Supplement – The Oncoming Anticlimax

Nov 27, 2022

“Because this is how the world ends: not in the falling incendiaries of an aerial attack, not in a storm of toy soldiers laying waste to the gods who brought them into being, but in the banal letters of a bank. Where once was magic: now only economics.” – Robert Dinsdale, The Toymakers


Welcome to the Supplement as we say goodbye to November! 2-3 weeks left before most of the property industry and associated professional services check out for the year – more on the opportunity that provides later.


The doom-mongers are out

We are soon to start hearing predictions for 2023 – the doom-mongers have got in early and it’s important to firstly point out that forecasts are (pretty much) never correct. They aren’t supposed to be – they are the best estimate, often of a number of moving parts, and quite often form a range – I can tell you it is going to be between 0 and 20 degrees Celsius today in England as a starter – then I can get more precise and tell you it will be between 2 and 12 degrees – then as I go more granular, I’m going to change my language – it “should” be between 3 and 11 degrees, it “will probably be” around 7 degrees on average (and that in itself raises a number of interesting points – averages can be dangerous, and none of us aim for the average in reality; what does “in England” mean, what’s the point of measuring the temperature in all of England or even talking about it, etc. etc). This logic very much applies to macroeconomic forecasting.


The bankers, next year

In terms of the certainties next year – there WILL still be high inflation. It SHOULD go down at some point (although things like energy price caps being lifted will provide some resistance to that in April). That’s a good example of something we KNOW will have an impact; even if Russia pull out of Ukraine tomorrow, there is still a global energy crisis and consequences will reverberate for years (especially with the pace at which we simply have NOT addressed the issues which were there for all to see in February, and going back to 2014, and going back to since there’s been geopolitical tension in areas where we get our primary fossil fuel supplies from – i.e. all-time). 


The predictions

Then if we move on to what SHOULD happen – the base rate SHOULD not need to go up at the same pace, with the same frequency, as this year. That’s a bit weak – but I say “should”, because it is not a mathematical certainty. It is a very near given, and would take a Black Swan event not to behave differently next year, but it is important to highlight that sort of risk. That sort of risk is an “upside” risk – where a metric can move upwards, more quickly and with significant consequences, creating issues in the economy for businesses and households. We’ve seen a couple of upside risks play out this year (one on interest rates already, one on inflation) and whilst things should be better in comparison, they are still rising from a vastly elevated base rather than coming up from the floor (although inflation really started to move in Summer of 2021). 


House prices SHOULD go down. If we move to certainties, they are certain not to progress over they have in the past 2.5 years or so – but that really was a given. The market has actually behaved itself much more than in many other countries around the world, but the pandemic should never have led to a 25%+ increase in house prices. It just doesn’t make real world sense. It is a symptom of gigantic Government stimulus alongside massive motivation to move, and a dysfunctional housing supply, planning and policy “death by a thousand cuts” situation.


Prices down – but read on….

Prices should go down because the price of credit is up quite so much. It is not yet priced beyond all reach and it most certainly is moving in the right direction – this has been a fairly monumental week in terms of going the right way on a number of milestones, in the gilt markets, as the 10 year UK government bond (the most heavily traded marker of longer-term safe returns), tested the 2.9% yield level and dipped below 3% for the first time since early May, so over 6 months ago. It tested that level and rebounded pretty hard to finish the week at 3.12%, so the attempts by traders to show confidence in Hunt’s first budget were basically rebuffed as the international markets said “you need to show us some more, before getting back down to those levels”. The 5 year SONIA swap, the most relevant metric for the cost of lending before lenders apply margin, dipped below 3.7% this week after spending a chunk of time above 4% and some above 5% (Thanks, Liz) – but once again, resistance was very clearly found and it ended the week at more like 3.81%. A 2-2.5% margin on top of that (depending on how competitive the market is, which is in turn determined by the price of that credit) is a fair rule of thumb for rate availability, so we should be seeing more lenders moving under 6% with their 5-year limited company fixed rates soon (we have seen one or two under 5.5% this week, but they are not operating to lower margins than everyone else; they are deposit-taking institutions who are paying their savers a fair bit less than 3.81% on their average savings balances, so are enjoying a healthier margin (but have more operational costs in “looking after” those savers, of course – so they need 2 margins…..)


The point, though, is that the direction of travel is currently down. In the last 52 weeks the 5 year UK Gilt has traded between 0.52% and 4.8% – an incredibly volatile range, and 3.28% (the Friday close) is significantly down from the very worrying numbers being posted around the end of September, “thanks” to the worst budget this country has seen since the 1990s, or possibly even the 1970s. 


Look out for the traps

You can be lured into a number of traps here. “Bond yields are always higher than base rate” – that’s definitely one. No, definitely and absolutely not. In fact, more often not the case historically. The reality is, the gilts and swaps markets move in real time. They are heavily traded, particularly the 10 year gilt. Worldwide bond markets are worth over £300 trillion. They truly are massive. Base rate moves much more slowly – and that is deliberate. What it’s been doing is catching up, and it will soon overshoot (we are close already, and had that inflection point this week, if you stitch together the pieces from the above). 


Partial information though, as often, is dangerous. This doesn’t mean base rate isn’t going up in December. The likely rise is 0.5%, as it is still lagging the faster bond markets, and also as inflation is still high (and whilst the budget was clever in terms of not making cuts now, other than raising taxes it did nothing to counter inflation in terms of cutting government spending in the now). That leaves inflation control FIRMLY in the central bank’s camp – which is clever by the Treasury, but ultimately not that useful to the public. Base may now go only as high as 3.75 – 4% next year – I think if you are exposed to base rate, and also interested (presumably you are, otherwise you wouldn’t have gotten this far!), then the average base rate next year may be around the 3.75% level. If we have a sharp dropoff in demand, it could be lower on average – but if we have more inflationary events other than those already priced in (yes, gas prices are going up quite a lot more, next year, but this is priced into the models already – although again, risks are to the upside, realistically), then rates may yet need to go higher. Still, this is the first time I’ve been “happy” to predict a base rate throughout 2023. The average I’ve predicted will be higher than the consensus forecasts, but the peak won’t be a lot different I don’t think. This is because I expect a longer duration at higher rates because I am expecting more persistence from inflation than is being accepted, expected or priced into the current models that many of the forecasters are using.


The Office for Budget Responsibility – decent job, in the near term

On the subject of other forecasters, I have found most confidence thus far – mostly heuristics on my part taking an overall view – in the Office for Budget Responsibility (independent body that advises the Treasury) and their numbers for the next year or two. There is (as usual) another side to this – their longer-term forecasts don’t look right to me at all. This is not uncommon – modelling that is better in the short term does not necessarily extrapolate well. Most of the models are wrong all of the time, remember. 


However I thought it was worth bringing the OBR numbers into this discussion. There is a 68-page fiscal outlook which is a bit strong for a line-by-line analysis even to those who put the time and effort into reading the supplement every week. There is one bit I couldn’t resist reproducing though, because this proves just how very robust the entire economy is, even when everything in parliament really does appear to be going to the dogs. There is real “public sector humour” contained within this, in my view:


“Our twenty-sixth Economic and fiscal outlook (EFO) has been unusual in both the time it took to produce and the process leading to its publication. With the agreement of the Treasury, we started work on this forecast earlier than usual on 29 July, three weeks after Boris Johnson resigned as Prime Minister. We did this to ensure that his successor and their Chancellor would have an up-to-date picture of economic and fiscal prospects upon appointment in early September and to be in a position to publish a forecast alongside any potential fiscal event later that month. In the 16 weeks since then, we have produced seven forecast rounds under three Prime Ministers and three Chancellors, working towards three official forecast dates. And this final published forecast reflects policies announced in five major fiscal statements since March.”


The ship is steadier

Frankly, that IS a joke and we are an international laughing stock, or at least have been. The ship looks steadier now as per the above, but the sirens are still calling us over to the rocks, left and right. The OBR goes into the next 5 fiscal years, driven by a committee of 3 members. The following numbers were where I started to feel a lot more accuracy compared to recent Bank of England forecasts, or other economic commentators and modellers:


“In the UK, CPI inflation is set to peak at a 40-year high of 11 per cent in the current quarter, and the peak would have been a further 2½ percentage points higher without the energy price guarantee (EPG) limiting a typical household’s annualised energy bill to £2,500 this winter and £3,000 next winter. Rising prices erode real wages and reduce living standards by 7 per cent in total over the two financial years to 2023-24 (wiping out the previous eight years’ growth), despite over £100 billion of additional government support. The squeeze on real incomes, rise in interest rates, and fall in house prices all weigh on consumption and investment, tipping the economy into a recession lasting just over a year from the third quarter of 2022, with a peak-to-trough fall in GDP of 2 per cent. Unemployment rises by 505,000 from 3.5 per cent to peak at 4.9 per cent in the third quarter of 2024.”


Since the report was published we know that October’s inflation number was actually 11.1%, and we are not guaranteed that this is the high watermark, although there are a few structural reasons why it might well be (energy price movements on 1st October being the chief one). The 7% additional squeeze on living standards is higher than was expected, but with inflation being so very high and the public sector (and as always the private sector) keen to keep wages down to avoid the extremely damaging wage/price spiral (famous in the 1970s – wages go up a lot, people have more money to spend and businesses spend a lot more employing them, so they change prices upwards, and so the cycle repeats)…….it feels very feasible. Of course I’m expecting slightly more inflation than most, so it does make sense to me. 


OMG, it all sounds terrible – shall we get under the quilt?

8 years’ growth in living standards gone after this recession? Sounds believable. Back to my point – pandemics, historically, have been difficult to spin into positives. Tighter labour markets – historically, thanks to death/depopulation – this time round, thanks to long-term sickness, the opportunity to find “another way”, and a generational imbalance/one more wealth injection to the asset owners allowing earlier retirement (and the time to think about the rat race, and what’s it all about, and what’s the point?). GDP down over the decades that follow – historically, there has been around a 1% drop for the next 4 decades. This might be better framed as relative rather than absolute, and it might “only” mean 0.5% or less in today’s world, but don’t forget – much of the pandemic data is centuries old, pre industrial revolution, and before “breakneck speed” global growth and aggressive population growth. Wars are historically better for GDP – rebuilding, forbearance on loans, debt to invest in infrastructure – economically there have been positives in the past (not to minimise the death and destruction that wars bring, of course) – but we are talking about after the event, not during. Investor returns struggle for decades afterwards, partially due to labour taking a larger share of the pie compared to historically (likely no bad thing after the direction of travel of the past 30 years as far as inequality has progressed – but not good news when you are an investor, of course!). In reality though with lower growth (combined with lower economic trade advantages c.f. Brexit), this sounds about right. There are no magic wands here, and infrastructure and energy investment has taken crisis points and still not really taken off.


2% GDP fall peak-to-trough – I’d go slightly lower here, but only slightly – so I think we will stave off a 2% drop in output. I think with persistent inflation wages will be up perhaps more than expected next year, and also if the unemployment forecast is correct here (and again, it looks good to me) – then the labour market at sub-5% unemployed is still likely tight, and historically very tight – we would be well past 6% before we considered it “loose”. Anyway – as discussed, by far the best forecast I’ve seen so far in terms of likely accuracy (on my numbers anyway).


That was a brief bromance, with the OBR, wasn’t it?

We start to part company after this though, a bit – around about here, you won’t be surprised to read:


“Inflation drops sharply over the course of next year and is dragged below zero in the middle of the decade by falling energy and food prices before returning to its 2 per cent target in 2027.”


Why I’m so dead set against this is two-fold. I’ve discussed transitory versus secular inflation arguments at length and, unlikely many, prefer the explanation that there are elements of both that are important here. The transitory elements have already started to fall away, however, with energy being the remaining (massive) component. I’m also very much bought into the argument that the energy crisis is an ongoing situation with (at the outside) 5-7 years left to run before it truly comes to an end and the world has adapted enough to cope – instead, a lot of the rest of the economic commentators prefer to pin a largely arbitrary timescale on it – 12-18 months more to run, and we’ve heard all this before for example in the last decade, when interest rates would start to go back up….even the comparatively few who predicted it would take a lot longer did not also predict the path of the rates this year, because that would have taken some quite incredible foresight over a very different period of economic shocks. Energy prices (and as a result, food prices, because energy is such a large component of the cost of food production) are, therefore, unlikely to slide off during the middle of this decade, in my view. 


Prices, as you will also know, from experience, tend to be stickily high – unless they are being improved by technology. I know we have entered an era of vertical farming, but until we don’t burn gas in the UK to get 40% of our electricity, we will be dependent on expensive electricity a lot of the time (let alone the direct burning of gas itself) – and this is why I feel 5 years is a much more realistic timescale than 12-18 months.


The forecast-off

This also raises another important point about forecasts though. In isolation, it’s highly possible that the OBR are much more likely to be correct than I am. You’d hope so, after all – I’m one guy and a keyboard, and I’m certainly not a world class mathematician or statistical modeller. However, we could likely all agree that IF the OBR ARE correct here about inflation, that interest rates would change significantly (downwards) and indeed WOULD drop back to the 1% or so base rate levels in order to stimulate the economy. Don’t get too excited though – check the economic history regarding times of high inflation (which are always, by definition, transitory – they come to an end in the end) and show me where double digit inflation, in a low rate and low returns world, turns into 0% within 2-3 years. Not for me, folks – not for me. Onshoring, and moving dependency on suboptimal geopolitical partners – even if not taken up by even 10% of the UK’s supply chain or public sector, for example – still has a long-term shadow on inflation. Progress is backwards and investment is in the toilet, from a macro perspective – therefore, major productivity gains (the single major driver of GDP going forwards) are also unlikely. Strikes are extremely bad for productivity and keep inflation stickily high, and the OBR don’t seem to be modelling this in their forecast. The industrial action situation gets WORSE in 2023 before it gets better – and the winter to watch might well be 2023-24, while all eyes are on this (so far mild, and windy) one according to the forecasts (wind = good, because it generates power, so we don’t need gas to generate that power). Mild is good too – because if it isn’t colder, we don’t need more gas to keep houses and places of work warm – or we don’t need as much.


So if I got your hopes up there about the return to cheap money, I apologise…..let’s all hope I’m wrong!


The rest of the report goes into more detail about the forecast period, the overall debt burden, the sensitivity to interest rates and gas prices, and is, I’m afraid, a litany of upside risks as I’ve been saying for some time now. This isn’t “reasons to be cheerful” BUT I’d encourage you to go out and see what’s happening in the real world. Retail environments touch us all, many of us more than we would like, at this time of year. I’m seeing bigger crowds than I’ve ever seen in the same spots, spending like it is going out of fashion. I’m hearing about the expansion of food banks but seeing the money that is out there – and not necessarily in affluent areas of the country. There’s one good reason for this that I heard framed in a really elegant way the other day, in a totally different discussion.


Bad at anticipation, great at adaptation – as a whole, but there is another way

Humans are bad at anticipation – really bad. Most are very bad at delaying gratification – those who are reading have, in some number, at some point in their life (or perhaps over some years) experienced a mindset shift. Some have had it forced on them or have their “Road to Damascus” moment (don’t worry, this isn’t a full guru sob story emerging, before I release the mentoring for £99997 + VAT for 5 minutes). Some have actively engineered their mindset shift via reading, educating themselves, and paying for it one way or another.


Humans are also excellent at adaptation. Once things change, we change quickly. We would be better off to be proactive than reactive – we know that – but once you start to accept THIS bias in your life, it can really help you. Proactivity is hard. That’s OK – if it was easy, everyone would do it. Once the money does stop flowing, the pain will come…..but, in reality, those couple of percent don’t make that much difference. Look at the above – we are back to 2014 living standards if the OBR are correct. I don’t remember life being all that terrible in 2014, and we haven’t really made that much progress since then, economically, anyway – flat growth, flat productivity, etc……compared it to say 1974 and then you’d be looking at a totally and utterly different world. The “lost decade” will itself be lost for a while, and instead we will be looking at a nearly lost 20 years – but not starting from a terrible place.


Light the Joss sticks and pass the incense – here comes the mindset chat

As usual – the hardest pill to swallow of all is that there is one person who can help you with all of this. Spoiler alert – it’s you. No-one else is going to do it for you. Put great people around you – sure. Growth and abundance mindsets, my absolute favourite, are addictive. If you are positive, those around you are positive – or they, or you, get new friends and contacts. There’s a whole world of opportunity here – we are already picking up deals from vendors that think the sky is falling and are selling at 30-40% discounts, and that just hasn’t happened since 2019 in our world. Even if we are going into a falling market – highly likely – the very fact that it is falling is creating fear, and fear is so, so dangerous for your pockets, your balance sheets, and your psyche. That word – falling – how scary! But what if it falls by a few per cent next year, and a few per cent the year after. Quel disastre! No……..5-10% off a market steam of 25%+ really shouldn’t be causing anyone any problems, or any concerns at all. Yields will improve, after all – because persistent inflation brings persistent wage rises (even if they are below inflation) which bring persistent rent rises, versus the nominal fixed debt you have from the bank if you are using leverage. Doesn’t sound like a recipe for disaster to me?


The deals have ALREADY STARTED! Get that Uncle Warren in your ears

“It’s so hard to get deals to stack up at the moment though!”. Sorry, I disagree. Interest rates are up. Get over it. Deals are MUCH easier to find right now than they have been for years, ESPECIALLY in this runup to Xmas – it is FAR better to buy when the unknown is ahead, because most are not capable of handling the downside risks and managing them well. There is only one more quote I can leave you with on the back of that, and we are going all the way up to the GOAT for this one – the one who will be enshrined for many years as the Greatest Investor Of All Time, when finally he does meet his maker – Warren E Buffett (so well known that, in a country where many use their middle names as a way of standing out, he just doesn’t need to): “Be greedy when others are fearful, and fearful when others are greedy.” We are approaching max fear, before what I think could easily be a big, fat, anticlimax. Boring. Slow. Painful. Hard for those of us with short attention spans and a healthy dose of impatience. Make the most of it. Treat yourself to 90 seconds of Uncle Warren here:


Until next week, keep calm, stay humble, and get on with fighting that fear. Sorry about all the capital letters this week – but I really had to get that off my chest. I really encourage all readers to listen to this one, read again, and CARRY ON!