Supplement 3 Dec 23 – RIP Charlie, Budget revisited, and a rant

Dec 3, 2023

“You don’t have a lot of envy, you don’t have a lot of resentment, you don’t overspend your income, you stay cheerful in spite of your troubles, you deal with reliable people and you do what you’re supposed to do. All these simple rules work so well to make your life better.” – Charlie Munger RIP, American investing legend who passed this week just a month short of his 100th birthday.


Before we begin – if you haven’t seen the Propenomix Advent Calendar because you listen on a podcast platform, it is worth checking out the Propenomix YouTube for the daily posts I’m doing throughout December to celebrate getting to 500 subscribers! Thanks to all the regular readers and listeners who have subscribed……if you haven’t yet, what are you waiting for!?


Welcome to the Supplement everyone. Plenty to crack on with this week, and it was difficult to decide what would make the cut and what wouldn’t. I’ve kept things as brief as possible without losing the budget momentum to boot – and I’ve started this week with the OBR (Office for Budgetary Responsibility) report which provides the Treasury and the Chancellor with the fuel upon which to make a meaningful autumn statement – yes the very OBR that Truss and Kwarteng tried to make a mockery of, before simply making a mockery of themselves instead (and a laughing stock of the UK), a little over a year ago now. Wonder when I’ll stop referring back to that? A fair few Supplements are bound to pass between then and now!


Remember the OBR is independent and is a team of 45 civil servants, so should be apolitical and provide continuity – a wise idea, the best idea George Osborne ever had apart from quitting politics altogether. It was an idea which to an extent was inspired by the benefits of having an independent central bank – which has turned out to be a positive (doesn’t make them bulletproof of course, because they are still only as good as the people in charge!)


To line-by-line the executive summary would take this week’s effort into record territory, because the summary in itself is massive with 26 expanded points and 7 charts – so, we will have to stick with my modified highlights, I’m afraid (thank me later!)


The main moral of the story is that GDP after inflation adjustment in the middle of this year was 3% above where the OBR thought it would be in their March forecast. That sounds like an awful lot, but remember there has been a revision in calculation which explains nearly 2% of that. Either way, 1% of GDP (the “change”) is still £25 billion or so – so quite a miss on the forecasts. The OBR accepted this but have also revised their forecasts downwards for the future (which did look quite hopeful, back in early 2023, but they were expecting a bit of a rebound from a particularly bad year this year). They were 1% out only a few months before – but this justifies my tearing apart of the OBR forecast from earlier this year in this very Supplement – that’s a horrific piece of forecasting right there.


The OBR now sees inflation down to 2% by early 2025 – which has always been my rough timescale, even going back a few years – solely by looking at historical trends and similar situations in other countries. One of the problems our forecasters have is that they think they are smarter than their equivalent forecasters were, and economic predecessors were – and the evidence is that they are just the same as they have always been. I could be on board with this, Q1 or Q2 2025 for target inflation.


The bigger miss though has had a profound effect. Hunt had much more money in his metaphorical pocket in the November statement than the OBR expected. That’s because everyone knew the tax thresholds were frozen, but didn’t think inflation (price AND wage) would swell the tax revenues quite as much as it did. Think about WHY here – price of goods goes up more than expected, what do most goods have on them? “Value added” (hmmm) TAX – sales tax, in international parlance. What about services – inflating at a strong rate, as discussed. Yep, VAT. Then incomes rise more than expected – what happens then – income tax receipts higher than expected because of the thresholds for basic rate, higher rate and every other tax going (pretty much) being frozen. Income tax and VAT are simply the “big two” of tax, so these receipts make a really sizeable difference to the tax take (which is now around 37.4% of GDP, by the way – the highest burden since World War 2).


Don’t worry though, we are on the road to 38% of GDP thanks to these threshold freezes, by 2028. The only way this gets better is if we outperform this OBR forecast as well! 


There’s some semantic points that worry me a little as well in this report. The implication is that there’s been a full recovery from the pandemic – of course, numerically, it currently appears that there has been. However it has left us with trailing inflation, far higher interest rates than anyone (apart from a risk-averse saver) would like, and a huge debt burden on top of the burden we already have. A recovery in GDP sure – but problems down the track, surely!?


The OBR doesn’t see inflation below 4.8% in the fourth quarter – although, of course, we are already below that. That doesn’t inspire much confidence either, but you’d expect that they are not suggesting much of a drop before the end of December in CPI. Their 2024 inflation forecast is basically a line sloping downwards from 4.8% to 2.5% or so – I wouldn’t be overly confident in the model they are using here!


The gilt yields – of which I talk about so much – are 1 to 1.5% above where the March forecast was, and so they see the bank base rate settling at around 4%. This seems historically unrealistic to me – I still feel 3-3.5% base would be a better stab for base in a few years’ time. In these lengths of time though, it mostly feels like guesswork (especially given that they can’t seem to get a forecast right when it is a few mere months away, let alone a few years).


Their medium term growth rate has also shifted from 1.8% to 1.6% – I feel as though this economy will struggle to grow at more than 1.5% in reality, going forward, although AI offers some major productivity potential (perhaps at the expense of unemployment, of course – but remember how GDP is measured).


The overall improvements since March, however, see a GDP 0.6% higher in real terms in March 2027 than the previous forecast did. Not everything, but not small change. The OBR sees a 0.7% growth rate next year, which sounds about right for such a stagflationary environment that we are now in. 


Now – in spite of all revisions on growth – there’s a recognition that real GDP per capita – a better measure of how well off, or not, people are – is 0.6% lower than in 2019. In a simple way – we’ve only grown overall because we’ve imported more people. The OBR only sees us getting back roughly to where we were in 2019 at the beginning of 2025 (a.k.a. After the election) – however, with net migration still likely at the 400k-500k level in my view, I don’t see us getting there if we only grow 0.7% next year. We grow 0.7%, population grows 0.7%, GDP per capita would stay where it is now. That’s a much more likely, meaningful forecast in my view.


It stuns me that at this level – the report that informs the Treasury about what decisions to make in a national budget in UK PLC, a company with a turnover of £2.5tn or more – that such glaring holes can appear in the logic. If anyone can help me understand where I’m going wrong, I’d be grateful. SURELY it is something I’m missing. You’d hope so, wouldn’t you, given I’m an army of one.


The overall results of Hunt’s budget are positive, in the forecasts – but really, as I said last week, this is not really news. This is a sign of just how surgical Hunt is in his use of all of this data – and making changes that cook the books in the best way. This isn’t a criticism – but since we can’t trust the forecasts, it also isn’t a cause celebre either.


OBR sees unemployment at 4.6% tops in early 2025, and then back to 4.1% with a base rate of 4% for the Bank of England. Again, for me, those things can’t add up. That just doesn’t FEEL like the natural rate of unemployment for the UK as things stand. I’m going to be surprised if we don’t go above 4.6% next year, let alone 2025. The wage rises are too much, and if prices hold (as they’ve started to in the US and Europe) at some point next year, then companies will simply have to cut jobs in order to appease shareholders and preserve profits. And that is exactly what they will do. Remember as at today we are at 4.2-4.3% depending on what side of the bed the ONS gets out of. 


The OBR prefers a measure of living standards as Real Household Disposable Income per person (RHDI) which is a decent enough measure. It is far lower than the GDP per capital figure suggests (even though GDP per cap is adjusted for inflation) – why? A few reasons, households with lower average numbers (migrants, for example, often come as a household of one, which lowers the average) – and, of course, the word “disposable” here. The tax burden. We are expected to be 3.5% worse off in average household terms by the time the election rolls round, basically, compared to 2019. Enough to really feel it.

I still maintain that it will feel better next year than it does today – and that relativity will help – but that is a big drop to stomach for the electorate, of course. 


The next part is a biggie. Government departments are £20bn worse off in real terms than expected thanks to inflation. This is exactly where Hunt’s tax cut money could have gone, but didn’t. This isn’t big money (I know it sounds like it) when it comes to Government spending these days, but to dismiss it as “being found via efficiencies” is a well thumbed and unproven line from the old austerity days, before we go into the new austerity days. Fairly frightening. 


Government spending at nearly 45% of GDP is historically very high for the UK, and is now forecast to fall to just under 43% – still high by the Conservative historical standards. This will require some fairly significant cuts, already promised by Hunt to appease international bond markets when he was sweeping up after Truss/Kwarteng, to be honoured by the next Government. The alternatives are limited other than stimulating growth (easier said than done!)


There’s lots around long term borrowing in the report – but I can summarize easily. As per usual, we will stop borrowing at some point, just not quite yet, and will be borrowing less than we have for 28 years in 2029, at a small 1.5% of GDP (compared to 15% during the pandemic). Let’s see how we go on that one……


The OBR does, in fairness, recognise that their forecasting has been pretty ropey, because of all of the unprecedented rises and falls in various metrics since the pandemic. I’m glad, because it has been! However, when will the next unexpected shock NOT come? I’m not hopeful on that front!


There is perhaps only one light on the horizon – there is a consultation on vaping duty which is long overdue, and could, of course, raise some fairly significant revenue (cigarettes raise something in the region of £10bn per year, not sure just how much more could be raised from taxing vapes, but several billion you’d think). In terms of the sort of numbers in these forecasts though, you are talking around 0.2% of GDP. Not nothing, but certainly not everything.


OK – enough OBR. Well done for sticking with it. Effectively, the future is pretty flat, and quite treacle-like as I’ve said this year might well be like, but has improved a shade. If there is the likely change of Government next year, then I will watch with interest for the relationship with the OBR and the figures once Rachel Reeves has the red case.


Onto the macro, and some of the reports and metrics released in the most recent week. Mortgage approvals were higher than forecast – beating forecasts by about 5% but at 47.5k or so for October, still around 25% below pre-pandemic typical trading. Symptomatic of a market that won’t behave as the permabears want it to, but is genuinely struggling with the price of credit. 


Net mortgage lending barely changed – a minor net repayment, but the market overall remains more than £10bn smaller than it was in March 2023. Those are also October’s figures, so when November’s are available, I expect there may have been a minor net borrow again as the market (and the rates) only started to repair the more recent damage some way through October.


The Nationwide also released their November figures, and instead of the expected -0.4% drop, November proved to be the second “up” month in a row and now shows the market down 2% year-on-year according to Nationwide. The month-on-month was 0.2% up, and prompted a few to point out that once again, it would appear that the big forecasters had got it badly wrong by being so bearish about 2023. 


Historically, it is also fair to point out that the typical fallout after a Liz-Truss style change in the yields – a massive revision upwards – would take perhaps 18 months to play out, so it would have been wiser in 2022 to predict a bad year in 2024 than 2023. We then saw significant repair to rates in the earlier days of the Sunak administration, before struggling once again with rates in mid-2023 – which again, would make predicting a bad year in 2025 more likely useful than predicting a bad year in 2024. You see the inherent problem with forecasting here – when the facts change, you should change your mind!


This is all against the backdrop of inflation, and the impact of that on a nominal pricing market – where prices are measured in pound notes, even when those pound notes simply do not buy the same level of goods, services, and experiences. That’s the really juicy bit that the forecasters have missed out – you could take a completely different viewpoint and praise the current administration for doing very well in such an inflationary time, keeping pace with the price rises and not going into recession is actually a great feat, but only a great feat if you conquer inflation and crack on without recession being an inevitable consequence.


That whole story took an interesting turn this week. We’ve got a new inflation buzzword, ladies and gents – profit-led inflation. What is this concept? Well, in its recent context it has been popularised by UBS chief economist Paul Donovan, who splits the recent inflationary cycle into three parts – firstly, for durable goods during the lockdown (think hot tubs and rowing machines), then for commodities (and we have all seen what happened to energy prices which would be included in this part of the cycle), and then for profit margins, which companies are of course always keen to preserve. 


It’s probably obvious that most companies would not miss a good chance to put a price up. You’d expect them to be pretty smart when opportunity knocks, and if you considered the builder’s merchants for example, you’d remember that they were still trying to force prices upwards long after the commodity prices of things like lumber had already peaked. They got into a place where the market was swallowing these price rises and just kept trying until the market said no – and then competitive instincts kicked back in, but of course they tried to maintain these new, higher profit margins. The fact that they were selling more products to finish existing jobs, whilst simultaneously pricing out a lot of potential new jobs, was perhaps lost on them (and is also very difficult to measure, so that would remain a theory rather than something I’ve got data to back up – even if that theory makes good sense, but I would say that wouldn’t I – it’s my theory!).


So – under the cover of other, general inflation (and also wage inflation), companies use the opportunity to expand their margins. All very believable. Donovan suggested that using something like social media to inform customers this is going on might be less destructive than just raising rates, the more traditional approach. Use collective consumer action to force/shame companies into stopping these practices, basically.


It seems reasonable to include some element of “fairness” into any pricing model – but of course, the problem is that the price that I think is fair (or that you think is fair) is likely to be different from each other, or from another third party’s idea of fair pricing. In aggregate, though, the market would decide. It also seems reasonable to assume that the average consumer sees a price go up and ASSUMES a greater profit margin, just as when they see a price go down they assume a lower profit margin – whereas it may be completely cost-driven, and this may well be an illusion. Companies do (as a rule) tend to try and explain cost increases particularly – as we saw with the builders merchants in 2021 and 2022 – the element to which their customers trust these explanations will depend on the brand and the level of trust that they have within their customer base, of course.


It could be as simple as the fact that the need to raise prices was huge during the pandemic, because of volatility in inputs. We all know that it is the case that prices go up very quickly when something changes on the cost front (oil at the pumps, or base rate tracker mortgages when the rates go up), but come down more slowly when the reverse happens. We also know that businesses are bound to be opportunists. The profit margins are more likely to shrink now, though, as the rate hiking is largely done (and instead cuts are on the horizon, certainly in the US and Europe). Margins have likely increased because companies have picked the input that has gone up the most and then put prices up by that input – so let’s say that wages are up 8% but materials are up 12% – if prices go up by 12%, the overall margin will improve since not all the costs have gone up by that 12%. 


I remain unconvinced about all this. There has been no evidence found by the Bank of England, who have investigated, that this sort of profit-led inflation (or greedflation) has been going on, despite of the good sense that it makes. I’m not sure how hard they’ve looked, because margins have generally improved – but the problem is that current forecasts show further profit growth next year, whereas in my seat that looks particularly unlikely, especially in the UK and especially after the Autumn statement.


There’s a further spanner in the works, though. Inflation has very much lost pace in the US and the Eurozone (and that’s inspiring the chat about rate cuts coming forward). In the US services inflation has abated from 6.8% in April (that was our September number) to a still-high 5.05% for October (and also doesn’t dominate their CPI number quite as much as ours does in the UK). There’s a bigger relative drop in the Eurozone, who never saw services inflation above 5.6% (whereas we were as high as 7.4% in July this year). The EU services inflation is down to 4%, with a relatively steep dropoff in this past month. 


As with most of this cycle, we still appear to be roughly 6 months behind the big two. Their chat about cuts is deafening now, whereas ours is still more hopeful than real – I’d be surprised if we cut as early as they do. Lagarde, the president of the EU central bank, is still convinced that inflation is going to bounce back a shade, although has tempered her talk from “no cuts in the next couple of quarters” (that was the mid-November narrative), and markets are pricing a 70% chance of a rate cut in April next year. 


This phenomenon, understandably, had a big impact on the bond yields in the US and the EU this week, and there was an associated drop on the UK gilts as well. The magical 4% barrier was once again broken on the 5-year UK gilt on Wednesday, and whilst the yield traded back above that in the interim, Friday’s close was 3.955%, which is more than 20 basis points lower than last week’s close. The SONIA swap for the 5-year is trading at a razor thin margin above the gilt (again, perhaps symptomatic of supply and demand, alongside greatly reduced volatility) at 4.04%, which sees rates at 5% pay rate plus a 5% arrangement fee very plausible indeed, for 5-year fixed buy-to-let vanilla deals. Most recent experience in the field has been around 5.15% with a 5% fee, so this is an improvement.


This segues me nicely into a soapbox moment for today. For the past 12 months, I’ve taken some issue with some of the advice I’ve heard being pumped out around mortgage debt, and I am increasingly aware that I’ve taken a fairly lonely position in this market. I perhaps earned my stripes in 2022 when talking about what rates might well do, inflation, risks being to the upside and spending most weeks SHOUTING about the fact that I was breaking mortgages to fix at the lower rates, or similar. I wouldn’t change a thing. 


However, by continuing on the 5-year bandwagon, I have been in a relative minority. Sometimes, I feel people are too scared to correct me for some strange reason – I love feedback, and I love debate, and I certainly don’t expect to get everything right. Far from it. Let me lay out my overall position:


  1. i) Risks remained to the upside, and some events (the middle east would be a good example) simply haven’t turned out as bad from an economic point of view as they easily could. Things also, sadly, aren’t over yet.
  2. ii) The pandemic taught us so much – all of which we already knew, but didn’t have at the top of our strategic plans. One lesson we need to remember is that massive volatility can occur, as long as there is a catalyst for it. Volatility is the enemy of long-term investors for a few reasons – one is that it can shake confidence, two is that it can lead to support or credit being withdrawn, or dramatically changing in price (the latter has been the fallout as far as property investors using leverage are concerned).

iii) The rest of the world showed greater stability by having longer-term debt cycles. 2 years is simply not long enough for a mortgage – at the current speed of many conveyancers, it looks more like a bridge term, for goodness sakes. There’s a strong argument that 5 years isn’t long enough – remember the rest of the Western world tends to use 30-year fixes if not even longer.

  1. iv) Frictional costs are rising and have risen. The amount of administration required is also significantly higher than it has ever been before. The number of extra reports requested by valuers has also rocketed in recent years. Have you really got time – and have you costed in those frictional costs – for this to all come around again in 2 years’ time?
  2. v) Two-year loans are often used in the early or mid-parts of a boom cycle. The point is that extra equity can be released and used to “go again”, and offer more momentum. It has never been something I’ve used in my business model because I’ve found more edge in buying really well than concentrating on squeezing what I’ve got to death/overleveraging. 
  3. vi) With a 5-year cycle in anything like a “normal” market, you get near the end and your new purchases may well be being geared to 75%, but your older ones that are nearing the end of their first 5-year cycle will hopefully now be 60-65% LTV, organically. This isn’t done for you automatically in a 2-year cycle and thus you are more likely to be at a risky gearing level

vii) When LTV moves above 60% (and this number is also massively yield-sensitive), the risk does not go up in a linear fashion. It is not a straight line. Instead it rises more like a parabola, a curve, and as you go above 75%, that steepens even more. It is unlikely, if you operate a portfolio like this, that you can withstand a significant shock and also that you are getting a fair return on the risks you are taking.

viii) In times of volatility and rate changes, the other big concern should be credit conditions when you come out of that loan. If credit conditions are tightening, what if that loan isn’t there in 2 years time? You could argue that the same applies in 5 years – and that would be true – but it gives you longer for things to settle down, and more options if you need to take action 1 year away from redemption – you barely have time to breathe in the 2 year product.


So, imagine my disappointment this week when I learned that one of my consultancy delegates was in the final stages of taking out a 2-year product. My immediate feeling was that I had failed them, by not laying out this position clearly enough! The product in question was a 7% fee (yep, for 2 years) and a near-5% pay rate. Why was this so very expensive? Well, the property in question had some quirks, and also the loan had been requested several months ago, when the 2-year yields were so much higher. It has gone to offer some time back, and the chances of a lower deal at today’s pricing are long gone. Using my back-of-the-envelope method, that’s an 8.5% cost (without thinking of the legal and other frictional costs as well). What a nightmare!


I’d suggest that even bigger is the hassle of going through this process all over again, starting in about 18 months time. I understand, the conventional wisdom at the moment has been saying “why fix for a long time when rates are high?”. My mantra is much more like “if I am not fixing for at least 5 years, there needs to be a really good reason as to why I am keeping the property.” If it doesn’t stack today, then should I sell it instead? It might be that year 1 and 2 are relatively underwhelming, but with a good asset management plan and a landscape which is expecting (and seemingly can afford) significant rent rises over the next 5 years, the years 3, 4 and 5 look much more promising and interesting. Your 5-year forecast has so much more uncertainty by using a 2-year product.


That’s not even the last problem, though. The last problem (promise) is the guesswork that has been going into the statement that “rates will go down over the next two years”. Let’s take a look.


I first started hearing this in October 2022. So, 14 months ago – in a 2-year cycle, not a lot. The 5-year bond is, today, JUST under where it was in October 2022. A nearly unnoticeable drop. There have been periods this year where it has been a fair bit lower, and also periods where it has been 1% higher than it is today. There has been significant volatility – but we know that. Enough of a drop in 14 months to justify a 2-year product? Absolutely not.


The yield curve is inverted, currently – so 2-year debt has been more expensive than 5-year. Sometimes a lot more expensive. That definitely doesn’t help and why expose yourself to a bad part of the yield curve when you don’t have to? 


Most cannot even start to calculate where the rates would need to be in 2 years’ time to justify their decision. That calculation will never get done. I suggested a couple of weeks back that the implication in the yield curve is that 5-year rates will be around 3.5-3.6% for the gilts (and so, 5 year mortgages in a year’s time might look like 4.6% with a 5% fee, or a higher pay rate and lower fee, for limited company) – this is simply derived from the yield curve, crudely, rather than a prediction from my own model. Worse still, it won’t matter if I’m right or wrong – because, like everyone, I am a price taker in this market, not a price maker. The likelihood, though, considering all of the above, that taking a 2-year product is a dominant strategy for a long-term portfolio player is low.


I choose my words carefully, there, though. Of course there can always be good reasons to look at alternative products in terms of duration (or anything else). 5-year is inflexible, and early repayment charges are high as costs of breakages go up in times of volatility, and in times of higher rates. You may well want to explore selling in 2 years’ time, or know that you are going to. That therefore makes sense to pay the ferryman – maybe. The only way to know is to do some accurate, month-by-month, cashflow forecasting or get your bookkeeper or accountant to do it for you. Then look at the likelihood of those scenarios. Or – Fail to plan, plan to fail, on every investment.


Whilst on the “rant bus”, I wanted to discuss a post I saw get some traction on social media very recently. The thrust of it “I’ve sold up, and the money is in the bank now. Better returns and I needed a lesson, have taken my medicine.” Perhaps fairly clear that property was not kind to that individual in terms of returns. Lots of ways to interpret this, as the comments offered the most insight (as they always do):

“You’re an idiot, mate”

“I’m the same, selling up when tenants leave” (a large number of people saying this)


“How can you possibly get better returns in the bank than from property?”


Those were the main 3. It seems to be obvious that those espousing the third comment are doing OK from the game, whereas those in 2 are feeling the pressure. 1 is just your average social media troll!


I read these posts and it reminds me just how very little people know or understand about investment – outside of property. Firstly – and I could make 50 relevant points here – bank rates today are unlikely to be reflective of bank rates in the next ten years. Fine going into a bond today at 5% interest for a year – or similar – although those rates have dropped like a stone in the past few months, far more sharply than the mortgage rates for 5-year fixes – because shorter duration is always more volatile.


Secondly, 5% in the bank before tax is still losing money to inflation unless you are a non-taxpayer, or have a small amount in the bank so it isn’t going to make a difference. Inflation is likely to stay around the 4% mark over the next 12 months, so perversely you were better off at 1% interest with inflation at 0, although that’s hard for people to get their heads around for whatever reason.


Thirdly, by dipping in and out, which the original post suggested, of course returns have not been positive. Frictional costs are high in entry and exit to property, and unless you are a great trader, you are highly unlikely to make it work if your time horizon is less than 10 years. This needs to be understood, and repeated. I’ll close this week simply by referring back to a legend of investing that we’ve lost this week – the originator of the opening quote for today – Charlie Munger RIP. It is somewhat strange to use so many quotes from Buffett and Munger – as I do – because neither really favour property (or real estate, as they would prefer) as a great investment class. That – however – is where I will part company with the great men. Anyway – to Charlie – and why investment is a long game, not one to dip in and out of (it also ties in nicely with my 2-year mortgage rant above:)


“You’re paying less to brokers, you’re listening to less nonsense, and if it works, the tax system gives you an extra, one, two, or three percentage points per annum.”


Well done for getting to the end, as always – if you haven’t heard, I made my 500 subscriber target and my Propenomix Advent Calendar is online (with a release each day, one 60-second explainer and one longer-form but under 10 minutes). Subscribers are very, very welcome, and here are the links – for the channel: and here to the Propenomix website: – thanks for supporting me spreading the word, more subscribers will lead to more and better content. Even in a week of losing some big names, and a true goliath of investing – we only have one choice – Keep Calm and Carry On!