Sunday Supplement – The future, macro & energy

Quite a week, in one way and another. Sunday is here and I feel like there are 10,000 words I could easily write regarding what’s going on at the macro-economic level, potential consequences, and then energy performance and energy prices. But time, both mine and yours, is limited and so I have cut it as much as I can whilst still trying to get the major points across. Enjoy.

Firstly, after being bullish when others were busy predicting the sky falling from mid to late last year, to cautious whilst many were announcing record growth and a great re-flation, to more bearish in recent times, I’m now at the place where I believe there will be a major event in the stock (and, perhaps more likely, bond) markets in the near future. However, the near future might be 18 months away still – the pace of recent events and swings thanks to the pandemic makes it feel like it is closer than that, but I wouldn’t go crazy shorting too much just yet. The music hasn’t stopped – but the music is playing, ignoring some problematic factors that simply cannot be ignored. Part of the problem is TINA, as I’ve alluded to before – in the US, stocks look expensive, bonds look expensive, and the shorter term path of interest rates is upwards (not a lot, but a bit) – in the UK the path for interest rates looks a little faster (at this time, although I think when we see 0.5% in perhaps the middle of next year, there will be a spectacular stall and perhaps even calls to drop back to 0.25%, even though I think the Bank will resist this at all costs if they can get back to the heady heights of the 315-year low from 2009, which feels miles away from the 0.1% from last year). 

When the music stops, no-one knows. There’s normally many more rounds whilst a lot of people pretend that there’s nothing to see, before a trigger event – Lehman being the most obvious, but all good crashes have a trigger event. Wood prices have doubled again from the august bottom (working from November futures), although that will only be half the May peak in price – but there may be more to come. Crude has rolled on despite a few pullbacks and looks set for $90+ by year end which won’t help. $100+ per barrel looks highly likely in 2022. The price at the pumps on top of the recent “bumps in the road” looks worse than I can remember and despite September’s inflation coming in below expectations at 3.1% (get your head around that!) – means October’s inflation is almost guaranteed to be up on that.

What I’ve also found fascinating is that there’s new life in the inflation argument. Not the part about it being transitory – very few would disagree there are significant transitory factors at the moment. It is the longer-term path that is more questionable than it has been for some time. The argument to now has largely been that there are so many long-term deflationary pressures – population/demographic shape being one of them, which is still the case (but with the “bump” from the baby boomers working its way through those at retirement age, it will arguably be less than it has been over the past 20 years), production advantages (crippled at the moment by struggling to deliver stock in a timely fashion, cost effectively, basically anywhere!) are under stress, globalisation is potentially in reverse (at minimum it is currently stalled) – some of this is likely to lead to longer-term inflation, depending on how it plays out. Deflationary pressures are not guaranteed to win this arm-wrestle depending on nationalistic politics apart from anything else. 

This, however, is largely a distraction. I’ve been as guilty as anyone of being distracted by it – whereas the bigger issues remain. How much genuine growth is likely? EU membership and free movement, whilst a political football, carried with it overall economic benefits even if you do accept the arguments around suppressing wages (which, right now, look to have more than a little anecdotal evidence in their favour). Reports of people leaving care in droves – somewhat down to mandatory vaccinations, somewhat down to poor treatment and social status and minimum wage offering an easier life for the same money, if anecdotal evidence is to be listened to. 

We know we want and need growth for a healthy capitalist system to survive. Many a study puts up to 3% of global growth annually down to globalisation. When we have some real, non-pandemic affected numbers to work on, it might be too late. We can ill-afford 0.3% growth to be lost, let alone 3%. We could turn to productivity as the major metric, but this has been anaemic for the last decade in the UK. We need the Keynesian methodology, often (falsely) credited as the architect of the demise of the UK economy in the 1970s, to work this time round – although I see no appetite at all to REALLY be Keynesian and “fix the roof if the sun is shining” – i.e. stop running a deficit. That looks like a pipedream in this parliament and into the next, whoever is the victor at the next election.

Of course inflation is important. We WANT healthy inflation (none of which we’ve had for 15 years, in my view, aside from an occasional 6 months or so). We are also interested in it, as investors, because of the effect that it has on interest rates. I’ve laid out above what I think the current most likely path is for rates – and wouldn’t be doing too much panicking just yet. I can’t see us above 1% before the end of 2024 – simply because we didn’t get there between April 2009 and December 2019, and we were much less fragile then – so a big rise is still nearly impossible and it would still nearly bankrupt the economy. We have advantages in being a larger economy and watching what will happen in the smaller countries that cannot carry such large deficits because the credit reference agencies will “out” them far too quickly if they even try. 

So in short – I’m losing no sleep about interest rates at the moment. Longer-term, healthy, quality economic growth – I am. How do you hedge against that? Look at solid local areas. Similar to always – good projects. Projects that are disproportionate to the local population size. Industries that are in massive need of infrastructure improvement and have a commitment to them basically guaranteed. For example, energy……

An easy segue into the second course of today’s efforts. Energy. We’ve had the “fuel crisis” – what fuel crisis – pass us by. Prices have rocketed as a result. We’ve got a much bigger issue in the pipeline though, and it is one that we’ve been looking at closely for several years, but more closely in late 2020 and early 2021. The looming EPC situation.

One piece of correspondence I had missed in my early year review was the consultation entitled “Improving home energy performance through lenders.” Another page-turner, of course. The spoiler alert is that the preferred response is to require all lenders to have a portfolio of mortgages with an average of “C” by 2030. This is quite interesting, when you break it down. Rightly or wrongly, it is far easier for the government to regulate against the buy-to-let sector (or the PRS housing providers that use leverage, perhaps more accurately) because the landlord voice is weak and has no friends, publically anyway, anywhere.

So if by 2030 all your buy-to-let lending is at C and above (and some will be at B and A – new build, some flats, etc. etc.) then this will help with your averages…..perhaps making buy to let more attractive to lend to than older stock in older areas. It looks like, other than that, it is of limited relevance to BTL if the regulation is going to make it unlettable anyway. There could be some nasty “mortgage prisoner” situations – listed buildings? Buildings that cannot achieve above a D/E/F anyway because of their construction and/or overall architecture? Perhaps some grenades to look out for there.

Let’s get some other key facts on the table here. Left hand is still a mile away from talking to right hand here. Heat pumps and the £5k incentive being back. Oh, Bravo, I hear you say. Tarquin and his pals can upgrade their detached home in leafy (county) village which otherwise would have to be on oil or LPG, and (particularly at current prices) can save a fortune by spending the 13k or so to change the rads, pipework and system to an air source heat pump solution, getting 5k back and saving perhaps £1500 a year on their heating bills. The other 97% have no need, use or chance of making the numbers work.

Oh well, what about the landlords? Another epic fail, I’m afraid. For 8 years at least there has been plenty of coverage that EPCs NEVER recommend a heat pump or ANY other renewable solution for space heating.

But wait – that’s not it…….

The even larger point (well, it SHOULD always be the main point, although I am learning more and more with renewables that it really isn’t) is that the heat pump is an absolutely typical government policy. Textbook. Straight out of the top drawer. Why? Because it treats the symptom, not the cause.

Let’s get into that. The government are not utterly stupid at every level, of course. Far from it. They are just short of architects. Not the very well qualified, technical drawing, creative ones we are used to – but the type that private sector businesses tend to have. The ones who understand it all. If you amend something in function A, in the business, it will impact functions B, C D and E here, here, here and here, and also impact the customers here, and here. 

Now don’t worry. I’m not writing this with the hands glued to the keyboard in some kind of sympathetic move to the faux illuminati of Insulate Britain, but we should recognise that they are largely correct in their domain. It is their implementation tactics that are the issue, in my view, where they miss the mark so very badly. The cause is the leaky homes – spewing out heat in an incredibly inefficient manner.

This is why it has hit the top of the government agenda when considering COP26, and also more importantly the net zero carbon target of 2050. They’ve gone after the largest sources of emissions, and heat from homes is one remaining biggie. Cars have already been addressed (on a silly season/quiet week I’ll have a pop at how the electric car, current tax darling of the government, will be turned on its head in one of the great taxation reversals of modern times) – so homes come next. What can YOU do, Mr or Mrs consumer? 

Does the EPC targeting address this, directly? Well, no. It is better than nothing from the central government standpoint, but it has no weight on emissions at the moment in a primary way – only by default. One solution that makes a massive difference but hits in the pocket is external wall insulation. This works – although it is not without its problems. One of the best solutions that is never recommended (go figure) is INTERNAL wall insulation – but needs evidencing to the EPC assessors when they visit. The other “big point” solution is solar panels (and generally, I’m a fan) but the scoring system allows them to consume or spew out/waste all of that extra energy generated, because it is measuring “energy performance” which, when you scratch the surface, is not the same as how well insulated the house is and is only 60-70% correlated with emissions.

So what’s the answer? A new “energy emissions” certificate? Please, no. Should we be looking at the environmental impact rating that already exists, that no-one discusses, on the certificates? Maybe. As it goes, with the choice of the two to look at, the beautiful irony is that we are most probably looking at the wrong one of the two, if emission control is the goal. Having said that, I haven’t looked into that in detail. 

To fix the problem as it is currently stated, solar looks like the answer. However, it isn’t really the answer. It would fix the current problem of not having enough sources of supply, and is more reliable than wind, although imperfect when heating system demand is highest in winter when daylight hours are fewest. It would fix the letters on the certificate, is really all it would fix – if it was backed up by a battery backup system it might also help with the probable impending electric car boom – the system also is not currently reflected on the certificate of course.

You could read the above and think “well, the whole EPC thing desperately needs an overhaul”. Like many government schemes, some have been calling for this for years, since implementation almost. Is this clear, and is it guaranteed? I don’t think so. It certainly would make many think twice before smashing into too many renewable solutions, even if they did have the money or could get the money back via grants, other payback (e.g. higher rents) or lower mortgage costs – which at the moment they certainly don’t.

There’s plenty of mileage in this yet – and this is before we even consider the reverse redistribution argument – it is already the case that more expensive areas tend to have houses that score better on EPCs, so if you are to effectively stealth tax the houses with lower ratings, this is likely to be regressive. If landlords have to pay, there could be an accelerated sell-off in a sector starting to feel supply pressures already – or tenants will also foot 60%+ of the bill. Certain swathes of the country, where rental stock is much higher than the national 19% (or so) are of course the cheaper areas which will become the least viable, for rental, in the fastest time. 

What could be done there? Well, of course, the local authority could step in, backed by central government funds. They could almost be quite predatory here – if an evil genius hard left government were in power, you could regulate to bust the private landlord and buy the stock in cheaply, for example – in the sort of areas I am talking about, even in the private market you can buy at 50% of rebuild value (especially October 2021 rebuild value)…..I feel the UK has for the next decade or so (at least) rejected such a government and so won’t lose too much sleep over this one either.

However, we are still miles away from even framing the problem correctly, let alone the solution. The “50% grant” never works as it is only the large organisations, that charge 100% more anyway, that go through the hoops to get things done. Tales of not being paid for the suppliers will keep smaller organisations at bay. Watch this space for more updates as this car crash unfolds in real time. If you aren’t starting at the EPC on your new purchases, and also working out how to REALLY do it rather than 80% of the correct measures which are currently listed (the best 20% are generally not in terms of bang for buck) – you need to be.

Until next week…….enjoy…..