There was an interesting piece from James Mackintosh in the FT on Saturday, where he acted the grim reaper for equities. He observed (and I paraphrase here) that if we recovered and interest rates went up, the appeal of equities relative to gilts would collapse, whereas if the economy did not recover, current dividend levels were unsustainable, and so, therefore, equity prices would also decline. His final rider was that the only way equities could sustain their current healthy position would be if the current, non-sustainable muddle, were to continue for the next few years.
Meanwhile, Merryn Somerset-Webb in the FT also predicted the collapse of London house prices which, she said, with a great deal of justification, had only been held up compared with the rest of the country by foreign cash.
After reading those two pieces yer average sophisticated investor might be wondering what on earth he or she COULD do with their money.
Well, my response would be, keep calm and carry on. The flaw in Mackintosh's argument is in his final paragraph, where he says that the only way that equities can carry on rising is if the current temporary muddle continues.
But, as all poker players know, the short-run is always longer than you think. And what Mackintosh does not explain is how, or indeed, why, the current "unsustainable" situation should not continue until there is absolutely no alternative. Indeed, what we now have is a strong argument for the muddle continuing even longer.
That argument is just a mite technical, but that does not make it any more forceful. You may recall that the Treasury is planning a raid on the surplus funds built up by the Bank of England during Quantitative Easing. Those funds are not "permanent". They would have to be given back as QE was unwound. What the Treasury and the BoE claim is that it doesn't really make any difference, except in accounting terms, where that surplus is kept.
But in fact (and the Office For Budget Responsibility makes just this point -- possibly to the great irritation of the Chancellor) that difference "in accounting terms" is of great significance. What it means that if, under the old regime, the BoE put interest rates up by 1%, then that would make no difference to the government's headline budget. However, if it takes those gains onto its own books, any rise in interest rates of 1% would bash the government's borrowing requirement higher by nearly £4bn.
Now, whether the government actually needs to or ought to "raid" this money is neither here nor there for this particular argument. The point is that it immediately makes it "costly" to push up interest rates. The gain achieved today is at the expense of a loss paid tomorrow, rather than any real wealth having been created. "Gains today at the expense of tomorrow" are, of course, what got us into the mess in the first place. What this particular trick does is make it far harder to raise rates from the current 0.5%. It make sustained low interest rates considerably more likely, because the cost of raising interest rates is magnified.
In addition, if the rates are kept at 0.5%, the "surplus" that has been built up by the BoE will continue to accrue -- to the tune of £11bn a year. That's a very big surplus to throw away on the back of a small rise in interest rates. The only thing that would force the government (whatever government that might be) to give it up would be if the alternative was worse – and that would be a run on sterling and an inability to sell gilts abroad at current rates.
In other words, the low interest rates are here in the UK until the eurozone recovers and can start offering more attractive rates in terms of numbers AND confidence. Since the eurozone is still heading to hell in a handbasket, that won't happen until there's some kind of stronger core eurozone in which investors have long-term faith.
The Merryn Somerset-Webb argument against London property prices has greater fundamental strength. New money has been coming in from Greece, from Russia, from anywhere. London property is seen as a particular type of asset (on a par with fine art and big yachts). It's a hedge against inflation and it's a nice thing to show your friends. A flat in Monte Carlo doesn't quite have the same caché. Somerset-Webb's line is that this free flow of money is drying up. Basically, all the money that was going to leave Greece, has left.
However, she doesn't argue that these people who have bought places are going to be selling up. Sure, the number of buyers could decrease, but that will merely prevent the recent surge in prices from continuing. It doesn't put forward a valid argument for a collapse.
Sure, housing needs "new" money, in that there are always some sellers (through deaths, divorces, business disasters), but there are also, even in times of difficulty, successes. And London has not lost its appeal to new money (indeed, one could argue that it specifically attracts new money). The surge in London might be over, but it was not necessarily a bubble. Eventually, yes, London prices will return to a more sensible valuation compared with the rest of England, as opposed to its current comparisons, Manhattan, Paris and Moscow. People like me (if not me precisely) will work out that they can sell up and buy a place for a fifth of the price somewhere else, and live out a reasonably comfortable retirement on the profit. But we won't all rush for the exit at once. A sudden collapse, a panic, it won't be, at least not in the next three or four years.
I went short for rather more than I was positioned on dollar/euro, a move that might require holding my nerve for the next few weeks. I don't see €/$1.29 as lasting beyond the next panic that the market chooses to pick up on. Target of about €/$1.25 this time round.
- Muddling through