aim to be free
money, assets, investment, debt & the economic outlookECB cuts Euro interest rate
The European Central Bank cut interest rates by 0.5% to 2%.
Trichet hinted that no further cuts would be made before March.
The January 2009 newsletter
Interest rates
On the 8th of January, the Bank of England slashed interest rates to 1.5% – to levels not seen since 1694. Anyone on a BOE tracker mortgage or other variable mortgage might want to cheer. We would counsel caution and set aside any ‘savings’ for a rainy day and when we say ‘rain’, we mean a monsoon. These series of interest rate cuts are a sign of panic in the face of the worst recession since the Great Depression of the 1930s. This does not look to be the last cut and chances are we could be seeing another reduction to 1% as soon as next month and even ultimately to 0.5%.
Sterling
The pound has effectively devalued against major currencies such as the Euro by 30%. While the Euro may weaken on the back of expected economic woes and interest rate cuts, most commentators feel that sterling will have to remain weak for the medium term.
Deflation
After warning us about inflation, the authorities are gearing us up for deflation i.e. a sustained fall in prices. Once this takes hold, it has devastating consequences.
For example, the real value of debt (e.g. a mortgage) goes up because income, rents and prices head downwards. Your monthly mortgage payment may remain the same but if rents drift downward then it’s the same as if the mortgage payment has actually risen. People put off purchasing bigger items in the expectation that prices will fall in the future. This becomes self-fulfilling if everyone does the same which will clobber the shops and send unemployment soaring.
House prices in 2008 & 2009
Around this time last year, the Nationwide forecast that UK house prices would remain flat or, at worst, fall by 4%. Last week, they revealed that average house prices had fallen by 16% in one year, which means a 20% since the peak in the middle of 2007. Any forecast made by them or similar institutions should be taken with a sack of salt.
The average sales prices in the auctions are already down 35% off the peak. The sales market has moved away from estate agents to the auctioneers as repossessions are dumped by lenders. The worst hit are the city centre flats. London is also now particularly vulnerable with the loss of jobs expected this year in finance, media and retail. How much tourism and the ‘Olympic effect’ can offset this is open to doubt.
This year, we should be prepared for another 15% drop as the credit drought looks set to continue. Savills suggest a sharp rebound in 2010 and 2011. We fail to see how, unless we move into hyper-inflation. This is possible given the unprecedented scale of government bailout and cash injection – though this is not Savill’s positiona and smacks more of talking up the market.
Savings and investment
With interest rates falling towards zero, savers are almost at the point where they pay banks to hold their money. The stock market was a graveyard in 2008 with falls of 40-70% across world stock markets. Crude Oil fell from $147 to less than $40 as hedge funds scrambled to sell to generate cash and pay off their creditors. While there may be an ‘Obama bounce’ or short term rally, the stock markets are very volatile – it is entirely possible they will fall even further this autumn as disappointment sets in with all governments and we accept that this is worse than the 1990s, early 1980s and 1970s.
That points to perhaps physical gold being a safe haven. Even holding cash in the bank is a smart move when the Warren Buffets can lose 32% in investments in one year. In other words, it’s too hot to handle, unless one really knows what they are doing.
Shock 1.5% cut in Interest rates
We said yesterday that if the Bank of England cut by 1% then it would mean a savage recession, worse since WW2.
Well, they went one better and cut by 1.5%. So it now stands at 3%, down from 4.5%.
What’s our reaction?
This is panic.
It means interest rates are going to fall to 2% (OR LESS) sometime in 2009.
With house prices in freefall (already down 15% this year, with two more months to go) and Capital Ecnonomic forecasting another 20% drop next year……. roughly 40% off peak prices…….. and the banking sector in full retreat,……………… the Bank of England is saying we are close to an economic depression.
Of course it is not saying that in words (and maintaining a stiff upper lip that they are really in control… sure!) but their actions indicate that they are throwing everything bar the kitchen sink at the problem.
Now for the bad news….
a) expect the lenders to act like oil companies when prices of their crude go down… they take their time passing on the costs…… in this case, banks will invoke small print in tracker mortgages and refuse to go below 3% and / or they will up their fees and need for deposits or use the Loan to Value ratios …. and other tricks to ensure they don’t lend sub prime and squeeze what used to be prime… Of course prime is rapidly devaluaing.
b) this is a solvency problem for a lot of big companies, beyond banks… Cutting interest rates implies that this is a problem of liquidity…. Wrong. The credit crunch will continue, after a few days of false euphoria. The big Private Sector is on strike (in terms of refusing to lend) while the Government is cheapening money and offering hundreds of billions to stave off depression.
Who will win?
My guess is that because we have a craven set of politicians, there is little political pressure that can be put on out of control Wall Street and the City of London.
They (as long as they survive, unlike Lehmans) can make a lot of money out of all this. Imagine buying assets at rock bottom prices?
The Bank of England interest cut is about 12 months too late, in the context of mainstream economics.
Why oh why does not Mervyn King resign?
Some traditional values of falling on one’s sword has seemed to disappeared from parts of the venerable British establishment……
Interest rates to come down?
On Thursday, we will find out just how serious this economic slump is.
If the Bank of England reduces rates by 0.5%, then they will send out a signal that it’s just a bad recession.
If they cut by an unprecedented 1% then it means the economy is in serious trouble and possibly in the worst position since the second world war.
Abbey raises rates!
Well, well, well.
Abbey decides to raise its rates by 0.5% a couple of days before the Bank of England cuts rates by at least the same.
0.5 – 0.5 = a big fat zero or what Abbey wishes to pass onto its clients on tracker mortgages.
In the scramble to ‘save’ the banks, the government waived all rules on monopolies, oligopolies i.e. competition.
As it was, the banks followed each other – working virtually as a quasi monopoly.
Now with less around they will do what they want.
How ironic that banks can work against ordinary people just as the bulk of the banking system is nominally in government (i.e. people’s) hands.
Anyone notice how Northern Rock is doing more repossessions after being nationalised?
Marc Faber says we are going into a global slump
Bloomberg talking heads are back with their smiles and disarming comments all intended to get joe Public to use their resources in propping up financial markets.
The interviewer started by saying that the markets have rallied …. i.e. things are all OK again……
Faber’s response: extended laughter.
He has recently been saying that the stock markets are oversold and will have a good run from October to March. However, this is all relative. If the FTSE goes up 5.5% today, that must be compared to a 21% drop last week.
just to annoy Bloomberg, Faber reminded her that the Japanese Nikkei was at 39,000 in 1989 and almost twenty years later is back to 9,500. He also pointed out that many Asian stock markets are still below their levels in 1997, a full eleven years later. Meaning that Western stock markets may not recover for many years. He thought the S&P500 would climb back to 1,000 but still be way below the peak 1500+ only a few months ago.
Today, his main message was the US Treasury bills would ‘be the next shoe to drop’. He forecast that with the gigantic debt now being added for the bailout the rates on US Treasuries would soar ‘2 to 3 times higher’, i,e, from 4% or so to 10 even 12%.
When bond rates go up, their prices go down. So anyone investing in US treasury bonds would see the value of their paper plummet. Faber stressed the ‘medium to long term’. At present he claims to hold 10% in equities, 10% in gold and the rest in US treasuries.
He admits that his equities are down, and that he is ‘relatively happy with gold’, though he sees the gold price falling as people become complacent this winter, incorrectly thinking the crisis os over. In any case, as a gold bug, he would have bought the majority of his gold a few years back at one third today’s prices.
His final point was the US government would be bankrupt one day. He ‘guarantees’ that.
Now, that is significant. While the general public has lost faith in banks, they retain the belief that ‘governments are too big to fail’. I have noticed a few other rightwing financial commentors point this out: governments can become bankrupt. We are seeing that in ICeland, but that’s small.
With the US budget deficit climbing to $1 trillion, we have to think the inthinkable. The US may well be a military superpower but in terms of its finances it resembles Mexico and ARgentina of the eighties – defaulting on its debt.
The clear message is that US government promises to pay back your money will not be ‘worth the paper it is written on’.
Meanwhile, Faber cannot say whether the slump will be deflationary or be stagflationary. The latter is particularly troublesome in that he suggests some asset markets could be deflationary (prices continue to fall – think housing & stock shares) while consumer prices keep rising (think fuel and food).
In this slump, the bottom 50% in WEstern economies will see a dramatic fall in living standards. Ignore the rally in stock markets the next few weeks. It could be a dead cat bounce and fool us once again that the globalised order can look after itself.
Buy-to-lose?
Do the 110,000 novice landlords realise that the buy-to-let game is now up? I guess not. The ground from under their feet is being removed… Northern Rock… Alliance & Leicester… Bradford & Bingley…… yet I suspect many a but-to-letter is licking his or her lips for the opportunity to ‘buy em up’ at the ‘bottom of the market’…..
If you want to play in a casino, if that’s your thing, then you need the cash to buy the chips. With bricks and mortar, it’s debt. The poor man’s hedge fund (just wait to see how a few hundred hedge funds collapse, but that’s another story).
As we enter the mortgage equivalent of nuclear winter, where will the aspiring property entrepreneurs obtain their debt? And on what percentages? Buy-to-let is a very recent phenomenon. The democratisation of property development for some – I prefer to think it was a cruel way of suckering decent people into playing roulette and not realising it was of the Russian kind.
The game is up for the one-property-entrepreneur. The big guys will clean up as they buy properties in groups. Do you remember the days when you could buy one get one free (houses that is) or take over an entire street in some of the worst areas of Liverpool or Salford? Those ugly days are coming back.
One last word: while the smaller wannabes look at the price of houses, do they forget what happens to their position as they themselves lose most if not all of their equity in their main assets?
Property in a capitalist ecojnomy will remain the bedrock of money making and prices will increase. One day. But that’s for the professionals and developers who have been in that game for a couple of decades. They have seen it all before and understand when to jump in and when to wait.
They will be the real winners. Estate agents carry the can for all that’s wrong in the property market. The finger is pointing at the wrong lot.
if this is a little too apocalyptic, have a read of a more short term view on the BTL market below.
This is how the Telegraph sees the impact of the fall of Bradford & Bingley on the buy-to-let market.
“Experts said the sharp fall in the number of buy-to-let loans available will hit the estimated 110,000 novice landlords with only one buy-to-let mortgage because they do not have a portfolio of properties to help cushion the blow of a slowing market.
“Clearly there is less competition – and as with residential homeowners, many buy-to-let landlords will struggle to remortgage,” said Ray Boulger at John Charcol. “Loan-to-value may be a problem, as will rental cover which will be expected to be around 125 per cent of the mortgage as it used to be before the buy-to-let boom.”
In the distant past, buy-to-let mortgage lenders required monthly rental incomes to cover at least 130 per cent of mortgage payments. So if your mortgage payments were £800 a month, you needed to collect at least £1,040 in rent. But in recent years the rental cover demanded has dropped to just 100 per cent, although this trend is now reversing. Most lenders have increased cover back up to 120 or 125 per cent, which makes it harder for landlords to get the figures to add up.”
Our Christmas message
We have not updated this blog for over a month now. The excuses are feeble with the usual one of going off to sunny (or sunnier) spain as the best.
In reality, we have been taking a rain-check.
There seems to be so much clutter around. What the last 18 months have shown is that trust, credibility and analytical ability are at an all time low when it comes to judging financial commentators.
How many financial advisers have put a statement on their website which runs something like this: we got it wrong! Sorry!
how many media pundits, government advisers, City wise men have done the honorouble thing and said they were wrong…. and that any further forecasts should be taken with a sackful of salt?
By the way, AIM-LLP arrived just before the credit crisis started in August 2007. Rather than worry about our short life (institutionally), we revel in it. At least, we are a fully adapted species to the new age that it is upon us. We have occasionally got it wrong regarding specific interest rate decisions, and sometimes come out the wrong end in our individual covered warrant speculation. Experience!
However, we have been consistent in our projections of a sea change in financial and economic conditions.
Our last article about a 45% drop in UK prices is still a little too loony for some, though within the last weeks we are seeing ‘respectable’ groups talking about a 30% peak to trough drop in UK house prices. Some of those august bodies could not see beyond a 10% decline….. all those months ago, when the credit crisis was something that would be over by Christmas.
Remarkably, that’s what they said about the First World War too and four bloody years later the world had changed, empires had fallen and new ideologies had taken hold.
We see the convulsions in the financial markets lasting a lot longer too.. Years rather than months. One down, three to go?
So if you are considering your position, here’s some of the highlights:
- UK house prices down 45% and don’t expect a quick rebound for years
- the crucial financial sector takes a body blow with job losses worse than 1990 – tens of thousands definitely and some more too. The stock market dives to 3,500 too……
- Cool britannia (as the Olympic organisers hope to brand us, to cover up the lack of funds) is passe and we don;t mean just the media – we mean the global bankers and fund managers who will put their eggs in other baskets such as in Frankfurt, Singapore and Tokyo
- A vicious recession in the UK that will be worse than the 70s (forget the early 90s) and draw some comparisons with the 1930s…. though….
- this time it will be different. Manufacturing was clobbered in the demented eighties…….. now the South, basking in the glory of the ‘knowledge” or service economy will bear the brunt as the debt hangover takes hold……
Naturally, society will continue to function and 80% will still have jobs.
UK PLC will remain one of the world’s leading economies.
Unfortunately, it will have lost its lustre and look with trepidation into the next two decades, wondering what it has in the locker to compete in the tough world. Even the unspoken prop of North Sea Oil is being removed as the UK becomes an importer just as oil becomes scarcer (we expect a short term drop of oil to below $90 but a medium term rise to $150 and beyond)…
In all crises, come opportunities. For entrepreneurs to adapt to the ‘stay-at-home’ economy. Take away rather than a la carte etc etc.Internet over retail stores….. repair, recycling and renewables…..
It also offers us time to reflect on the bribery of the electorate (cheap council houses and masses of debt) in return for the rich to become super rich. And what do we have to show for it? a broken society?
Perhaps a modern green, just vision might have its place, after all, once we have admitted to the folly of the last couple of decades…….
so our Christmas message comes early. Why? Because the retailers are already waiting for the Chinese cargo ships to arrive, sending our toys and knicknacks to warehouses. This year, the warehouses will bulge with stock not keen to leave. After all, one reason the UK official stats did not show a negative figure (only zero) was because stock piled up. The other was that imports fell quicker than exports.
The retailers fully realise that they can not sell you a Happy Xmas, like years gone by. This December, consumers will start becoming people (in small steps & hesitantly) and find ways of cheer and joy, without more debt and stuff.
The operative word is hesitant.
People are still piling up new credit card debts – to pay the mortgage in some cases. And there were long queues to buy the 3G iphone, so expect this to be a long drawn out affair of an unravelling consumer economy.
So to enjoy a decent Xmas, start cutting up the plastic (at least those extra ones), manage the expectations of family and friends about what Santa is delivering and think how you are going to maintain just one resolution in 2009…. Saving, if you are lucky to retain your job – many won’t.
And, when you pop into your local bank, tell them to stop selling you products (cards, mortgages etc). Remind them you may have to prop them up some day, as some banks get into serious difficulties in 2009……… ‘only’ $500 billion has been written off globally. We expect the final figure to be $2,000 billion or $2 trillion by the end of 2009…. how do you think that cuddly bank is going to fund its balance sheet? Many won’t. The second leg of the credit crunch will make its presence felt before Santa pops around and warn us of a bitterly cold 2009.
You have been warned.
Uk house prices could crash 45%
Noticed how everyone is changing their tune. A flat housing market is giving way to a ‘shallow’ drop. Now the penny has dropped and the numbers are becoming larger.
With the British Chamber of Commerce survey of 5,000 businesses out today, we now know we are in serious risk of a recession.
Well, use real inflation figures (not the cosmetic official ones) and we are in recession now. Spending has been financed by credit cards. Increasingly, people are even using credit cards to pay their mortgage. How dangerous is that? Using short term debt (at high interest) to pay long term debt. The Third World Debt crisis (of yesteryear) has now arrived in UK PLC.
Commentators are now pencilling in a ‘worst case scenario’ of 20% drop in residential house prices by the end of 2009. Well, does the world end on December 31st 2009? What about 2010 and 2011? Do house prices miraculously shoot straight back up? Afraid not.
One member of the Bank of England’s Monetary policy committee let the cat out of the bag when he suggested the property market isn’t ‘coming back’ into strength before 2018…… a full ten years away.
Let’s encourage such longer term perspectives, including looking back. Unfortunately, too many people believe the credit binge of 2001 to 2006 was normal. It was not, and it’s not coming back any time soon, if ever.
We all agree that American house prices are crashing. They are down 17% from the peak of 2006 and looking to drop to 25% or more.
At what level should UK house prices be? Let’s be old fashioned and compare mortgages to earnings.
The house price to income ratio in the UK used to be just over 3, i.e. mortgages about 3.2 times above income. That moved to 5.5 times in 2006. Way, way out of kilter.
The snapback has barely started. For the ratio to return to its long term average of 3.2, house prices in the UK would have to drop 45%. In other words, the £300,000 ‘asset’ collapses to £165,000.
Why not? If it can triple from £100,000 to £300,000 since 1996, it can also get back to some sane level.
Always remember Japan. In Tokyo, house prices declined 70% in fifteen years, after 1990. We find it difficult to understand how so many people ignore the japanese experience. After all, it is a richer, more sophisticated economy than UK Plc (especially if one is more impressed with hi-tech manufacturing, rather than the witty inventiveness of City boys producing more ‘investment paper’, rather than electronics). Despite the long era of deflation, Japan remained one of the world’s largest economies. There was no blood on the streets.
If it can happen there, it can happen here. The UK residential market is absurd and depending on a vibrant financial sector…..
Q: which is the most vulnerable sector right now? Financial sector.
Which shares would you least like to own? Banks and housebuilders.
Which two sectors does UK PLC rely on the most? Finance. Followed by? Housing….
It makes us wonder how people think one should get into debt to the tune of £350,000 to purchase a terraced house in, say, Barking, in Essex? Many did. A 45% drop would bring that house to £193,000. Massive negative equity for a decade or more.
What’s the engine of growth in that area? Used to be Ford car plant (one of the largest) in Dagenham. That went years ago. Now, it’s the destination for commuting workers to the City…… But not much else. So what happens when tens of thousands of jobs go in Canary Wharf and the City? A sharp drop in demand for housing and a collapse in the local economy (restaurants, clubs, nail salons, estate agents, mortgage brokers, clothing stores, furniture shops, consumer electronics……..). As an aside, perhaps betting shops and (some) pubs, pawnbrokers and repair/maintenance outlets will thrive.
You can multiply this scenario up and down the country. And while there won’t be ‘blood on the streets’, it will be a lot messier than Tokyo (think social cohesion, nasty politics and crime).
Japan shows that even during deflation, and imploding asset prices, life does go on and some companies thrive. Just remember, it won;t be the financial sector for a decade.
Which means the engine of growth for London (and therefore UK PLC) is about to stall, with a dramatic change downwards. A whole generation of ‘get rich quick’ property owners are going to be ruined as the banks leave them high and dry. You may not agree today though we are sure you will next year.
The problem is, we cannot figure out which sector is going to replace finance and housing to provide jobs and keep the economy afloat. Once manufacturing jobs and factories fly abroad, it’s next to impossible to get them back. So what is it going to be?
House prices back to 2005 level by Xmas?
Nationwide were reassuring people that despite the 2.5% drop in May, house prices on average are still 10% above that in May 2005… three years ago.
We could look at this in another way. Since the Housing Minister, Caroline Flint, inadvertently let us know that “at best” prices would be be 5% to 10% down this year…. we could plausibly say that in a more pessimistic case, house prices could be 12 to 14% down by the end of 2008.
That would mean that roughly house prices would have returned to those last seen three years ago. Which is another of saying that a whole bunch of people who bought since then are at risk of falling into negative equity.
And then there’s 2009 to come with even more drops to come. We should not be overly surprised since prices in California, Florida, and Nevada have plummeted 25% plus in 12 months. While markets are different, the lesson from the US is that what goes up can come down. The UK housing market is not in a crash, yet. But you can see the ingredients for one.
aim to be free 