A slight change in focus can produce a profoundly different understanding

Somewhere to Live

You cannot go wrong with property seems to be the confirmed narrative in the UK. The experience of 1988-1994 appears to have dropped from the memory file. The experience of other countries may also not register. Things change and the past is no guide to the future. Understanding the nature of this narrative might help those that have or are inclined to invest directly in property.

The most common direct property investment is to own a home. There is no capital gains tax and the implied payment of rent (to yourself) does not involve HMRC. In order to own a home however most must employ leverage. They put down a deposit (equity) and borrow the rest. The loan is secured on the property ( a mortgage) and the lender registers a charge on the property with the Land Registry. You don’t really own it until this charge is removed. The leverage is what makes direct property investment seem so attractive.

If you put down a deposit of 50k and buy a property that costs 500k you are very leveraged. If property prices rise by 10%, equity rises to 100k. That is a 100% return. Of course if property prices fall by 10%, the equity falls to zero. But of course property prices never fall do they (1988-1994) and in any event so long as you service the debt (pay the interest and sinking fund on the mortgage) you can keep living there and paying yourself the implied rent. The problem is that in a world in which property prices have fallen by 10% other things may also be going on. One might be unemployed or have to pay a much higher interest rate. The base rate in October 1989 was 15%.

If you have 50k to invest in stocks and the market rises by 10% the equity rises to 55k. Not so exciting because you have not leveraged. You could leverage by signing up to a spread betting service which allows you to bet on equities using margin payments. The latter is regarded as ‘risky’ and ‘speculative’ but apparently doing the same thing through direct property investment is prudent. After all property prices always go up don’t they? The same could be said of equity prices in the long term. The point to take from this is that with a leveraged investment you are taking a risk.

Another aspect of the direct property investment narrative is that there exists a housing ladder. Compare two properties one costing 500k and the other 1m ( a London flat versus a detached home in London). If you buy the flat hoping to trade up later how might this work? Assume you have 50k as a deposit. To buy the flat you need to borrow 450k. To have bought the more expensive property you would have needed to borrow 950k. Now assume property prices rise by 10%. Your flat is worth 450k and you have 100k for a deposit. The more expensive property now costs 1.1m. You now have to borrow 1m in order to buy it. How did buying the flat help? Assume property prices fall by 10%. Your flat is worth 450k and you have zero equity. The more expensive property now only costs 900k but you have lost your equity so have nothing for a deposit. Once again how did owning the flat help?

The key to trading up is income and income growth. It requires that income grows fast enough to enable you to get ever larger mortgage debt. At 5x gross salary you would have needed to be earning 90k per annum to buy the flat. Perhaps joint income would have reached this and the lender liked you. To buy the more expensive property you would have needed to be earning 190k. After property has risen by 10% you would need to be earning 200k. So to trade up you would need to have seen income growth of more than 100%. In your dreams maybe. The assumption of 5x salary is generous by the way.

Median income in London is 35k. The average price of a flat is approximately 500k and the average price of a terraced house 750k. The average price of a detached house is approximately 1m. The numbers simply do not add up. Incomes in London are obviously too low to justify the level of house prices. The reason is partly that the averages include a lot of properties at silly prices owned by people with silly wealth. But this does not adjust the ratios sufficiently. Try finding a one bed flat for less than 350k. The other explanation is that landlords have acquired many properties and are letting at attractive rents. The rental on a one bed flat seems to be about 1300 per month or 15600 per annum. That is a yield of 4.5% on a 350k one bed flat. This makes more sense.

House prices, in London at least, are being driven by rental yields. Take home pay is 27180. So for a single person the rent alone is 57% of take home pay. Does not leave much for all the other expenses. For a couple it is half this which is more manageable but it does beg the question where do single people live? And what of those earning less than the median? The rental yield also looks to be unsustainably high. And the housing economics for half of Londoners look to be brutal. Where does this end?

If it is left to a market solution then it will eventually sort itself out but the ‘equilibrium’ might not look socially acceptable. Low paid workers will either find themselves living in squalor or migrating out of London until wage relativities compress a bit. If we leave the EU there could be quite an adjustment depending on how we leave. The BoE has said that it will raise interest rates in response to a supply shock and that is what leaving with no deal could bring. The arithmetic of buying and letting cannot cope with a jump in interest rates. Tenants cannot absorb higher rents and demand may well drop after Brexit. But why is property being left to an unregulated market solution?

Water, energy, telecoms, financial advice, etc all have regulation. There seems to be little regulation of the ‘somewhere to live’ sector, yet it is an essential social need. What regulation there is seems not to be effective or enforced. One would have thought that something that takes over 50% of disposable income and cannot be avoided should be regulated as a high priority. The fact that many of those that might promote regulation also profit from it, is coincidence of course. Indeed why is public provision of ‘somewhere to live’ not up there with education and health. It is hard to maintain health or benefit from education if you are living in squalor and spending half of your disposable income on rent alone. There is something very wrong here and it needs to be addressed immediately.

My preferred solution is a national housing association. This would be non-profit making in the sense that there are no distributions to shareholders but would be self financing. The purpose would be to ensure adequate supply of ‘somewhere to live’ near places of employment. The implied reduction in commuting would also ease pressure on transport services as well as the quality of existence. This would take a while to become fully effective so the sooner it is put into place the better. It comes with the ideological principle that ‘somewhere to live’ near ones place of employment is a social right and not a privilege and indeed is good for society. In the meantime more enforced regulation of private property rentals is essential with rent caps. As I grew up the term ‘Rachmanism’ entered the OED. It was not a compliment, yet today I see it is rife and people take pride in being successful slum landlords.

The reality is that the first property you buy will also be your last unless your income rises. So, buy carefully. If you want to invest there may be better ways to invest in property that offer more liquidity. There may be better assets in which to invest. The right to ‘somewhere to live’ is increasingly on the agenda and will impact property investment in the future. Socialisation of housing is fast becoming a policy reality once again.

Postscript 23 01 2019

I have just read that Sadiq Khan, the present London Mayor, will make rent controls a key plank for his 2020 re-election platform.


Brexit Poker

Parliament has signalled that it is not terribly keen on May’s withdrawal agreement. In my blog ‘Or, No Brexit At All’, I expressed the view that leaving with May’s agreement is the most likely outcome. Oddly, despite the defeat, I still think it is the most likely. The opposition is united on what it does not want but quite disunited on what it does want. It is in this disunity that May can snatch victory from defeat. And she seems to be playing quite a good game of Liar’s Poker.

The strategy is to push the time to the limit. She repeats her commitment to leaving on March 29. She repeats her determination to deliver the Brexit the ‘people’ demand. She pays lip service to cross-party co-operation. She will win the vote of no confidence because no one is interested in a general election. There is no mechanism for a second referendum unless May proposes it and Corbyn supports it. There is no material amendment to the withdrawal agreement that the EU can offer so cross-party talks cannot achieve anything. The DUP will not yield on their position on the backstop. The ERG would be happy with a crash-out with no deal. It is a game of poker where crash-out and her deal are the cards.

The assessment that May has made is that rather than crash-out, parliament would choose to leave with her agreement as the basis. This will require a number of sceptical Tory MPs to swallow the backstop. This is not a bad gamble by May. The electoral consequences of having been seen to acquiesce in a crash-out will be severe. Then there is the implied the threat of a referendum if all else fails. This too will have negative electoral consequences for the Tories. May is gambling that Tory MPs put self-preservation above the interests of the country. It is a good gamble and formed the basis of my original blog conclusion. The question is who will blink first?

The ERG prefer to crash out and the DUP have a fixed red line on the backstop. These votes will not be won over for May’s deal whatever the circumstances. All other votes are up for grabs. She need only take it to the wire and let no deal or ‘my deal’ be the option facing parliament. The blame for no deal will not fall on her. She has fulfilled the terms of the referendum result. She has nothing lose. Parliamentarians have career defining decisions to make. She is betting they will put career before country. It is a good bet. The only hope for any other outcome is to make another referendum the option to crashing out. But with May still at number 10 it seems impossible to achieve this.

Social Problems are History

The cry from Bob Geldof was ‘make poverty history’. He meant, of course, confine it to history. Yet poverty is history. There is no phase in the history of any known society in which poverty is not present. The definition of poverty does of course vary over time and context and this may confuse the issue. Yet take any society at any point in time and the chances are you will find poverty according to some definition. This does not mean it should be ignored. It does mean that confining the concept to history as Geldof seemed to be demanding is not going to happen.

The same might be said of crime, and in particular, violent crime. Poverty and crime are ever present in the history of humanity. There is periodically an attempt to link them but it should be obvious to everyone now that there is no link. Rich people commit crime and often when they are already rich. They may be better at getting away with it but they are quite capable of criminal activity and their motive is not the need for bread. A percentage of every population, rich and poor, seems to be drawn to crime.

In London we have a media frenzy about knife crime at present. One could be seduced into thinking it is a new problem or that it is a new trend. I would be more convinced if the history of recording crime and collecting data was consistent over time. I would be more convinced if the history of media reporting of such crime was more consistent. I have lived in London for the best part of 65 years and can say with confidence knife crime is not new. Moreover, I am not sure it has even increased recently once you adjust for the population growth. There is an ebb and flow to all types of crime and knife crime is no different.

The media report lots of concerned people pontificating in some vague way on the causes and solution to the recent ‘surge’. Apparently it is rooted in childhood experiences and deprivation. Really? A large number of young people from the same communities experience the same childhood and deprivation but only a small percentage go on to commit knife crime, or indeed any crime. Crime is fairly constant in society give or take a percentage or two. It has been addressed by different people in different societies across time but it is still there. It is our attitude to it that seems to change rather than the fact of crime.

Violent crime, and in particular knife crime, seems to have similar origins to some other risky behaviours, notably drug taking, sky diving and even skiing. It delivers a ‘buzz’ or more precisely some release of chemicals that has positive mental effect. The buzz most likely comes from a sense of being powerful, at least for a moment. In my generation large boys frequently got this buzz from fighting and punching people. It was partly dealt with by getting them to do it in a boxing ring. The solution for knife crime probably lies in a similar response. One needs to deliver a buzz to these young people in a more socially acceptable way. This may be where we should be focusing our search for a solution for many socially undesirable behaviours.

In my career I came across individuals driven by making money. It did not matter how much they already had or what they had earned the previous year, they felt down if they earned less in the current year. It was quite disturbing to observe. They had no sense of ‘enough’. Making money was a buzz. I often speculated that the buzz came from the sense of power that earning a lot of money can deliver. It led to progressively more and more risk taking and on several occasions jeopardised the institution. In 2008 it jeopardised the whole system but it came close to doing this many times before. Society has taken measures to damp such behaviour but the buzz seekers are still out there and will find a way.

The conclusion that I have come to is that buzz seekers are part of our social structure. They are always there and will seek the buzz whatever the situation. The solution is to identify those with a predisposition to need a buzz and to seek it, and to provide socially acceptable ways to meet the need. Repression will not work. It will merely divert the behaviour. Gyms are full of people that need this buzz and find it through exercise. Others jog, ride horses, climb mountains or ski. Others still take drugs, gamble, commit violent crime. Is it this simple? Maybe not but I wonder how a brain scan of someone committing a violent crime compares to, say, a sky diver. My suspicion is that if you want to wean people off knife crime you need to provide a socially acceptable alternative behaviour that delivers the required buzz.

I am aware that knife crime may be associated with drug dealing and gang association. But both are also ‘buzz behaviours’. The general point is that a number of behaviours attract people because of the buzz they offer and not because of the intrinsic nature of the behaviour. A percentage of the population will always need this buzz. If we recognise this and provide it in a socially acceptable way then we have some chance of minimising those behaviours that we do not like.

A Tale of Two Britains

Two articles in the digital FT appear juxtaposed such as to scream ‘A Tale of Two Britains’. The first, ‘Working but homeless‘, highlights the plight of employed (mainly young) that have nowhere affordable to live. The other, ‘Bull markets need fresh blood‘, speaks to the concern of people (mainly older) of how to generate income from assets. If there had been one about the plight of pensioner landlords then the set would have been complete. What struck me as most interesting was how the articles seem to speak to separate worlds, different countries, and most certainly, different realities.

There is full employment in the UK. It had been relieved by EU workers moving in but that process is now going into reverse. Getting a job is not the issue for the young. Finding somewhere to live that is affordable and close enough to the place of employment is a big problem. The failure of the benefits process designed to assist the working poor has made matters much worse. Housing benefit is no longer fit for purpose and this has rendered many working poor homeless. There is something seriously out of balance when employed people cannot afford somewhere to live near their place of work. Commuting is not a solution since what is saved on rent is lost in commuting costs, pecuniary and non-pecuniary.

Meanwhile, in a country, far, far, away, old people with homes containing large amounts of equity, and with liquid assets, struggle with the new found responsibility for deriving an income from such assets. The demise of the defined benefit pension and the collapse of annuity rates (largely because we will all on average live longer) has thrust the older generation into the rentier class. Many of these rentiers are life long Labour voters that still mouth the usual contempt for rentiers apparently unable to grasp that they too are now rentiers. The lucky ones have defined benefit public sector pensions so have been bailed out by the tax payer but still have the audacity to rail at the rentiers.

The two stories are connected by the missing article about landlords. One response of the rentiers to the need to generate income was buy-to-let. A new class of amateur landlords has emerged. These are often people using rental property as a means of generating income in retirement. These amateur landlords have scooped up the very properties in which the first time buyer might normally have expected to start their home. The first time buyer is now a renter and subject to market rents. There are not enough affordable properties for rent where there are jobs. This is the failure of housing policy.

Blame has typically been placed on everyone but the Ministry for Housing. Yet what is the purpose of such a ministry if not to formulate and implement a housing policy? And what other primary objective can there be for a housing policy than affordable homes near jobs? The Tory government has left the solution to market forces and ignored the huge externalities involved. It has divided the country between property owning and renting classes. It has created a new rentier class. It has created a class of working poor and homeless. There has been a redistribution of wealth from the young to the old.

Two new policy initiatives are desperately needed. The first is a state backed national housing association. This should have as an objective the provision of homes near jobs. This is a complex problem since jobs wax and wane in specific localities. It is however a problem with several solutions and there is plenty of evidence from successful states such as Germany that it can be managed. It will require innovative ideas and a new attitude to property ownership but is clearly required. The second is a state backed national pension provider. This reflects my oft expressed view that the best way to deal with externalities is to set up a state backed entity to compete with market based responses. The state institution can set the standard and the private sector can either match it or cease, leaving provision to the state.

The end result of my suggestion may well be sole state provision of some services but importantly it does not eliminate market solutions where they have a role. The same approach could be applied to say banking or energy provision. Set up a state owned energy provider and compete. Customers will either move to the state provider or not. Similarly, set up a state bank (convert NS&I) and compete. This is an alternative to nationalisation, the favoured method of the marxist.

There is a huge potential for state enterprises to compete against private enterprises. The state has the advantage of tax-payer backing for finance. The private sector may, as is often claimed, be more efficient. Making the two compete will evolve into the optimal structure. Typically one or the other will dominate in a sector. And policy is set through the corporate objectives of the state provider. Nothing is nationalised. Nothing is banned. Yet the state sets the tone.

Living in No Man’s land

The Mental Health Foundation notes that people from black and minority ethnic groups are more likely to be diagnosed with mental health problems, are more likely to be admitted to hospital after diagnosis, are more likely to experience a poor treatment outcome, and are more likely to disengage from health services. This seems to be true among a diverse group of ethnicities so we can probably exclude genetics and culture of origin as an explanation. The common factor is being a minority or as I prefer to style it, living in no man’s land.

Ethnic minorities are classified according to their ‘country of origin’ yet they may have little knowledge of, or association with, that culture. It defines them as different and the host community will treat them as different. Quite often the discrimination is subtle but it is designed to make one profound point; you are not as entitled as I am. The discrimination is made worse by the narrative that it is the ethnic minority citizens that are to blame, because of their refusal to integrate*. Integration is a two-street. You must also be allowed to do so. If you are constantly reminded by the host community of your lesser entitlement, full integration becomes impossible. You are forced to think in terms of your ‘country of origin’. You are unable fully to identify with the country of residence or the country of origin. You live in no man’s land. Herein lies, in my opinion, the source of the exceptional mental health experience of this diverse group.

Identity is central to good mental health. It does not matter to which school of psychology you subscribe. They all highlight the importance of having an integrated sense of identity for good mental health. The corollary is that the absence of a well-defined and integrated sense of who you are will leave you vulnerable to poor mental health outcomes. This is particularly concerning at the moment as the Brexit situation is likely to heighten the sense of living in no man’s land. It will also increase the numbers that find themselves in this lonely mental state.

In a previous blog ( Brexit and the Children of the Empire) I offered an explanation as to why many ethnic minorities that originate from the British Empire chose to support leaving the EU. What I did not say was that I thought they were seriously mistaken. The host community will not ever regard them as fully entitled as long as they can be identified as ‘other’. They will be more vulnerable in nationalist Britain than in the liberal pluralist democracy that is the EU. It requires only one member of the host community to deny their entitlement in order to generate a sense of unease and push them back into no man’s land, and there are many that will do this.

The problem is not unique to the UK nor indeed are the English any worse than any other species. A sense of entitlement by the host community is universal. Governments may welcome immigrants for sound economic reasons but the host community will still deny full entitlement and they will do so across the generations as long as the mark of difference is visible. Meanwhile, migrants and the subsequent generations will be subject to greater mental health stresses than the host community.

The problem will get worse. The planet seems to be experiencing large migrations for economic and political reasons. These may get worse as climate change forces ever more populations to seek a life elsewhere. The nationalist model of organisation is ill prepared for these developments. The mental health of ethnic minorities is likely to deteriorate further and is not going to be the priority of nationalist governments. What is the solution?

There is nothing we can do about nationalism or migration flows as individuals. We can however influence our own mental states. Recognising ‘what is’ and accepting reality is a good start. Perhaps we have to find a sense of identity that does not stem from stereotypes of ethnicity, family, job etc. This will not change realities of discrimination but it will enable you to confront them with a stronger sense of self. When a stranger asks ‘where are you from?’ it is rarely a question. It is usually an accusation. I now reply, planet earth.

I have taken a much greater interest in wildlife in recent years. The issue of climate change is one of my priorities. The report of large amounts of water on Mars impressed me. Alternative energy stories grab my attention. Such subjects help integrate my sense of self as a Citizen of the Planet. There is a community of people that think this way and this community offers a strong sense of identity. It is healthier than living in no man’s land and might help the planet as well. What have you got to lose?

*A previous blog, Rethinking Identity, explores how identity is implicated in the exercise of power

The case for a second referendum

There is a general clamour among the Remain community for a second referendum, also styled a ‘people’s vote’. The arguments used are numerous and varied but typically invalid. The first vote was indeed flawed but this is now irrelevant. It was parliament that ultimately approved the triggering of article 50 and we are a representative democracy.

The opportunity to express a different opinion came in 2017 but it was declined by the electorate. The three parties committed to enacting Brexit achieved over 84% of the votes cast. Once again our representative democracy confirmed the original referendum result. Many Labour Remain voters seem surprised at this assertion but there is no doubt. Page 24 of the manifesto begins with:

Labour accepts the referendum
result …

There is nothing in the manifesto to suggest this statement is ambiguous. Read it for yourselves

So what is the democratic case for a second referendum? Parliament it seems may struggle to follow through on its commitment. The Withdrawal Contract agreed by the Prime Minister is unpopular with most. Unless she can persuade parliament, it will be rejected when the vote is taken. This will result in an impasse. It could lead to to an exit without a withdrawal agreement. Parliament does not wish this and there is no evidence the majority of the voting population wish it. Another possibility is that the whole Brexit project is rejected which seems to contradict the referendum, and parliament on two occasions. The only way to resolve this is to ask the people again.

It is possible to delay departure in order to hold another referendum. The referendum would now have something concrete on which to vote. It can have three options; the negotiated agreement, no agreement, no Brexit. The voting population is now better informed than it was in 2016. Another referendum would be decisive. In this respect it is the only hope of bringing the country together and this is perhaps the most compelling case for another referendum. Whatever the outcome no one could argue against the result. The country could move forward and cease this self-destructive pseudo civil war. Far from dividing the country, only another referendum has any hope of uniting it.

Brexit and the Children of the Empire

The Leave vote appears to have included a substantial number that can trace their origins in the UK to the British Empire. Certainly the Tory party includes a few Euro-sceptics that trace their origins to the Empire, including the present Home Secretary. Originally this puzzled me. It meant an unholy alliance with people that might well once have (and maybe still are inclined) discriminated against them. A child of the Empire myself, I found this to be a conundrum. The resolution of this conundrum may lie in the nature of identity.

In psychology identity is something you give to yourself. It is clearly bounded by the willingness of others to accept your identification but this still leaves a great deal of agency. If you push beyond the social boundaries of course then you enter the mental health space, which is another story. The Children of the Empire are those that can trace their origins to families born in the Empire when the British Empire, in its arrogance, declared all in the Empire to be British. I was born British to parents that were also born British. The trick was to move to the UK before the relevant bit of the Empire gained independence and before successive UK governments introduced legislation to remove this Empire anachronism. There are a large number of British people that might look foreign and not have Anglo-Saxon names but are such Children of the Empire.

Over the generations the Children of the Empire have come to see themselves as British, like the English, Irish, Welsh, and Scots. Not all in he latter groups necessarily accept the Children of the Empire to be as entitled as they but, under law, they are fully entitled. Moreover, they have integrated and earned their entitlement. The Mayor of London and Home Secretary are both Children of the Empire (according to my definition). They have come to see themselves as British and their link to the past is also British. They were part of the British Empire. They are not Indians, or Jamaicans, or Kenyans. They are Children of the Empire and fully British.

Along comes the EU and Freedom of Movement and a new identity; European. The Children of the Empire are not typically ethnically European. The new European identity has disrupted their carefully crafted British identity. They may well have felt some resentment at White Christian Europeans suddenly having the same entitlement. They may also have found these Europeans a little racist. However, the emotion goes much deeper than this I suspect. There is a sense that the influx of Europeans into what has become a European state has undermined their ability to identify with their home and country of Citizenship; Britain. Ironically their identity needs the British Empire to not be forgotten and to be applauded. It is thus natural for them to be drawn to Empire nationalism and the Leave mentality.

The epiphany for me came last month when I realised that I was in an almost unique position. I am a Child of the Empire and European. Only two former colonies (ignoring Gibraltar) are EU states; Cyprus and Malta. There is no conflict of identity for me. Indeed the accession of both Cyprus and the UK to the EU resolved an identity conflict for me. It made the UK European. This is probably why I am so emotionally unsettled by the UK leaving the EU. It is also why we should be a little kinder to those Children of the Empire that have opted for leaving the EU.

Annuity v Drawdown (again)

The annuity v drawdown debate seems to go on with no reference to what is actually available in the market place. In the UK, at the moment, it makes little sense to consider an annuity. Drawdown offers a better prospect provided you do it right of course. So how might this work? Let me consider the case of a 65-year-old retiring with £131k. She can take 25% tax-free in either annuity or drawdown space so there is (almost) £100k left to invest for income. She must either choose a compulsory purchase annuity or drawdown (or some combination of the two).

Checking typical annuity rates it seems one can buy a CP annuity of £3.2k for £100k. This escalates with RPI and has a 5 year guarantee. It is a single life. A joint-life would yield even less. This means that if she dies after 5 years the annuity ceases to pay out and the capital sum used to buy it goes to subsidise those annuitants that still live. This risk pooling is of course the basis of insurance. Purchasing the annuity will inevitably involve costs, usually up front.

In contrast one could move into drawdown. This may also involve upfront costs. There will be a platform fee for the institution managing the drawdown. If she dies before 75 she can bequeath the residual value of the fund to any beneficiary tax-free. If she dies after 75 the beneficiary can receive the income at their marginal tax rate. Valuable IHT benefits. The big question is what income and what risk?

The FTSE 100 is yielding 4.74% on a trailing dividend calculation. It promises £4.74k, over £1.5k more than the annuity. Of course this is not a guaranteed income. Dividends are often reduced but, typically, grow. Moreover, they will, over time, at least be expected to keep up with inflation. The FTSE 100 index may of course fluctuate considerably but since we are only concerned with natural income, the dividends, the market value of the portfolio is not necessarily relevant. You would not sell the annuity so why would you sell your FTSE 100 investment? You have invested for income.

The key variable of interest is not the volatility of the index but the volatility of dividend payments, if one invests solely for income. Strangely, I have been unable to uncover data for absolute dividend payments on the index. The dividend yield is volatile but this largely reflects the volatility of the index. My personal experience is that absolute dividend payments on the index are not that volatile and do indeed tend to trend up over time. Of course you have to take the index for what it is. It contains alcohol, tobacco, arms, and oil so not wholly ethical. It is presently offering you £1.5k more than a comparable annuity, and the option of leaving your fund to some one outside of the estate.

What about Brexit? Well FTSE 100 is an index of stocks that list on the LSE. Not all do their business in the UK. In fact most of the earnings that drive dividends are generated outside of the UK and so benefit from sterling weakness. It is not necessarily harmed by Brexit and, in so far as it is, the market has had time to digest the worst case Brexit outcome. The FTSE 100 stocks are not typically growth stocks. They are dividend paying value stocks. The £1.5k income premium (46%) over current comparable annuity rates seems quite a cushion for what are not obviously huge risks. Then there are the IHT advantages. Finally you can always go from drawdown to annuity but doing the reverse is not so simple.

Buying a low-cost FTSE 100 Index fund in drawdown makes considerable sense compared to buying a UK-based CP annuity. I doubt any IFA would offer you this view. However, it seems to me it is for IFA’s to refute this observation. This should be the starting point…


Economic Forecasts

It is very fashionable to knock economists and economic forecasts. The Bank of England is coming under some pressure again for its attempt at estimating the costs of Brexit under different assumptions. We have graduated from project fear to project hysteria. If economic forecasts are so useless why is so much effort devoted to producing and reporting them? Why do they figure so prominently in public and corporate policy? The truth is they are not useless and indeed they are not even forecasts in the popular sense.

Economics is about understanding how the economic system operates. The focus is not on the future but the present. Applied economics tries to answer a lot ‘what if’ questions using the accepted economic paradigm and mathematical statistics, also known as econometrics. It is a difficult exercise and subject to quite a lot of manual adjustment. The objective is not to forecast the future but to gain some perspective on how the system or sub-system will evolve given assumptions about ‘independent’ variables. The forecasts are simply simulations. At some point someone from America called these simulations scenarios and it stuck (I hate the term).

So how useful are economic simulations or forecasts? Henri Theil*, an econometrician, defined the usefulness of forecasts in term of the quality of decisions to which they lead. No one produces forecasts in isolation. They are produced to inform decisions. In order to judge a forecast one needs to compare the decision reached without a forecast to one reached with a forecast. Unfortunately this comparison is strictly speaking impossible as we cannot simulate life. We can normally only make a specific decision once. His definition does however focus on the purpose of such forecasts. They are designed to help people make important decisions.

The various estimates about the cost of Brexit under different scenarios are designed to aid decisions. They have been constructed from established economic models. These models may be ‘good’ or ‘bad’ but they are not biased. They inform the government, parliament, and the ‘people’ of the potential costs of exiting the EU under different arrangements. They should be judged on whether they help these parties make better decisions than having no attempt to estimate these costs. In the latter situation we merely have different groups asserting what they wish people to believe. If leave campaigners are believed then leaving the EU is the first step to heaven. The reason they disparaged ‘experts’ in the referendum campaign was because they knew that any expert analysis would uncover the high economic cost of leaving the EU. The corollary is that being in the EU is beneficial to the UK in economic terms.

The mendacity of the leave campaign was in some sense inevitable. It is unlikely all of the leave voters would have so voted if they had understood the economic costs to them personally. It was important to the leave campaign that they deflect voter attention from expert testimony. However, the chickens have come home to roost. The price of bigotry and xenophobia is now clearer. It is a high price. Some are still willing to pay it. Others may well have qualms. Given the new information and, more important, willingness to listen, a second referendum is a democratic imperative. If the fully informed decision of the people is still to leave then so be it. However, it is likely that fully informed with these forecasts many will make a different, and dare I say better, decision than before.

  • *Applied Economic Forecasting, H Theil, North Holland, 1966

Equity Markets 2019

It is that time of year again. The pundits look into their crystal balls and try to guess what will happen in the markets next year. I have no idea where equities will end up next year. However I have a good idea what levels they may visit. Some say it is in the stars. I suggest it may be in the charts.

US 500_20181126_07.18

The above is the latest chart of the S&P 500 futures, monthly. It maps a Fibonacci retracement from the last dip to the long-term trend line which dates back to the start of 2016. As you can see the 61.8% retracement coincides with this trend line. This establishes the parameters for a fairly standard market adjustment. Below we can see divergence in the RSI from a very overbought position. The momentum down is strong. Wherever we end up we will almost certainly visit the trend line in 2019.

Is it really that simple? Well sometimes it is. It is conceivable we get a ‘Christmas’ bounce which lasts into January but I suspect it will not be very pronounced on this occasion. The Federal Reserve is set on an interest rate ‘normalisation’ path and nothing is likely to deter it. Bond yields have risen and will quite probably continue to edge up. Trump’s trade war is creating uncertainty and ultimately we know that trade wars are bad news for everyone. The decline of fossil fuels, so long a huge component of the industrial complex, is continuing in the background. We have a come a long way since 2009 and the market has barely stopped to draw breath. It is time to take stock, as it were.

The situation is reinforced by the fact that it is not obvious that any asset classes offer good prospects in 2019. Even cash is problematic. The loss of the too-big-to fail tag for banks means that deposits over insured amounts are just unsecured loans to banks. It is a risky asset that offers a not very attractive return. Government bonds (outside of the eurozone) have better credit characteristics but of course with bond yields edging up market-to-market losses are likely. The great asset price inflation may well be over for now.

The one market that might do relatively well is, ironically, the UK. The Brexit fiasco has seen cash pulled out of sterling assets. The Brexit fiasco is coming to a close and provided we get either a negotiated exit or no exit at all, there is scope for some catch up. However, if we crash out with no negotiated exit then there a may be a little more downside. A negotiated exit looks most likely despite the parliamentary arithmetic. It is unlikely parliament will allow a non-negotiated exit and if forced it will probably opt for another referendum.

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