? Let’s start with a good reason, the reason that we hope is true. Remember it takes 6-24+ months for monetary policy to truly bite. Wherever the natural rate is in the economy right now (the natural rate is the rate at which the economy would neither be expanding nor contracting based on current monetary policy), you would be hard pressed to find someone who thinks that the natural rate is above 5.25%, even temporarily, at this time.
The rises haven’t had anything like the impact that anyone thought they would. That much is true. However, to say that means they’ve had no impact would be completely wrong. Also, to say that it wasn’t the right thing to do to try and control rates in this way – I’d invite you to look at the recent past in terms of monetary policy in Turkey. Let me save you the sordid details – Truss and Kwarteng would have done a much better job. Just imagine that.
So – 5.25% is above the natural rate (a rough stab – today – between 3 and 4 per cent, but that’s based on the pandemic stimulus, and the resultant inflation – not where I’d expect the natural rate to settle down, which would be much lower – but this cycle could play out for the rest of the decade if there isn’t a genuine black swan coming, rather than just a bit of clickbait). Therefore, it plays a part in slowing down the economy.
Cranking the notch once more, with a guaranteed drop in CPI coming in the October print (couple of weeks time yet), and with wage rises claimed to be being reported “falsely high” with experimental unemployment data collection methods also under scrutiny, seemed unnecessary, and this time I’d say the committee have done the right thing.
The markets reacted just as they have done ever since June. Yields fell. The 5y gilt touched 4.06% on Friday in-hours, (the joy) and closed at a meagre 4.09%. That’s a real bath from 16 days ago when it closed at over 4.50%, and 89bps below the 12-month high of 4.98% (early June this year). The 5y swap market last trade was at 4.24%, only 15 points of premium above the gilt – seriously skinny margins there. That’s down nearly 40 bps on the month, and is happy news for borrowers. ACTION: If you have a current mortgage/remortgage in with a lender, that hasn’t gone to offer yet, make sure your broker is constantly reviewing rates at that lender to see if you can be moved onto a cheaper product. Price cuts are coming soon, if this bullishness holds up. That needs to happen before you go to offer.
If only someone had recommended a buy on the 30-year gilts at over 5.1% on one of the premier property podcasts (the mighty Rodcast quarterly investment mastermind) just a couple of weeks ago, now trading at 4.77% and still looking like more than fair value. OK, no more patting myself on the back this week – I promise.
In plain English, this is as good as it has looked for 6 months in the market, and eases a bit of pressure. It matters little for the rest of the year in the market – I believe – but promises good things in the new year, you would think – IF it stays the same. The bears are still in the woods – hiding – ready to reverse this bond bull trend of the past two weeks – BUT the conventional wisdom (including capital economics, who are vastly superior to many of the big banks and press forecasters) is saying that the rate rises are done. It’s too early for that – but the market reaction to the 6-3 hold was really significant compared to how it reacted to the 5-4 hold 6 weeks prior.
Next week we have the regional meet, and I’m sure to make a nuisance of myself and write that up – I’m still really interested in why we are undergoing quantitative tightening at the moment, since that’s giving the public more bonds than I think they really want, and thus holding the yields up, falsely – just another reason behind my 30-year trade a couple of weeks back.
Anyway – this week I promised the truth, and the truth I shall deliver. I think that at the moment the signs are that the Bank, and the Government, have been lucky. I liked the pandemic economics with Sunak in 11, compared to both the US and the Eurozone. I think he was the best of the rest. However, he missed a gigantic opportunity not ploughing 250bn+ into infrastructure projects under the guise of a 100-year pandemic bond, or similar, issued Feb 2021 at 0% coupon or near offer. It would and could have been one of the world’s great refinances – if Rishi had been reading the supplement back then, the BoE could have just bought back all of the index-linked securities (those that pay more as inflation goes up) with the money whilst they sat on it waiting to deploy it. Might not have been that Conservative (although it could be, it just wouldn’t have fit the neoclassical school that had dominated since Thatcher, although Boris went “Big Boris government” completely flying in the face of all of this). Could have done better, though, Rishi.
Why do I say lucky? Well, we had huge savings balances saved thanks to the pandemic. Forced saving. How do you get people to save – put the interest rate up? Nope – that’s not been happening. A higher interest rate than for 15+ years – although the big banks have been very slow to reflect that in their monies on deposit, and their near-50bn net interest margin (the difference between what they pay on deposit and what they lend out at for the 4 big banks) has been in the news this week – does that make people save more? No – because they are struggling to keep up with the cost of living.
No – you made people save by scaring the absolute life out of them. Signs by the side of roads. Doomsday press conferences, dominated by medics, with economists ignored (Is it a surprise that I’d be upset by that?). Lines, stickers, and arrows all over the floor. Add to the fact that people simply COULDN’T spend it on their usual habits (60% of money spent on food in the UK is spent at the supermarket, so a massive 40% is eating out in one way or another). No pub. No cinema. No leisure apart from a walk (and only one of those a day, at times). That built one of the great warchests of all time.
Then – the gloves were off. Not just for those working at 10 downing street (where they were never on, and my goodness – doesn’t the covid enquiry remind you of “Yes Minister” for those who are fans of the show), but for everyone. But the price of poker went up…..right up. Electricity and gas doubling, or more. Food up 20% year on year – basic food up 50%+ year on year.
So. What happened? Prices rocketed up on staple goods. At the same time, people felt short-changed of weeks, months and even years of their lives – so they wanted – and arguably NEEDED, from a mental health perspective, to get out and spend. And spend they did – but a lot of these forced savings ended up being swallowed up by inflation. Wage growth was above CPI from Feb 2018 to October 2021 – with a minor blip at the very height of the first lockdown – and sometimes quite a bit above. It then reversed, and at some points there was a really significant gap, until June 2023 when wage growth was once again above inflation.
Reframe that – if you wanted to maintain your October 2021 standard of living, you needed to go into savings to do that. Those savings were there – on average – and massively bolstered by the pandemic (please remember this is a general case, not an individual case). Then for nearly 2 years (some months the gap was nearly 5% between inflation and wage rises, annualised of course) this reversed, and so you either cut back and living standards fell, or you dis-saved/dipped into those savings. We are back on a positive course now, but one with economic concerns.
What’s the concern specifically here? Wage-price spirals. This plays into the “fluke” narrative as I will be referring to it as. Excess savings were run down. Existing savings were, of course, devalued in real terms as banks paid very very low rates until recently (now we are at just low, but still negative in real terms, particularly after tax) – BUT, if the gap was filled when CPI was much higher than wages by dipping into savings, as the balance has been redressed for 5 months or so, those rises might NOT be inflationary, they might just refill the gap between what was coming from savings, and what’s needed to maintain lifestyle. It is a nuanced point, and absolutely has not come from a place of deliberation in any way, shape or form. Hence the fluke label!
This is today’s graph. It should make sense to you that as a high-level economic snapshot, that when the silver line is above the blue line – it is tough times. When it is the other way around, it is good times, and potentially boom times. When they are close together – it is sludgy, treacly times. It also provides an insight into the fact that the pandemic really didn’t affect wages too badly at all, but that almost all the problems in fact stem from an out-of-control inflation rate for at least 12 months.
It is the area between the curves that is the real measure. You would certainly long for an 01-07 period, the stuff that dreams are made of. However, the bus has been back on the road for 5-6 months and this is why the cost of living crisis is easing – although that gap between Oct 21 and Jun 23 is a big old area to recover, and it is likely to look like the Feb 18 to Oct 21 period, where there is no clear daylight between the two, unless we solve our productivity puzzle. That feels like a best case scenario for the next few years on this front, I’m afraid to say.
To summarise – we saved because we had to and we were scared. We spent when we could because we felt we deserved it, and used savings to keep up with the times. Then, we started getting paid more again, and slowly caught up. That’s a fluke soft landing if ever I saw one, and this is still the best case scenario. I will repeat again – there have been no hiking cycles in history like this one that have ended anywhere near as well as this, even though it might not feel great at the moment.
That’s the macro picture – but it isn’t the picture of the BTL landlord. If we looked at the gap between mortgage interest rates and 75% BTL leveraged (returns after costs) in the same format as this week’s graph, then we would see huge blue sky between 1996 and 2007, with a couple of minor wobbles. Then a big old reversal, which would have carried on until 2010 (London) or 2014 perhaps (regionals). Then, more blue sky but the gap peaking in 2016/17. Then the gap narrowing, with blips again around the pandemic, before a huge reversal as the rates started to climb. I’ve said a number of times before – it feels very dichotomous at the moment. If you say your prayers, eat your vitamins, and read and action the Supplement – you fixed your debt in 2022 for 5 years and existing stock looks good, even in the face of rising operational costs – because rents are also rising significantly. On new deals, however, the bank wants more of a slice than ever before. The builder is the same. Do you want less of the pie? Or have you inevitably pivoted to more active Asset Management strategies as I’ve been talking about this year?
Or – dare I speak those words – have you diversified away from property (get the garlic). Surely not? You are not a true believer? How dare you. At some point, it makes sense to focus (Uncle Warren would say forever – I would temper that with “it depends on the debt”) – after all, even Warren who focuses has 15-20 businesses of significant interest, in very different sectors, at any one time – and that is simply applying the 80/20 or Pareto rule to diversification, frankly.
The figures from last week’s supplement hold water though. 20%+ (and likely 25%+) returns were available with a modicum of skill, ever since 2016. The bond yields at 1% were just a gift. Those same returns now, doing the same thing as pre-2022, are not available. You have to force them (if you want those sorts of returns) by doing something else – something more creative. Vendor financing. Deferred considerations. Bespoke deals – not the stuff you buy at the auction (it can be stuff you buy AFTER the auction, interestingly enough, but not on auction terms).
Personally, we’ve taken a turn to “cashflow day one” only strategies. This is quite defensive, and I don’t mind saying it. “Growth at all costs” is NOT the strategy I want to pursue – this is the equivalent of the developer who builds one house, then 2, then 4, then 8, etc. etc. until the market turns when they are developing a 1024 unit site, and they lose everything they’ve ever done or made. It isn’t sensible. Completely ignoring the macro events is for idiots.
Letting it spur you into inaction is also for idiots. There will always be an excuse not to invest, not to prospect, not to make the next phone call. The strategic way is to pivot, as required, and accept that if you want to maintain healthy margins – the single best way to keep risk down – that there will be times when you are offensive, and times when you are defensive. Also – you might be defensive to build warchests for use when you need to be on the front foot.
So – I really want my cake and to eat it at the moment. I want positive cashflow from day one – AND I always stack my deals at 100% financing. Nearly impossible, I hear you say – but I have done deals that other people seem to consider impossible many, many times. You could also say I can afford to – and that is also true. That’s the business model I’ve designed – not answering to private equity backers, not having to generate more profit year on year (note – this isn’t not TRYING to do that, but it is being realistic about it – the only venture that showed more and more profit every year regardless of the environment was Madoff’s ponzi scheme, and massive listed companies regularly have blips, sometimes for years, where they lose money and have to tap up shareholders for funds). That leaves me looking at deals where there is already solid yield, but also value to be added in one (or ideally more than one) way.
Existing pipelines still bring deals, of course – so again, it might be “alright for me”. I’d defend that by saying I, and my team, have worked hard to build those relationships and those pipelines. I don’t work for the bank – I don’t work for the bridger. I work for myself, and my joint venture partner/investors. I stay evergreen, and always remember to be fearful when others are greedy (in the hot market what was I doing – selling properties, although the pipeline was so well stocked we still managed to increase our net number of units) – and greedy ONLY when others are fearful. At the moment, people seem more confused than they seem fearful – and the black swan is not obvious, although the probability of one has moved upwards in recent weeks just as spreads and volatility indices have moved downwards, which is weird, and wrong.
What’s that black swan? The Middle East conflict. Again, restricting commentary to the economic side – there are low-probability events that could easily lead to $150 oil. If I was a trader, I’d be taking bets on these events in fairly significant volumes – this is not the Big Short volume 2, this is just value betting or considering expected value before making trading decisions. Just remember this is not investment advice.
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