We begin today’s Weekly Roundup with housing.
- Prices are already falling in nine rich countries, and the Canadian market is already down 9%, Sweden 8% and New Zealand 12%.
UK prices are still rising (albeit more slowly than recently) although official figures are released two months in arrears.
In the US, mortgage rates (typically a 30-year fix over there) have hit 6.9%, the highest since 2002.
- With borrowing capped by the monthly repayment, purchasing power is down 33% in a year.
But this doesn’t mean that the US is in for a repeat of the 2007 crisis:
The country has fewer risky loans and better-capitalised banks which have not binged on dodgy subprime securities. Uncle Sam now underwrites or securitises two-thirds of new mortgages.
Which means that taxpayers will be as hard hit as homeowners.
- State insurance schemes underwrite defaults, and the Fed owns a lot of mortgage-backed securities, which fall in value as rates rise.
Other countries could fare worse, particularly China, South Korea and the Nordics.
The Economist identifies three factors to predict where there will be the most pain:
- Recent price growth (higher equals riskier)
- Borrowing levels (the UK is not doing so badly here)
- Speed of pass-through of higher interest rates to homeowners (the inverse of the average fix period)
A gummed-up property market means lower labor mobility and a stodgier jobs market.
- This is bad news under current labor conditions, but a recession next year could mask the worst of the impact.
The Economist predicts that a 20% fall in prices (greater than is predicted) would mean that 5% of mortgages (and 10% in London) were in negative equity.
And of course, lower house prices will hit consumer spending, making any recession worse.
- And as homeowners in countries with short-term remortgage fixes (and this includes the UK), we might see houses dumped on the market, making things worse.
UK rates (for five-year fixes) are now above 6% pa.
In housing corrections, and sometimes for years after, home ownership rates tend to fall, rather than rise. Economic conditions that cause house prices to fall simultaneously imperil the chances of would-be homeowners.
Unemployment rises and wages decline. If interest rates jump, people are able to borrow less and mortgage lenders tend to become more skittish about lending.
Depressed prices might sound like good news for disgruntled first-time buyers from younger generations, but higher interest rates (and lower boring limits and affordability) could keep homes tantalizingly out of reach.
From an investing point of view, profiting from a fall in house prices is far from straightforward.
- I will give it some thought and perhaps come back with an article on the topic.
In the FT, Madison Derbyshire and Joshua Oliver reported on data from JP Morgan showing that retail investor portfolios in the US fell by 44% from January to 18th October.
- The explanation provided is that PIs are overweight growth stocks, whose valuations fall as interest rates rise (because their cashflows are weighted further into the future).
We should also mention raging inflation and the determination of central banks to kill inflation by rising rates until we have a recession.
- But the US index is only down around 20%, so that’s not the whole story.
JP Morgan also notes that PIs are on their longest weekly selling streak since 2016.
- But the volume of selling has not reached that of March 2020, perhaps because people remember the Covid rebound.
Here in the UK, many investors will have been protected by the fall of the pound (and almost every other currency) against the dollar.
- Interactive investor (ii) says their clients have lost an average of 12% this year.
JP Morgan also noted a switch from stocks and active funds to passive trusts, and ii backed this up.
The Economist also looked at why inflation refuses to go away.
- Spending is too high and interest rates have been too low, but things have changed.
The IMF has three reasons: shocks, wages and expectations.
- Covid messed up production and the reaction was a lot of fiscal aid.
- Consumption shifted first to goods and then back to services.
- Commodity prices went up, driven partly by Russia’s invasion of Ukraine.
- Fed rate hikes have led to a rise in the dollar, exporting inflation to other countries.
- Lockdowns constrained the labor supply, driving up wages.
So what happens next?
Much depends on what happens to inflation expectations—a third and unpredictable inflationary force. People’s beliefs about the future affect their consumption and wage bargaining.
If recent experience looms large in the formation of these beliefs, that would help to explain persistent inflation, and would complicate central bankers’ jobs.
The newspaper is not optimistic about interest rates:
Having been fooled and fooled again, central banks will not relent until the only
inflation surprises are those on the downside.
Bank of England
John Authers looked at a speech from the Bank of England’s deputy governor, Ben Broadbent, who is responsible for monetary policy.
The bottom lines are that the UK economy is in a very nasty place, and that market expectations for the progress of interest rates are too high.
The first is no surprise, but the second helps to explain the weak 0.5% rate hike from the BoE the day before the ill-fated mini-budget.
Inflation and import prices mean that real incomes have fallen.
The volume of output may have just about recovered to pre-Covid levels but its consumption value has note.
More interestingly, the BoE has very conservative calculations on how large the increase in interest rates needs to be in order to deal with:
- the weaker pound (stronger dollar)
- the inflationary impact of the energy subsidies (which free money to be spent on other things)
This is why the BoE didn’t think a 75 bps hike was needed.
- Broadbent also made it clear that a base rate of 5.25% (as predicted by the markets at one point) would mean a severe recession.
He was also clear that lower levels of fiscal stimulus from the government would mean lower interest rates were needed.
It will be interesting if the Fed sticks to its guns and the BoE raises rates by less.
- Lower gilt yields and lower sterling are the obvious implications.
Shaun Richards of Not A Yes Man’s Economics looked at the same speech but was more critical.
That is a pretty extraordinary intervention even for a loose cannon like Ben. After all if Bank of England economic models were reliable we would not be here would we?
It would have seen the inflationary episode on the horizon and allowed us to respond with higher interest rates. Instead seemed to think that prices night be falling now.
Shaun took the speech to mean that the bank thinks that it’s too late for interest rate rises.
- This might be the case, but if the same model also said last year that it was too early, that’s not so great.
Ben ignores the main player right now which is that other central banks need to match the US Federal Reserve. He will do the minimum and I do not expect it to be too long before his thoughts head towards cuts in interest rates.
In one sense this would be good news, but I’d like to see the Fed come to the same conclusion, and that might not happen for some time yet.
In FT Adviser, Amy Austin said that DB pension transfer values have fallen to record lows.
- This is bad news for my household, as we have a DB pension due to start in around two weeks.
Values were down 8% in September, and have fallen by almost a third during 2022.
- Transfer activity is low at present at 38 members per 10,000 per month.
The transfer value index is run by XPS Pensions and their spokesman Mark Barlow commented:
Pension scheme members considering a transfer will be impacted as values fall to their lowest level for almost 20 years. On the other hand, those using their transfer to secure benefits in alternative arrangements, for example annuities, will see marked improvements which may offset some or all of the fall.
He’s not wrong, but annuities remain at terrible value – my break-even age for getting back the annuity price in payouts (ignoring the opportunity cost of growing the money by investing it) is over 90.
Link Fund Solutions (LFS) has been put up for sale by its Australian parent company Link Group.
- The UK subsidiary is being investigated (and likely fined) by the FCA, as well as being sued by lawyers acting for disgruntled investors in the Woodford Equity Income fund whose winding-up it supervised.
Link had previously indicated that it was unlikely to underwrite the fines and compensation (perhaps £50M and £306M respectively) that the FCA has warned it might impose on LFS.
- This FCA warning also led to a bid for Link – from Canadian firm Dye & Durham – falling through in September.
- D&D has since returned with a revised bid which excludes the UK business.
It’s understandable why Link would like to dispose of LDS, but who would want to buy with the fines hanging over it?
I have three for you this week:
- Mauldin Economics was Turning Bullish on Energy
- UK Dividend Stocks asked Is GSK a Good Choice for Dividend Investors?
- And Alpha Architect told us two Mind the Momentum Gap to Improve Performance.
Until next time.