Sunday Supplement – Schools in after Summer!

Welcome back everyone to the first supplement back after the summer mini-series, unbelievably we are two-thirds of the way through 2021! We will be catching up on some of the more regular analysis and also talking through some possible scenarios – my pet subject at the moment that I’ve been reflecting on over the past month or so is whether we’ve seen a seismic shift in the market to rival the last seismic shift for investors (and property in general), which was 2008-9 – so some thoughts on that as well, and addressing some of the points and concerns which were very helpfully and articulately put to me on our first face to face meeting back in the rooms, this week, which was held on Friday in Birmingham, happily.

So – on the macro front, I’ve spent the summer looking at graphs (yes, rock and roll) and asking myself the same questions I asked myself at the end of last year/beginning of ‘21, and stressed and steelmanned all the conclusions that I had come to or not come to, and whilst they have definitely moved throughout the year and I believe that all good forecasts have to be fluid and updated (not to do so is to be closed-minded to the point of belligerence), it was good to take a little breathing space and come back with a fresh set of eyes and ideas. 

On a macro level – where is the UK economy at right now? Well, we have a record number of job vacancies. The media and many commentators, as usual, seek blame and scapegoats here. I see little point. We are where we are – an immigration policy built on ideology and populism rather than facts and data, and supply chains disrupted by new bureaucracy alongside a fading and returning, volatile, pandemic. Ingredients (and not a comprehensive list) to the recipe of the issues we are facing. Supply and demand has been all over the place – it is all very well seeing accelerating trends “thanks” to Covid, but sometimes those markets just don’t move fast enough to accommodate them in any meaningful way. That’s some of where we have been and got to.

Classic economics teaches us about types of unemployment. Pertaining to the accelerating of trends, then all else being equal, we would expect unemployment post/intra-pandemic. Some old skills aren’t required as much anymore. Some new skills are in huge demand. Things have moved sometimes 20 or 40 times faster than “normal” (remember normal?) – this leads to what we call structural unemployment. A skills mismatch or skills shortage. The difference is that structural unemployment is usually about long-term changes in demand for skills – however in this instance it has happened much more quickly. 

There’s also the great resignation wave. This isn’t much publicised (although of late some articles have started to appear), but I’m pleased to say I gave this some airtime last year. Here’s my theory: The pandemic and particularly the first lockdown forced many people to have some time to slow down, and think carefully about their lot. Forcing people off a constant treadmill – and that space was filled with a want to change. The recent Adobe survey shows a plethora of people from Gen Z and the millennial generation doing this, not people taking early retirement as the main driver (as I suspected it might be). 

Now, let’s not be too hasty. The vast majority of these people will not only NEED to work (even if they have temporary solutions for income/shelter/etc) but they will WANT to work. They may therefore retrain, study further, and then go back into the market for the job they really want or the career they really want. Time will be our friend here. However, this is the start of the constant armwrestle between capital and labour tipping in the favour of labour. Quit rates above those seen for the past 2 decades are a confirmed side-effect of Covid-19, currently. This has definitely upped voluntary unemployment, however, currently. 

So, jobs are out there. The unemployment concerns look unfounded. This is a major metric that makes the government and the Bank of England both very nervous when it is creeping up. We need to see the numbers post-end of furlough (last released figures are for 30th June, and looked a lot less worrying than some suggested) – there may well be a second wave of resignations when people come off furlough at the end of this month, even if the employers did want them back!

Next up – debt. Debt as a percentage of GDP is looming on the high side. Historically, we’ve seen much worse as a country – but only post-WW2. We were essentially bankrupt at that point and kept afloat by the Marshall Plan of course – so that could well be omitted from consideration. The US have passed their previous high watermark set post-WW2. However, at 106% for the UK (and rising) at the end of the last financial year; concerning because the 90% (comparatively arbitrary) figure is well breached, but less concerning when you consider Japan’s 266% of GDP as debt (not that we want to replicate the economy of Japan – but there is some comfort).

Debt is one thing and there is a near acceptance that it might take 50+ years to pay this back. The post-war boom saw a lot of damage repaired, and us coming down from 250% to under 50% of GDP within 30 years – but there was spectacular growth here and advances in productivity which might be very tough to replicate today.

The next consideration is the cost of actually servicing that debt. This has crept up in recent months, partially because of inflation moving upwards (a portion of the government debt costs more to service because it is issued in the form of index-linked bonds). In many ways this is more important in the “now”, and of course the constant cost of debt servicing is money that cannot be invested in infrastructure, or used to pay down capital debts, or for one of the many other alternatives for government monies.

Debts are high. Also, thanks to money printing and stimulus, there is more money out there swishing around the system than for the last 100 years or so – at levels similar to the 2008 levels. This on its own is not a critical stat – but you can understand why it forms part of an uncomfortable picture. If the velocity of that money – the speed with which it moves through economic actors – picks up significantly, the inevitable result is high inflation that potentially races away.

What happened last time this situation was replicated? Low interest rates for the following 15 years. As soon as was possible and effective, interest rates were put up and that allowed a return to monetary policy dominance (hard to be dominant when you have fired all of your bullets). What does this mean? A period when governmental tax and spending policy (fiscal) comes second to the monetary policy, primarily the setting of the bank base rate.

Is this a cast-iron guarantee of ongoing rates staying low for a similar period of time? No. Forecasting for 5 years is very difficult indeed and prone to massive errors. 15 years would be ridiculous. But I struggle with probabilities in this space, because the damage that a rate rise could cause could be really significant, if the rate rise was meaningful, causing so many other problems in the economy that it really would be a move of last resort (and instead further stimulus would be preferred, even if that stimulus is comparatively ineffective) – more QE, perhaps MUCH more, before raising rates significantly. 

The “game” here if you like is to look like you are still playing by the rules, but having no real intention of playing by the rules. The upside is that almost every other country (China aside) is playing exactly the same game but no-one wants to call it out, because it helps no-one.

The phrase “financial repression” came up last year because this is how the yield curves were controlled post- and intra-war in the USA, and a similar situation was seen to be potentially emerging. However, the actions that the bond market has taken at the moment is to carry on as if bonds are actually providing meaningful returns – regardless of the fact they are losing money, on average, in real terms, at a rate of over 1% a year (once adjusted for inflation) is making a limited difference – to an extent it is easy to make a case (particularly in the US) that bonds are returning next to nothing and indeed losing money in real terms, and equities in general look expensive – so where do you allocate the capital? If you manage a trillion dollars in assets and above – like some of the fund giants do – what now? It’s a problem that the markets simply don’t want to answer.

Graphically and sticking with the post-WW2 trend, as the last truly major debt event of the past 100 years, the response was inflation to reduce the debt from that 250% to under 50% of GDP. There’s no doubt this was a) what the government at the time wanted and b) an effective way to tackle the mountain. However, my fear for a long time has been that this time round, the government want inflation so much that they are seeing it as THE solution, rather than a side-effect of a healthy and growing economy. After all, in the short term anyway, the referendum vote was theoretically harmful – lowering the credit rating, and creating inflation due to currency devaluing. However, this inflation was actually welcomed at the time (but didn’t have a commensurate rise in productivity or growth) – even if this was not said in so many words, it was happily tolerated without tweaking interest rates (indeed, they went down on the morning after the referendum, not up). 

So inflation is the story the government would LIKE to tell, and the Bank will play along, for the moment. The US is dealing with far higher headline figures than the UK, and we usually run a little hotter than the US on inflation numbers, so the figure is really significant. However, the narrative is that it is transitory – it will pass – and of course this fits the story you would be telling if you were quite comfortable with quite a bit of inflation. If it IS transitory – genius, you called it. If it persists, oh well, it chips away at a couple more % of debt. As long as the horse doesn’t bolt out of control – and then it destroys significant value.

Two more pandemic conclusions from historical studies of pandemics versus wars – firstly, wages AFTER inflation tend to increase over the following 40 year period. This is back to the labour versus capital armwrestle – not in itself a bad thing for property prices (particularly retail prices) – and for affordability of rents, as well, of course.

Secondly, real GDP per head tends to rise also – so again, after inflation there is genuine growth. Not as much value is destroyed, and also not as much is spent rebuilding the infrastructure so damaged after a war. So, for me, inflation still remains on the balance of probabilities a relatively likely scenario, not just this year, but into 2022 and for as long as the government and the Bank can keep the narrative “clean”. More cynical than usual – maybe – but who believes in coincidences any more….???

Trying to apply some of that is not easy. It’s been nearly 2 months since we’ve look at the rightmove litmus test – for reasonable comparison I’ve replicated the data from 2 months ago first of all – and then up to the minute figures afterwards:

What we see here is nothing in terms of significant change in SSTC percentages. The 2.1% nationwide index growth for August was unexpected, and shows that only a brief sojourn in July after the first half of the SDLT holiday was enjoyed, before returning to business as usual. 

We need to be careful in interpretation because figures like the above need seasonal adjustment. There isn’t much point in attempting it because the normal seasonal patterns are still disrupted, although I think we could agree that the stock would be expected to be lower after an August simply due to holidays. We see a very small tick downwards, mostly, and so there is an argument that there IS more stock, but the seasons need to change for it to play out. 

This will become more clear in the next fortnight or so, when I will revisit these figures again. Easy street is clearly not there for the agents as yet though, who will still be working very hard to get stock. This isn’t seeming to be the case at auction however – I will directly quote from the excellent EIG newsletter for August:

“However, as with previous months, when we compare July 2021 against July 2019 we see broadly similar values. The amount realised last month was £445.5M – up just £700,000 on July 19, with 2,396 lots sold in July 19 compared with 2,136 lots sold in July this year. Interestingly, it was recently reported by HMRC that private treaty sales were down 62% in July when compared with July 2020.”

The frame of reference being 2019 because of the skew in the 2020 market. My favoured interpretation there would be that stock in terms of lot numbers was down 11% on 2019, so there is still a stock squeeze – however, given the stamp taper, private treaty sales clearly suffered much more (but then there would be many “false completions” pre-July 1st, and then some chains falling apart which might easily take 4-6 weeks to put back together, pushing those into August – so no need to draw too many conclusions.

To compare July 19 to July 21, the success percentage was far higher – so in ‘19, 3306 lots were offered compared to only 2693 in ‘21, making the actual squeeze closer to 19% (by lots offered) – but again, more caution because in June there were actually 8.5% more lots than June 2019. (in May it was a squeeze again, down 20.6%). Then if we look at 2019 in isolation, we saw again far fewer lots offered – so compared to historical volume in auction, we just aren’t back to where we were.

When will the supply come back? Not until everyone has to face the true consequences of the pandemic, including those in arrears with lenders, and debt obligations mean debt obligations again. This is easily 6 months away, in my view………but more on that next week!