So a new year, a new decade, has arrived. What could lie ahead, and how could it impact your goals? In general I try to avoid the news and speculation on this blog. For ease of digestion I’ve condensed down my thoughts on current risks and boons on the financial horizon into this one post. As one man’s rubbish is another man’s treasure I’ve not separated the positive and negative, and any old hack can predict doom, so in a linked follow-up to this post I’ll also offer some ‘Ninja-style’ thought experiments. I encourage you to play out the options in your head, thoughts and comments welcome.
- The whole damned B***it saga is nearly over.
Or at least we can see a light at the end of the tunnel. Is that light a rose-tinted halycon glow of coal-fired power stations and a Wolseley in every council-semi car port? Or is it a bright new future of an independent UK driven by strong economic growth and an embrace for emerging technologies? Is it both? Does it matter?
It is re-assuring that following the general election there was a general upswing in economic confidence in the UK, typified by the surge in the pound (1). But since the heady heights of $1.34/5, we’ve seen the pound whipsaw depending on what BoJo is saying, whether Trump is inadvertently warmongering, and the ECB/ BoE’s machinations (2). My top line take is companies hate uncertainty, and at least the current government will provide some certainty, even if it’s distasteful to some quarters. Whether you’re pro-Brexit like the DIY Investor UK, or anti like TI at Monevator, at least we can all agree that it’s time to get the debacle moving (3, 4).
- World markets continue on an unprecedented bull run
People keep predicting recessions. They’ve not happened. Last year saw gains on the US stock market (S&P 500) of 28% (5, 6). Alright some of that was recouping the losses of the December 2018 ‘correction’, but that’s still massive. In fact it was the best return since 2013, with new record highs.
Help from the US Federal Reserve through cheap cash, and new tech IPOs/ expansion are the fuel for this growth. Trade wars, warnings of global economic slowdowns, Brexit and the inverted yield curve have all been unable to stop this juggernaught. The Stoxx Eurozone 600 also a 23% jump, with the Shanghei Composite close on 22%, and the Nikkei 225 a relative laggard at 18% (6). The FTSE was the only fly in the ointment at 12% (7). Still impressive by most standards. The CBOX Volatility Index (^VIX), a measure of fear in the market where spikes are usually associated with sell-offs, started 2020 well down on 2019. Much of 2019 was spent between 16-22, where fear levels greater than 15 suggest traders think a recession is imminent. 2020 started around 12-14 (8). Traders see people crying wolf about recessions, and are starting to ignore them. Investment through low-cost index funds may have removed the human behavioural volatility from the market, whilst consistent developments in technology and other sectors mean that gains in one area offset slowdowns in others (9, 10). Is the permanent bull charge the new normal?
- Interest rates remain low meaning cheap credit and mortgages
Interest rates were cut in the wake of the 2008 recession, and they’ve remained there and it looks like they’ll stay low for the forseeable future (11, 12). The BoE base rate is currently 0.75%, and didn’t change at the last vote (12). In the US mortgage rates are also falling, though for different reasons (13). This is crap for cash savings, but fantastic for mortgages which due to the ongoing competition in the market, remain at or around record low rates (14). The house price to earnings multiples are also falling, and the combination of cheap mortgages, a bit of government certainty and (slightly) more affordable prices means the number of mortgage approvals is going up (15, 16). For us on the street this means cheaper mortgages and cheaper credit cards.
- Monetary policy is limited by current low interest rate
Interest rates have been kept low over the last decade to continue stimulus (along with quantitative easing) to the sluggish economy. Here’s a 7 minute video on how interest rates influence inflation and public spending as the basis of monetary policy (17):
Low interest rates discourage cash savings and encourage spending (18). But the economy remains beset by headwinds, and at this point in the (supposed) economic cycle we should have high interest rates that can be cut again when the next recession comes. Instead quantitative easing and low interest rates have remained. Where can economic policy go to spur further growth? Some countries have started using negative interest rates to promote spending (19). Most notable is Japan, which has had negative interest rates for decades, with minimal effect on growth (20, 21). Has Japan led the way into a brave new world of shackled economic policy and stagnant growth?
- Flatlining property prices
This could be something to cheerful about, or fearful about, depending on your point of view. Dan at Pursue Fire discussed in this month how house prices appear to have rebounded somewhat since the December 2019 election (22). This is Money also did a useful piece, looking at what different organisations are predicting for the coming months on property prices (23). The general consensus is that house price growth will remain ~2%, roughly in line with inflation. Lots of reasons behind this, which can be broadly summarised as: very high house price to earnings ration (-ve effect on sales due to affordability), low mortgage interest rates (+ve effect on sales due to affordability), government meddling with Help to Buy and LISAs (+ve effect on sales and inflation of prices), government meddling with Buy-to-Let rules (-ve effect on prices through landlords offloading property), changes in immigration including Brexit (-ve effect on house prices in South East due to decreased demand), and the coming of age of interest only mortgages (unknown so far). Bad news for those whose nest egg/ pension is the growth in equity in their property, good news for anyone just starting out or upsizing. All those wannabe property developers better pack up their bags, as the days of 10% year on year growth may well be gone (24).
- Corporate and private debt is reliant on low interest rates
A monetary policy of low interest rates has not only meant cheap mortgages, but also cheap debt for consumers and industry. Those 0% interest credit cards are tempting. So tempting UK household debt has risen 11% in the last two years (25). One could argue that recent lifestyle inflation/ keeping up with Jones’ has been financed with cheap debt, but these stories are never that simple. If you deep dive Hire Purchase (PCP) and ballooning student loans (not low interest rate) are the majority of the story (26). What happens to all this debt if the interest rates start to rise?
Looking beyond private debt, there was some debate in media channels about the rise of ‘zombie firms’ – companies where turnover and profit were persistently low and with high leverage (27, 28). These firms have hung about because low interest rates enable them to survive, whilst in the good old days a recession would have killed them off. They drag down productivity and GDP, crowd out markets and generally stink up the place like a good zombie but with less bitey action. They haven’t gone away and probably constitute 10-15% of global companies (29). The IMF has spoken of almost 40% of the debt in the eight world leading economies would be too expensive to service in a recession (30). These crappy companies and their dodgy debt remain a sword of Damocles hanging over the market (31).
- Many financial products offering high returns or underlying current strategies are untested
There’s a whole raft of financial instruments which can be filed under ‘working now’, promising and at times attaining strong returns, which have never seen an economic downturn. That’s either because they’ve gone mainstream since 2008, or they’ve been developed since then. We’ve got no idea what will happen to them. In this bucket of uncertainty I chuck:
- P2P lending – Connecting those investing with those borrowing with minimal middle men (32). I’ve spoken before about my concerns of default risk in P2P. There’s analyses that suggest P2P resembles subprime mortgages (32). The default rate at Zopa was 4.52%, and 5% doesn’t look unreasonable. The services take a percentage to cover for these defaults, but what happens when the default rates start to rise in an economic downturn. Zopa has stress-tested again BoE modelling, so here’s hoping they’re doing enough (33, 34).
- Buy to let, particularly student flats and hotels – As investors look for returns and the BTL allowances are tightened, those seeking returns have lent on students. Much easier to be a student landlord than a slum landlord. Increasing numbers of students, particularly from overseas, have been seeking better quality accommodation than the traditional damp bedsit. This has driven a property boom, with plenty of agencies helping you to invest in a purpose built flat providing 7-15% returns (35, 36, 37). University cities around the UK have seen massive blocks of flats go up to house students (35, 38). Problem is students don’t want to live in them as they’re too expensive, and there’s now market oversupply (39, 40). I don’t blame them. I wouldn’t want to spend £600+/month for a studio flat with shared kitchen. My student accommodation was £280/month with an ensuite. That’s £300 for beer! So the companies are going under and investors are losing out (41). Hotel room investment appears to be aimed at a similar target market (42). 10% returns in bricks-and-mortar away from the scary stock market. Investment in this sector is growing despite a string of high profile collapses and vague references to ‘ponzi-schemes’ (43, 44). Frankly I file the whole idea under ‘too good to be genuine’.
- PCP car sales – My pet hate, I advise everyone to read the FCA findings and tell me how this is not a car crash waiting to happen (45). Default rates remain low, but commission-based salesman are racing to the bottom of the lending pool. Everyone who wants a flash car has one, people aren’t buying but the pressure for sales remains (46). There’s already talk it could be the next PPI, but people are signing themselves up to this wittingly (47). Even when they admit they don’t understand (48). I’ll stick to my ropey old shitbox.
- Crypto – I’m not even going to try and speculate on that rollercoaster.
The simple answer here is stick to tried and tested financial mechanisms.
- China, the engine room of recent growth, has an untested banking sector
Bit of a funny communist state China. The majority of the banks remain state-owned, and there’s a national culture of saving. They therefore rarely share worries about the sector. Beyond the state banks are ‘shadow banks’, which have funded much of the real estate development in recent years (49, 50). The lending those banks were built on was fuelled and funded by China’s hyperbolic growth. Now that growth is slowing, risky business ventures are failing, and there’s been a spate of bank bail-outs (50). Stress tests suggest this is the tip of the iceberg, with the People’s Bank of China’s annual stability report suggesting 586 out of 4,379 banks are at high risk of collapse (51).
- Green and sustainable technology and funds are going mainstream
The diversification and ease with which individuals can self-invest, coupled with global recognition of the climate emergency, is fuelling a massive growth in green and sustainable funds. Millennials aren’t consulting a financial advisor and then putting cash in an active fund containing oil and tobacco, they’re using Nutmeg or Wealthsimple and selecting green companies (52). It feels like a tipping point has been reached when even companies like Vanguard bow to pressure (53, 54). Growth follows investment, and I hope the pressure will mean a societal industrial shift towards sustainable approaches. Are we seeing the re-invention of our economy, the greatest shift since the industrial revolution?
LATE BREAKING ADDITION:
- 2019-nCoV, a.k.a Wuhan Virus.
To be clear, there are lots of coronaviruses, they are a source of the common cold. The novel coronavirus which emerged in Wuhan is a nasty bastard. I’ve been chatting to my friends who work in infectious diseases and they’re worried. To them it is Wuhan virus, and that is how I’ll refer to it. Why is it so bad:
- It’s seriously infectious – Conservative modelling suggests a basic reproductive number (R0) of 2.68, i.e. every infected person spreads it to 2.68 others (55, 56). I’ve seen less conservative estimates at 4. Epidemic doubling time is 6.4 days. Growth within the population is exponential. For reference most pandemic and endemic infections have R0s between 2-5, including Spanish Flu (57).
- It can be asymptomatic or mild – Control measures such as those used for Ebola, SARS, MERS etc were effective because once someone contracted the infection they became unwell, and they could be separated out and isolated. Their symptoms allowed isolation during the infectious period. Wuhan virus appears to be infectious while asymptomatic, meaning people can spread it without knowing (58).
- It hits the mortality sweet spot – It appears to kill around 1-2% of those diagnosed (probably much lower with asymptomatic cases). Ebola, SARS, MERS etc were all more deadly, but this reduces a pathogens ability to spread quickly and reduces the host reservoir. Wuhan virus kills the old and infirm, at a rate that maintains a large host population (59, 60).
- China has almost certainly hidden the true numbers – People in Wuhan are having quick burials, others aren’t being tested, and the fact Wuhan virus can be mild and asymptomatic suggests the spread could be significant worse than reported (61, 62).
People are already speculating on the effects of Wuhan Virus on the stock market (63, 64, 65). My friends suggest this is the next Spanish Flu, and we’ll see tens of thousands of deaths globally amongst the infirm and elderly (66, 67). We live in interesting times.
So that’s it, and I haven’t even touched on Trump or the Middle East (68). Making forecasts is a fools game, the only surety of which is that you’ll smack yourself for what you said (69). We suffer from huge psychological biases when thinking about the future (70). Is a consistent bull run the new normal, or will we see another great depression (71)? Join my in my next post to think through the options.