“I want the truth”.
“You can’t HANDLE the truth.” – Tom Cruise/Jack Nicholson, A Few Good Men.
Welcome to the Supplement everyone, and whilst we are in the full lull of summer, the macro events have been more prevalent this week. We’ve had inflation numbers – with some mixed signals, that commentators seem to struggle to interpret – and a less bearish picture from the ONS on house prices than Nationwide’s numbers, which are the most bearish of the “big 3” indices – some pointers on interpretation of those mixed messages too.
I’ll wrap up this week with some “tactical medicine” to keep you driving through these uncertain times, cashing cheques not breaking necks, moving forward rather than inertia which is what I’m seeing and hearing from those around and about. Inertia is often misunderstood and it’s what you ARE doing when you aren’t buying that is a big part of the toolkit you need to be successful in this game.
First – for what feels like, and probably is, the 100th time in the past 2 years and 7 months – inflation. The broader commentary seems to be struggling with how to interpret the figures – good, bad, indifferent – let’s dive in to why, and look at all the metrics we’ve been looking at over the past period and how they’ve performed.
One place where analysts struggle is, frankly, effort and detail. They take a figure and set a narrative around it. I prefer to get under the bonnet and that’s why I’ve been talking about quarterly progressions and month on month changes, rather than just the headline 12-month lagging figures – and I’ll continue with that methodology so that we can get to a broader understanding together.
Firstly – CPI. I often criticise CPI at the moment because at this point in the cycle it isn’t telling us what we really need to know. It remains important for two reasons generally – firstly, so we can understand the sort of pressure our tenants are under, and secondly so we can see quite how much our leases linked to CPI are likely to go up!
It still informs policy quite significantly and is what Rishi is talking about in his five targets, as well. I’ve said for some months that we were guaranteed a nice drop in July, because energy costs form a decent chunk of CPI – directly (in the form of energy bills) and indirectly (in the form of transportation for goods like food) – and of course the forecasters knew that too. As such the 6.8% print was the consensus forecast, so the expectations matched the reality.
In terms of month on month prices actually fell 0.4% – the first decline for 6 months, and only the second time in 3 years – and this is welcome respite, driven considerably by a much cheaper set of prices for fuels and lubricants which were down nearly 25%. Month on month consensus was actually a drop of half a percent, so this did fall short and provided one reason of several for the 5 year swaps to tick back over 5% to end the week – which provides collective sadness to the readership base, I’m sure!
The last 3 months inflation, annualised, would be 1%. It would be premature to suggest this is the prevailing real time rate of inflation, but nonetheless that number is very promising.
Now onto the indicators that I feel tell us more of the story. Firstly – core. 6.9% is an ugly print at any time – same as last month, great, but above the forecast of 6.8%. Still sticky, and last month’s downside surprise was, as I suggested, a bit of a flash in the pan. The month-on-month figure of 0.3% was above forecasts of 0.2%, and that was another reason for bond yields to harden again. Annualised the last 3 months here and the figure is 5.3% – which sounds a lot more realistic as a prevailing rate of core inflation.
Remember core strips out food and energy, both of which are falling, in order to get to the less volatile but more persistent measures of inflation. I’ve mentioned before that services inflation makes up 47% of CPI and that’s why it is so important for our purposes – so that’s where we go next.
The 7.4% print was a move back upwards to the previous May print of the same number. The 7.2% from June looks a false dawn as we are back at the peak. That will cost another 2 or 3 months of stubborn inflation at least. Reason 3 for bonds to react by prices going down and yields going up. This is the right time to introduce another piece of big macro news from this week – wage inflation up to 8.2%.
This really was the very big surprise of the week – the consensus forecasts were 7.3% and in spite of unemployment heading in the “right” direction (to cool off the economy), this completely dominated the impact on the bond markets of the labour market data and – putting two and two together – if companies are facing an 8.2% increase in their largest single cost (staff) then they are bound to be pushing prices to compensate.
This fits in with a number of threads that I’ve laid down over the past few years. Firstly – as a rule, pandemics favour labour over capital in their aftermath, which carries on for decades. The impact is relatively small but remember how much capital has taken from labour in the past 15 years or so since the GFC; labour is striking back which will impact investment returns and returns on equity as a continued underlying trend.
Secondly, people have been squeezed whilst watching companies make record profits, and are demanding their share when labour is in short supply in the immediate aftermath of the pandemic. The direction of travel is “right” for the employers, but the starting positions in terms of vacancies and unemployment were so stark that there’s still some time before a longer term equilibrium is reached – although the pace of change has been quite dramatic in the past several months.
Thirdly, remember that this is looking backwards over the past 12 months. Total pay increased 0.5% above inflation in the past 12 months – which could be deemed a bit more like the “real” increase. You could interpret this as saying that the feeling of the cost of living crisis is now over – on average – and from hereon in, things should improve notwithstanding a significant recession.
Overall as labour continues to win the armwrestle, company values declined as returns on equity slip in environments like these – seeing the FTSE close the week at nearly 7250. We need to be quite careful on the unemployment figures though to see whether this really is “good” unemployment or not.
Good unemployment would be companies making cost savings and increasing their productivity levels, or increasing their profit margins by automation. This is more like people coming back into the labour market seeking a job, who were not seeking a month ago or more. This looks like a phenomenon I’ve alluded to before – the Bank of England suggested last year that those involved in the “great resignation” wouldn’t be back to the labour market, but – since their idea of what inflation would really do compared to mine was very different, its no surprise to see my prediction of them being squeezed back in by the spiralling cost of living coming to some fruition. Anecdotally I’d be keen to hear from people who know people who tried to take early retirement but are now back to seeking work, and the reasons behind that.
This should help companies with their labour requirements and wage negotiations – but as above, the starting points were so stark that it isn’t enough to tip the scales. Still, it will be interesting to watch the figures for the next couple of months because things might tick back downwards if these new participants are snapped up thanks to the shortage of skills that always seems to be out there when you discuss with business owners and recruiters. The jury is out and it takes more than two months to set a trend, but it creates plenty of opportunity for the bearish and the miserable to talk about the next recession/crash/crisis etc.
A quick one on house prices. ONS figures for H1 2023 show a flat market thus far and peaked in November 2022, which we are around 1.75% below. Remember these are the deals that really transact – Nationwide and Halifax are both limited by demographic and target customer. Both the bank indices are also much more “real time” and as such are usually compared with the ONS by lagging them 6 months. I.e. the ONS June figures would compare to the Halifax and Nationwide figures from December 2022 – which looks much closer. If this pattern holds relatively true, we will see 2-3% come off the ONS prices by the end of the year (figures we will receive in late Feb 2024). My prediction at the start of the year was 3% down and that looks on relative course, although the real story is house prices compared to inflation, and particularly compared to wage inflation – because affordability is crucial. One thing I think we can conclude with 100% certainty – there’s no bubble to burst!
Before I get to the tactical medicine promised I wanted to note Dr Michael Burry (star of The Big Short, one of my favourite movies of all time, played by Christian Bale so brilliantly in the film) – and his short position on the market in the US. He’s so convinced of a downswing he’s “betting 90% of everything he owns” – or so they say.
Bear in mind I’m sure he’d close that position a long time before he lost it all – that’s well sensationalised. However the US macro podcasts I listen to have been suggesting the market will take a bath and hasn’t found its bottom yet – it has recovered alarmingly well from the money that came off it in 2022. I’d just make one similar, boring point again and again – and I wonder how Dr Burry has accounted for this. Inflation.
If the market is still a couple of hundred points off where it was in January 2022 – if companies fixed their debt for long terms when they saw the interest rate rises coming (that’s what we are told) – and if since then inflation has been 15% or similar – then, once again, 15%+ has already come off the real value of these companies.
Dr B is a lot smarter than me – so I’m sure he’s “on it” – you’d expect he’s found where he thinks the next time bomb will be – I’d just remind everyone he was all over the Financial crisis in 2005, but had to sit very very tight before he got paid. I’m sure he’s learned from that but his reputation is one of being premature rather than aftertiming…..so let’s see. Stock market crashes don’t make a whole heap of difference to the average Joe anyway, so we can just watch with interest, mostly.
Onto survival plans and the biggest mistake I’m seeing propagated at the moment – and that is that inertia is acceptable, sensible, or even the dominant strategy. That’s absolute nonsense. I’m hearing it from experienced investors who, frankly, can afford to sit out – but representing it as some kind of voice of experience is unfair on those who are earlier on in their portfolio development.
The last few months’ worth of supplements should be stitched together in to one message. It isn’t a bad time to buy, by any stretch. Prices might have come off the top, as per the above. This may or may not continue…..rates need to adjust downwards a bit to reverse the direction of travel and that’s still a couple of months of good inflation news away as we speak. However, sitting and waiting for prices to go down is just stupid. If we do end up completely flat from here until the end of the year (in Nationwide/Halifax terms) we will still be 15%+ cheaper in real terms than their recent peak in August 2022. That’s inflation adjusted but in wage terms it won’t be far from that either at current rates. That IS a correction in real terms equivalent to the 2008 crash. Read that again. So……what the bears have been waiting for has actually already happened. It’s just that the majority of commentary has been looking in the wrong places and reporting on the wrong facts.
Anyone who is actively trying to buy right now, or speaks with traders or agents or anyone dealing with property in volume, will tell you there are plenty of deals out there. The real issue is the financing. Low yield simply doesn’t work, to own. To rent/add value via R2R – sure. As long as your landlord isn’t subject to a floating rate mortgage – if it is an income you want via more active asset management – get on with it as long as the figures work!
So – you need higher yield, or lower yield with very flexible payment terms (or options). There’s still plenty out there who think rates are still all of a sudden go back down near zero relatively soon – and whilst I’ve been consistently saying they are wrong for the past 12 months, the medium term trend is still back downwards (and I still maintain we’ve seen the top of the swaps market although we are dangerously close to that top as I type this).
Cash on cash returns are key as I said last week. ROI is a distraction – if you can pass the rent affordability tests today, then even if cashflow in year 1 is zero after operational costs, rent should progress nicely (residential rent) and when you refinance after 5 years I’d wager you are refinancing at a lower rate than those available today.
BRRR always remains great but requires really exceptional deals at the moment – and is much harder than it has historically been. Patient equity partners are a much better bet in this environment.
Stay on the sidelines in this market at your peril. If you have any doubts left…..refer to the encyclopaedia of Uncle Warren quotes:
“Time IN the market, not TIMING the market.”
I’m convinced those peddling inertia are dead wrong and you won’t thank them for it in years to come given some of the prices deals are changing hands at at the moment. This market will be gone before you realise it if you watch it from the sidelines.
Godspeed, supplement readers…..get on with it, on the basis that, as always – you Keep Calm and Carry On!