Thinking long term NOW

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“You can’t build a long term future on short term thinking” - Billy Cox

Welcome to the Sunday Supplement, and this week gets into a phenomenon that is typical at times of extreme stress - a lot of thinking I’ve heard in the past week or so whether it be at the macro or micro level has been relatively short-term. Property investment, and indeed any investment, is a long-term game and many a warrior who has trod the path for decades will tell you that dodging the bullets on the way to the exit is often the way it feels. Not always, but memories of less volatile times are fairly shaky at the moment.

Everyone knows where we are at the moment. Putin’s Russia is seeking to reinstate the glory days of the old Soviet Union (if there were any) and indeed beyond that. Time is moving forward and the West, with its tail well between its legs after Afghanistan’s botched withdrawal, and, we can hope, a more 21st century attitude to war given the track record of the past 50 years, will in general be a fan of that. Why? Sanctions get time to bite harder. Economies that more than double their interest rate overnight do not have good times ahead of them. The noose is around the throat, and the logistical progress of Russian forces tells us a little about how far, or not, Russian wartime tactics have moved in the past 75 years. 

Every day the war goes on the expected length goes up by more than one more day - one day could be worth another 1.2 days. There is a warchest built up to withstand economic pressure to some degree but if the Russian state tries to fight the global capitalist markets, it will be ravaged just as the Bank of England were in the 90s when the withdrawal from the ERM came. George Soros’ counterpart today (or indeed, George Soros himself) will be the primary beneficiary. The current administration look ill-informed enough to make the same mistakes that have been made time and again by regimes who believe they can overplay their hand. What happens as the war goes on? From a selfish rest-of-the-world perspective, the longer Russia is focusing on Ukraine, the weaker they get and the more a probability of a larger and even more bloody conflict decreases. This may sound cynical but this is one reason why many countries are very willing to provide the smaller and weaker nation with weaponry to prolong that war. I accept this is the complete Hobson’s choice scenario - and again don’t seek to make value judgments, but I do seek to be pragmatic.

The natural reaction when there is a threat to life is to focus on what’s right in front of you. Surviving until tomorrow takes precedence over everything else. I certainly share an anti-war stance but not the approach of the pacifist. As a tool of last resort it absolutely needs to be there to deter the bad actors in the world. This is the epitome of short-term thinking, and current trends are, at times like this, short-lived, aggressive, and occasionally nonsensical.

There’s a further nuance right now however and I touched on this last week. Just as early on in the pandemic, when there was really significant uncertainty around what would happen next, I speculated that the death of one of the G20 world leaders would likely change the game even more. Not long after that, Boris was in intensive care (although not intubated). Had that turned out differently, just imagine the difference that that would have made to the UK pandemic response. This is not a better or worse conversation, just a conversation about how different things might well have been.

A war on the back of a pandemic absolutely has that potential to exacerbate the problems within an already fragile economy, and introduce some new ones as well. Notwithstanding the above around the longer the conflict, the less likely the world war, a spillover conflict or incursion into a NATO country would be the event on the back of the last event, with no real time to have recovered from the last event.

There has also been plenty of coverage around sanctions and the depth of them, and also criticism of all countries that are doing any sort of trade with Russia. This is a tough one to swallow - primarily because hindsight is 20-20, although I accept that since the annexation of Crimea that more care could and should have been taken. This is the reality of today’s world however, especially with economic pressure at record-high levels on many metrics - when I heard during the pandemic that 90% of the US’ prescription drugs were made in China, I was surprised nothing had been done about this. Reality dictates that the fulfilment price available in China was the most attractive. Whether this balance has been addressed in the interim I do not know, although as I understand it the iPhone is still made by FoxConn which has a larger production base in China than in any other country (it might surprise a few to realise that around 40% of all consumer electronics sold globally are manufactured by FoxConn, however, so Apple definitely don’t carry the can here on their own). The straightforward choice is to pay a lot more for an iPhone or to continue to work with FoxConn, and, as Apple are a little more responsible than some of the other big tech companies, one would assume they’ve done the work and realised what would happen to their bottom line if the iPhone doubled in price but retained the same margin!

Germany certainly looks irresponsible here with such a large proportion of their resources coming from Russia. The flip side would suggest that a Russia which was cut off from the West could become more hostile and has, perhaps, been better kept closer than it otherwise would have been. Keep your friends close and your enemies closer? After all, why do you think so much of the Western intelligence has been so accurate? Hence it is relatively hard to swallow some of the aftertiming that seems to be going on in parts of the media.

The point around the problems on top of problems cannot be laboured enough. The Brexit referendum result was deemed more significant to the UK economy than the current war situation, by the markets, at the time. You might agree or disagree with that, but that is what the case was. This had a 2-2.5% bump effect on inflation in relatively short order - however, as we were bumbling along at or below target before that happened, that inflation could be relatively easily absorbed by the economy. I remember being stunned by just how easily that inflation was absorbed, and a decent amount of the shock was borne by the suppliers. It made very little difference. This is the nature of the situation when there are few or no underlying issues - I recall saying at the time that a problem on top of a problem, after the referendum, would be dangerous. Luckily, we skated onwards until the dawn of 2020, mostly. 

I’ve also referred back to the roaring twenties a number of times over the past two years. Primarily because post-pandemic behaviour has been relatively uniform in its effects on certain factors in the wider economy. However, I’ve not made the point before that the roaring twenties is as useful as your average phrase that refers to an entire decade - in reality, when you go to bed on 31st December 2029 and wake up on 1st January 2030, nothing changes any more than a normal night. Black swans don’t check the date before they land, wreaking havoc wherever they go. The reality of the 1920s - of interest because there was of course the “Great War” (an oxymoron if ever there was one) followed almost immediately by the Spanish Flu pandemic. Indeed there is a school of thought (A Trumpian one, to be clear) which suggests the Spanish Flu “ended” WWI. This is an incredible stretch, and often it is not credited even as a factor for ending the war, which seems overly harsh on the other side of the debate - I would suggest it would be reasonable to consider it in the melting pot. The point is - the War ended and the pandemic had already begun. It took over 2 years to reach its three peaks in terms of its waves across the globe, and finally diluted just as Covid-19 has done to become endemic and the “father virus” of many viruses to come, including Bird Flu.

Following the pandemic phase, there was a significant struggle in economic performance, inflation, unemployment and other key metrics, until around Q4 1923. It was then the roaring twenties really got into gear, between 1924 and 1928 - before the start of the great depression in 1929. So in reality, half the decade at the most was truly roaring. 

The behaviours I expect to see (and on a timeline basis, the timings could be similar but we need to understand the true scale and implications of the Russian incursion firstly) include a large rise in consumer confidence, resulting in borrowing and consumption increasing, but we could be waiting some years for this if the 1920s is a fair yardstick. 

The big differences include the unemployment rate right now in comparison to the early part of the roaring 20s, double digits (indeed, the highest ever rate of unemployment in the UK was in 1920) versus around 4% currently. Market behaviour is similar to how it has always been - look at the Crypto markets over the stimulus period, versus other periods of mania - whilst some argue that “this time it’s different” - that saying really doesn’t have a great track record - so I see no argument for not looking at the plethora of post-pandemic data that is available over hundreds of years and the impact on economic performance in the decades that followed.

The most significant impact on the level of the individual that tends to repeat itself after a pandemic is the capital versus labour arm-wrestle. Devon Larratt is not needed here to understand that after a pandemic, historically, the labour side of the battle has drawn the most blood. Investments tend to underperform compared to historic returns, and wages tend to rise compared to historic returns as workforces shrink. In ye olde days, this was simply down to unwanted population control more than anything - these days, the stimulus packages, near-death experiences and glut of fearmongering have persuaded some that participating in the labour market is no longer worth it, and for many others changed the way in which they want to participate it in. So, there are fewer fish in the pond and more demand for jobs to “build back better” or equivalent. Simple supply and demand economics, ultimately.

This translates into higher than ever wages for city workers, particularly in financial services, which is bearing itself out in the US data quite clearly. People don’t want to go through the Port Authority to get to Manhattan island from New Jersey - so salaries on office-based FS jobs are screaming upwards because the big bosses want everyone back in the shiny office buildings where the concertive control of the strong culture can bite once again. Rank and yank; get em in and burn em out, when they do, bring out the dead and get some new blood. Labour costs go up; capital returns in a struggling world go down as returns struggle to hold steady, overall.

It would be fair to conclude that I’m predicting we will see a lot of the same longer-term results that we’ve seen after previous pandemics, but for different reasons - although not as different as they might seem. Often, economic history has the answer. We have struggling GDP, inflation, unemployment and potential stagflation on the horizon alongside long-term challenges on productivity and the fertility rate. You could argue Modern Monetary Theory has had its first test in the pandemic, and the taste of the stimulus is addictive, the pure crack cocaine of the system - the rest of the hierarchy has desperately introduced cold turkey as quickly as possible, but some of the potential outcomes of the current conflict have “taps back on” as the dominant strategy or perhaps I should say as the least worst outcome available to the policymakers.

We then need to consider the ballooning in public sector employment since 1-1-2020. Many of these jobs will close back up again, and pressure will be on to cut budgets as numbers don’t add up and the incumbent party go back after its grass roots support to try and stay in power when the next election comes in a touch over 2 years from now. Unemployment does have an organic trend upwards as these contracts come to an end throughout 2022, I am sure 10% of those employed since Covid will be kept on for some time, perhaps even decades, as a pandemic response or insurance; but 90% will be back either in the private sector or the metaphorical dole queue (clicking the universal credit website refresh button, perhaps?)

So this is where my crystal ball is clearing and revealing that word from above, stagflation. Growth looks difficult after the pandemic bounce. Inflation is not under control nor will it be via the changes in monetary policy. It isn’t coming from the traditional tradeoff between inflation and interest rates. Raising rates WILL cool the economy but with very little natural growth in it anyway, this is a high risk strategy. It will not sort out the supply chain issues, nor will it stop the upward pressure that there will be on wages when the energy price hikes actually get here. 

Which sector(s) of society are in good shape? The super-rich? Naturally, darling. The bottom 20% - no, never, almost by definition. Asset owners have done OK in the past couple of years. Some blue collar workers are getting large pay rises, even double digit percentages, for new starts. So where’s the squeeze? The bottom of the pyramid as we’ve said - but after warchests built up in 2020 disappear thanks to 2022’s inflation, what then for the middle classes? Problems ahead - there are a few years to go yet before that happens, pending the inflation numbers for the rest of those years anyway…….and just think, who is having a well-below inflation increase to their fixed incomes? Pensioners, that’s who. Forget them and you get hung out to dry at an election. 

So are the supply chain problems working their way through? There is some indication that some of it has. More importantly the very weak base effects - where the numbers started - are almost worked through the pipeline. Still - with Brent Crude hitting $118 a barrel with a ceiling of $150, $200 or beyond - all depending on the conflict - logistics, farming, workers who travel, food - everything gets hit and it all moves in the one direction the West cannot really handle at the moment - upwards. We are not at the 54% seen in Turkey this week in terms of inflation - but it is ugly.

Energy bills are forecast to go further and further as the Russia/Ukraine situation deepens. Luckily they are not a huge percentage of household bills, but they do impact all the aforementioned items as well - so we could be talking another 200 basis points on inflation if we are not careful. I am not there yet, but there’s a material possibility, now, of hitting 10% this year. 

Fragility, danger, and then legislation - who’d be a landlord? Well, a few long term reality checks in the face of the short-term danger:

• Hard assets are excellent during times of inflation
• Real interest rates are negative 2.5% at the moment or thereabouts for limited company borrowing. Borrow at 3%, inflation at 5.5%. If you can match inflation on any equity needed that might be OK in this situation, and most are looking at a 10% absolute minimum ROCE I would hope
• Rental stock is still dwindling
• EPC and other legislation nooses are tightening - driving more people away from the sector
• Housing stock is still thin on the ground - more next week but the market is still tight, and demand is still solid
• Stocks are extremely volatile, and other large investment markets are at least as fragile as the property market, if not more so.

We don’t invest for tomorrow morning. We invest for the long term. Repeat after me, 10 times before you go to sleep, if you need to. If not property, then what? Until next week…..