Supplement 290123 – green shoots?

Jan 29, 2023

“The hardest thing to see is what is in front of your eyes.” – Johann Wolfgang von Goethe


Welcome to the supplement and this week I wanted to take a look at what’s becoming increasingly obvious, although, as usual, there’s a caveat or two.


Let’s start with some of the anecdotal evidence I’m seeing at the coal face in our own operations, alongside an interpretation of what others are telling me in their businesses. I’ve had a fairly punishing week in terms of travel by my standards – over 1000 miles racked up going north, south, west and I’m picking up neglecting the east over the next couple of weeks!


One benefit of course is that this smooths out the regionality of the interactions that I’m having. There’s a good taste of the national picture. The overwhelming message that I’m seeing and hearing is that things just aren’t as bad as was expected back in November or December. There were a number of comments about the market really being in the doldrums by then in terms of housing, and struggling on the back of restarting after the new year.


From what I’ve seen, there has been an element of that. The market hasn’t picked up particularly until just this past 7 days, whereas in a robust or booming market, January 2nd/3rd would see things pick up very quickly. No surprises there. However, there were those thinking that a pickup of any sort wasn’t going to emerge – and it would appear to have done.


I’ve framed this over the past couple of months in various talks that I’ve given in the following way – this is absolutism versus relativism. It isn’t generally well understood – but in this context, having gone from a white hot market to a red hot market to a trappy market – perhaps a buyer’s market, but only a marginal one, and likely to be regionally variant on that front – feels like a massive slowdown, but is in fact still functioning and, in plain English, Estate agents are still selling houses. When measured against 2019 against a variety of metrics, the market doesn’t look all of that different – to put this into context, remember that 2019 was a trappy year, with an election at the end of it – the market was largely sideways as the long bull market looked like it was coming to a slow end, more of a whimper than a bang – nominal prices barely moved, but of course there was no inflation to speak of at the time.


As it happened, my group traded particularly well in 2019 so I would welcome more of the same, of course. I do feel as though the trappy sideways markets need a lot more skill to get through them, because when everything is going up at a rate of knots you attract a lot of speculative buyers who don’t care if they make mistakes on the way in, because the market will protect them. A slew of developers come out of the woodwork to try and grab some of that action.


This also “zooms up” into the major macro data. Inflation has performed in line with expectations in the past month or so. This has been a rarity in the past 12 months, and in all the major western nations the metric was overshooting the predictions to the upside. Predictors react, of course, and no doubt start forecasting that little bit higher – but also, the pace does seem to have come out of the inflationary pressures. The US has seen its peak in this cycle – of that we can be as near certain as you ever can be – and it looks like the UK might have done, although we cannot say that we have the same level of certainty.


Alongside this, the UK economic performance in Q4 has been adjusted to appear to be better than expected. The World Cup in football has been cited as one of the reasons – these relatively small fluctuations worth 0.1 or 0.2% (whilst the nominal numbers can be quite large) are so important whilst everything is limping along struggling to stay where it already was, in terms of GDP.


In many ways the most important metric at the moment has also continued to be more robust than has been predicted by the larger institutions and governmental bodies. We have unemployment figures to November 22 at the moment from the ONS, and the ONS measured it at 3.7% at that point. The one point there is consensus on is that unemployment will trend upwards this year – but there’s some fairly major disagreement about how far it will trend upwards by.


There’s a whole raft of reasons why unemployment as a whole is a difficult metric to hang our hats on – but it does offer up that macro picture about size, and pace, of the problem. Vacancies continue to be much, much more of an issue than they were pre-pandemic – although we are seeing large companies freeze hiring for the moment, this is more positive than downsizing or making cuts of course. Tech companies have been the ones making the cuts; but after such incredible overperformance in their shares during the pandemic, they do seem to have gone after the oldest and most tried and tested way to woo the market – direct cost cutting – and probably also hired at the rate of growth in ‘21 which was never sustainable.


The UK has a number of reasons to be less volatile than some other major developed markets – particularly when it comes to housing. Firstly, the pandemic “bump” – whilst significant – when it comes to prices, was one of the smaller bumps worldwide, despite the UK having some of the most significant structural problems in its market when it comes to planning, desirable land supply, and construction resources. There were countries where the growth in pricing was double what it was in the UK or more – much more “bubble” territory.


The adjustment has also started – whether we should lay the blame at the door of Liz Truss, because it did correspond with her brief premiership (or more accurately conferenceship, I would argue), or not, I am neutral on. The ONS has shown the first move to the downside, officially, in their November figures (remember that Halifax and Nationwide showed a move downwards from September, but they are not basing their figures on transaction prices alone, there is an element of real-time forecasting incorporated because they are also using their mortgage data) – that move was 0.3% down or £1,000 off the average house price.


It is worth dwelling on that divergence for a moment. Nationwide and Halifax don’t publish their methodology – and we do need to be aware that both will only be serving a certain slice of the market. There are geographical considerations too, most likely, although the days where Halifax only write mortgages in Yorkshire (for example) are long gone, of course. How good their models actually are, we do not know. The 2022 figure for the increase in the housing market according to Nationwide was 2.8% – however, the ONS for November ‘22 still has the annual rate at 10.3%. Short of a very large surprise in December’s numbers, there is going to be a massive difference between the two. Nationwide did have 2021 at 10.4% versus the ONS 8.2% – 2020 had much less divergence with the Nationwide at 7.3% and the ONS at 7%. As Nationwide seem to have captured more upside more quickly, it seems fair to assume they’ve also captured moves to the downside more quickly, although they might have been overegged. Their January numbers might be quite interesting and might actually arrest the decline (as they are measuring it) more quickly than expected. If not, at the current rate, I’d be expecting it to be arrested in February, which is faster than I was thinking in the last quarter of 2022.


I like both measures – the Nationwide I respect for always getting the numbers out on the first day of the next month, more of a “nowcast” compared to the lag with the ONS getting numbers out 6-8 weeks after the event. The ONS have more robustness from a data perspective (as you would hope and expect) but time is valuable even in a slow-moving asset such as property. I’ll be watching with interest as this market develops.


This tale of the tape is very similar to the unemployment story. The Bank of England in their most recent forecast sees unemployment rising to nearly 6.5% in 2025, which feels far too bearish to me – their record on unemployment predictions is fairly weak to say the least. The OBR sees 4.9% by Q3 2024, which feels a lot more realistic – however, I would still rather go lower on this number than higher. 4% looks a given, 4.5% looks fairly likely, but 5% looks a stretch, black swans notwithstanding.


The reality seems to be dawning that despite the fast pace of interest rate rises, people and businesses are just about coping. The train is not being knocked off the tracks just yet. Some productivity gains (and there is an impossibility about measuring the productivity gains from working from home, but what we could expect to have happened in the past 2 years is that individual companies have become more acceptant of it, and also more competent at measuring the output from it – and workers have as a whole decided they quite like it and traded off some of their time saved, estimated at 75 minutes of productive time per day in a recent survey, by putting that into work with the rest put into leisure time) will always help to offset the downward pressure on technological advancements that there has been.


There’s one significant caveat here. Let’s not forget the energy price cap and the protection it is currently offering being reduced at the end of March, so households could (and with near-certainty, will) see a 20% rise in energy costs again. Of course, the gas goes off, but with the pay negotiations in general going the way that they are, a very small percentage of people (those who have moved jobs or gained a really significant promotion) will be keeping pace with that level of price increases. The commercial protection is being withdrawn altogether. This is inflationary by its very nature.


The economy absolutely stunned me in 2020 when it only lost around a quarter of its measured output when the country quite literally ground to a halt and was locked down. It still does. It is an incredible beast, and perhaps this is one of the reasons why it fascinates me so much. The buffalo that it is, it is carrying multiple poisoned spear-tips at the moment, but still stumbling forwards and refusing to give up. We do need to remember that the larger interest rate rises do take that minimum of 6 months to really kick in, and there’s no doubt that businesses have a specific challenge, particularly those built on cheap debt. A number of opportunities have simply evaporated – if I can borrow at 3% or less, there are a lot more things I can borrow to invest in (or gamble on!) than if I need to pay 5% or more – that much is a mathematical fact. However, those who have used debt with some degree of skill and risk management in place, will find their way through. Pricing in some areas will steadily continue going up (bridging and development finance, I’d expect) – whereas we might well have seen the worst of the mortgage rates now.


Will there be a large drop anytime soon? Only if all of the above becomes moot because we have a black swan event. The trend will be sideways and slightly downwards, bringing some investments back onto the table as viable with leverage. There are also likely to be some volatile points, because the bond yields will remain elevated due to inflation hanging around, if I am right about that. The path of the wage demand and unions and strike situations will run for the course of at least this half of the year, if not well into 2024, and will make a difference – if wages are still trucking at 5%+ increases (and I’d suspect they might be on the upside of the forecasts) – then prices will continue to rise at around this rate as companies attempt to capture as much of this back as possible in order to maintain their margins, and as the consumers have that 5%+ more money in their pocket in order to pay for goods and services.


Whilst we are busy avoiding a wage/price spiral, that logic still holds to keep inflation higher than it otherwise was or would have been. Framed a different way – it has gone up very quickly, as often happens in recessionary conditions, although almost always for different reasons – but will trail down relatively slowly, after the base effects of the supply shortages caused by Covid work their way through all of the figures.


Interestingly, the levels of excess demand in most countries are not higher than they were before the pandemic. The US is a notable exception to this – but this suggests that a forced recession (caused by the central bank putting rates up to “break” the market) is not actually necessary. The US does need to go a bit higher on the back of this metric, but not a lot higher. This might well be why the bond markets are suggesting that rates will not go up to the levels that the Fed are thinking; or that they will not stay there as long as the FOMC members are claiming.


The UK has more structural inflation to deal with – the energy price situation is not going to be resolved by peace in Ukraine, even when it does happen – and it looks nailed on that this year is at least going to see significant conflict and more loss, rather than ceasefire – and this will be a solid upwards pressure for the course of the decade. There’s a school of thought that still sees oil as very cheap at its current price. There are the continued disinflationary pressures in the longer term that have prevailed over the past 20-30 years, although if technology has slowed in terms of prices of tech coming down, then these are potentially weaker than they were. My feeling for the next 2 years is still that, on balance, inflation will be higher than many have thought and that will keep rates that little bit higher than we would like, all else being equal.


What do we do about all of this – and what are the consequences? There needs to be a bit of a reality check here. There are currently property deals out there in far greater numbers than there were in 2020, 2021 or 2022 – and sitting on the sidelines waiting for a crash is as unwise today as it ever has been. You could (and some did) have made a strong case for a crash in early 2005 – in reality, the market as a whole went up about 17% before it came down 15%. All that was missed was opportunity. That is with full knowledge about when the bottom came, and assuming you’d acted perfectly – a true impossibility.


The backdrop to all of this is that rents are very likely to be robust in their rises going forwards. The simple translation can be to look at deals that are not cashflowing megabucks today but are in areas with affordability and solid employment prospects. Year 2 will look better, years 3-5 will look quite good and may well see refinance onto lower rates rather than higher ones than todays. I suspect we might see a number of investors back to the market who have been on the sidelines since late September and these green shoots might grow that way, in the absence of an event to send things in the other direction.


As so often is the message – the primary need is to keep calm and carry on!