Capitalsynthesis

(The following report is available as a downloadable PDF here: UK-Oct07-13 )

 

This past weekend, US and Swiss investment teams have made the case that the UK’s current mono line cyclical boom could be a structural revival. In recent years I have advocated investing for the UK’s cyclical boombut I have always maintained there is no evidence that is can be structural, yet. And not to be ‘suckered’ into believing that ‘this time will be different’ as the policies are identical to every other failed cyclical UK boom of recent decades.

CS and WF make some bold statements in their latest economic reports on the UK and specifically the UK housing market.

Lets start with CS here:

CS-Focus-UK-04-10-13

I’ve extracted their summary case and provided my own thoughts and comments after each statement as below.

CS – “Although house prices may seem “high”, there’s little to suggest they are currently unsustainably or unrealistically so”.

RP – The average English house price end june 2013 reported by the ONS was 251,000 gbp. The average English salary was 26,500. Across the world only a few Scandie countries and Hong Kong are more expensive (as a ratio of asset value to income) than the UK residential property market. Disposable family income has been declining as energy and food prices have been rising. Housing participation rates have been in secular decline. The number of first time buyers is in structural decline. The Uk baby boomers are in the process of retiring. The vast majority without adequate pension cover. Their major asset is their property. For as long as property prices are as high as they are the market will remain dis-functional. The young are unable to buy as prices have become totally detached from wages and disposable incomes. Why are volumes so low?

And a few charts:

Nominally UK average wages have risen by around +50% in the last 13 years or so.

Nominally UK average house prices have risen by more than double nominal income rises at +100% to +125% depending on the region over the same period.

Unfortunately real disposable incomes are up around 10% over the same period, according to official statistics. Household incomes, perhaps a better judge of housing affordability are barely up at all over the same period.

And whats more, these real increases in house prices over and above incomes and disposable incomes are not new. They have been on this sustained trend from the 1970s in fact. The best performing asset class in the 1970s was UK housing even out performing gold over the same period. Effectively UK house prices have been on a super secular march upward for the last 4 and a half decades.

Look inside the data at income distribution and the structural sustainability worsens further as incomes at the lower end of the income distribution sees real disposable income decline vs increase at the higher end of the scale.

In terms of UK housing construction might this not be an important point for CS to consider? I think so. The phrase ‘nose in front of your eyes comes to mind’.

Most UK families earn very little. Surely its clear why there is so little construction given this income distribution vs the average UK house price.

In spite of CS making very hard work of seeing the “wood for the trees” here I think its pretty clear what is occurring here and the structural headwinds that will come to bear soon enough on the UK housing market. Some economic issues are difficult to call but this one is not of these, imo. Of course timing, as always, is more complicated but that’s a separate discussion.

 

As we have mentioned before the structural tail winds of multi decade declines in UK savings rates must be close to their secular trend change driven by two key factors.

What was once the tailwind of buyers setting up family homes are rapidly becoming a headwind of sellers seeking to extract capital from their principle savings asset ie their home. (As most approaching pension age are dramatically under funded as deposit savings and pension savings have been too low for decades).

As if it weren’t bad enough the public sector’s own fiscal position is already poor adding to its 2013/14 deficit at the rate of -7% of GDP once again. Having been a significant secular tail wind to house prices they also are about to become another headwind. And the public sector’s off balance sheet unfunded pension obligations make the fiscal sustainability of the these commitments very questionable, at least in real terms.

I wonder what would happen to UK house prices if the UK government ran a balanced budget again?

Or what would happen to UK house prices if the secular bull trend in global interest rates since 1981 (32 years and counting) ended?

Back to the CS report and some more quotes:

CS – “It’s not apparent that the Funding for Lending and Help to Buy schemes will lead to a sharp rise in prices from here”.

RP – On what basis? The UK residential property market is a “thin” market as CS correctly point out. What do all our price studies tell us will occur when fiscal subsidies are poured onto thin markets?

CS – “In our view the main problem with the housing market is that in recent years there hasn’t been one to speak of. Activity – in terms of transactions and new build – is at levels consistent with a housing bust, not a boom.

RP – Correct. Why is participation so low? Are there some deep structural issues here that have been created by government fiscal subsidies since the 1970s in the UK?

CS – “Policies that boost activity and transactional liquidity in such a depressed market could lead to increased housebuilding and a boost to GDP from construction”.

RP – Are more “policies’.. ie yet more publicly funded fiscal incentives the solution to the dis-functional UK property market?

And into the depth of report.

They make the case that mortgage lending growth is “non existent’. Vs peak lending volumes its correct but vs the recent volumes applications are surging.

http://www.spf.co.uk/marketcomment/Pages/Mortgagelendingsoarstofive-yearhigh.aspx

Whats more, volumes are surging vs all other developed world economies. The last housing boom was a global phenomena whereas this is only home grown. Why? Is this is a healthy sign?

The CS team also site asset value to rents as a sign of the non bubble like nature of UK house prices.

Its correct that rents have been surging upward in recent years directly in an inverse proportion to disposable incomes falling & first time buyers lack of participation. Once again i find this is negative indicator not a positive. Why have rents been increasing as disposable incomes and transaction volumes have fallen? What does this tell us in terms of rents and prices being in an unsustainable price trend bubble vs people’s ability to afford. Why would it be that purchase transaction volumes are so low?  In my view simply as affordability is totally unsustainable.

Of course zero interest rate policies, free interest loans by government, tax relief on mortgages, capital gains tax free policies, etc, etc can all help to extend house price rallies but when the average English house price stands at nearly ten times average English salary you know this is a market that, in the medium and long term, is very susceptible to violent mean regression moves!

CS present nothing new here. They fail to convince. The latest government policies are not about increasing liquidity in the UK housing market. They are subsidies to bring down the cost of entry transferring risk and cost to the public purse to allow entry to the market at extended high price levels that would otherwise be unattainable due to the multiple of incomes needed to purchase UK property. If the UK government wanted to increase liquidity far better to remove capital gains subsidies or impose bans on second property ownership or limit the BTL boom that is underway.

I won’t go through the WF report in detail as the same issues i raise above also apply to their report.

Here for ref: WF-FocusUK-03-10-13

Their main point appears to be that the UK’s savings rate has room to run down further and this will support continued domestic consumption and asset price growth feeding in to a perfect, never ending, balance sheet growth consumption growth loop.

In the UK, at least, it is as if the 2008 banking insolvency crisis never occurred. That, in effect, the lack of savings, over consumption and over concentration on house prices to sustain consumer consumption never occurred.

The UK are repeating the same old mistakes they made a decade ago. Nothing has changed expect the extent of the level of intervention. Ten years ago low interest rates were all that was needed to sustain a world wide consumption and property bubble. Now we have the UK’s central bank creating new money supply itself alongside direct government fiscal subsidies to housing to sustain higher prices and further consumption alongside reduction in savings levels.

Yes, these policies will lead to consumption and even significant, short term, asset price gains. But they come with a medium and longer term price tag.

I’ll end on a trading quote as jumping on cyclical trends with liquid instruments is what making returns are all about in the fiat currency world we live in.

“When I see a bubble forming, I buy”. G.Soros

But no one be suckered by CS’s and WF’s blinkered notes. These policies cannot sustain a secular UK consumption and investment trend.

Rather it is the absolute reverse, in my view.

Luck to all

Rich