A while ago, MBMG penned an article for on Qualifying Recognised Overseas Pension Schemes (QROPS). Back then we warned that the Chancellor, Alistair Darling, would not be happy with the income tax revenue that he was losing via the transfer of pensions away from Her Majesty’s Revenue and Customs (HMRC) jurisdiction and that if the mis-selling continues, this could give the government an excuse to close this potentially lucrative vehicle that expatriates may benefit from.
Recently, a director of the Financial Services Authority (FSA) told a Treasury committee that, “There is a ticking time bomb that has been created over the last 20 years.” He is referring to the Interest Only Mortgage (IOM). Of the eleven million or so mortgages in the UK nearly 40% are IOM. Before the end of this decade around one and a half million will become due for repayment. Now for the scary bit - only one person in five has any sort of repayment plan.
One thing which has been very resilient in the face of adversity is the UK housing market. Nationwide reckons that UK prices are down by more than 12%. This may not be stunning but, when compared to other countries, it is not too bad a result. As a comparison, the average cost of a house in Spain is down 31%, in America it is down 34%, in Ireland it is over 50% off its peaks of a few years ago.
Let’s face a few facts here. The UK has not exactly set the world alight with its economy. It is basically in a recession, unemployment stubbornly refuses to drop and the family earners have been hit hard with a combination of higher taxes, poor wage increases and inflation - a triple whammy.
This begs the question why has the housing market not crashed? The main reason is money is now cheap. Interest rates are very low, in fact they are as low as they have ever been. Up until the end of the Conservative government in the early 1970’s, UK rates remained no lower than 2% and no higher than 10% with an average of around 5%.
Then in 1973, global inflation forces UK rates up to almost 13% and it kept going higher until reaching its peak in 1980 at 17%. Inflation was gradually brought under control and rates slowly came down to around 5% in the mid-1990s. It stayed at about this figure for well over a decade and then things started to get interesting as the Global Financial Crisis took effect. The Bank of England (BoE) took action in early 2008 and cut rates from 5.5% in January 2008 and kept cutting until they were at 2% by December of the same year. Things did not stop there, though; three months later rates were down to 0.5% and that is where they have stayed ever since. To put things into perspective, rates never dropped this low during two World Wars or the Great Depression. The lowest they went down to was 2%.
However, the BoE view things differently these days and, according to them, we are in more economic pooh than we ever were in the first half of the last century. But at least in those days we were in charge of our own destiny whereas now we just seem to copy what the Fed does.
If this is so then why haven’t we suffered as much as them when it comes to the cost of buying or selling a house? Well, the fact of the matter is, there are more forced sellers in America than there are in the UK. Over the last couple of years the amount of home repossessions runs to just over thirty thousand per annum. This is a lot less than levels incurred during the property crash of the 1990s.
In America, things are a lot worse. Almost 100,000 homes are seized every month. There is a good reason for this number and that is much of the property financing is done via ‘non-recourse’ loans. This means that if the borrower can no longer afford to pay the loan then he/she just ups sticks and walks out. The lender then takes over the property but that is it and cannot make any further claim against assets or earnings. This cannot happen in the UK.
However, not everything goes the borrower’s way in the US. One of the more common mortgages is ‘long term fixed rate’. Compare this to the UK where it is much more usual to take out something which is more akin to short term variable rates. Thus, any cut in the base rates is of far more benefit to the UK borrowers than their counterparts in America. Despite this the UK is still in the metaphorical pooh and all this means is that it has prolonged the inevitable but necessary correction. The simple fact is that property in the UK is not exactly cheap.
Let’s look at some recent history. In the ten years that followed from 2001 the average cost of property rose by 94% whereas earnings only went up by just less than 30%. To put it in plain English, you do not need to be Einstein to see that when the former has risen by more than three times the latter then see that something is not quite right. If you look at the history of property prices then you will see that, eventually, after any large increase then they ‘revert to the mean’ and make the necessary adjustments.
It is interesting to note that The Economist reckons the prices of the UK property market are as much as 28% too high. They are not alone: Fitch - 25%; Deutsche Bank - 34%; Morgan Stanley - 25%; International Monetary Fund (IMF) - 30%. It must be said that the very low interest rates over the last few years do distort things and, as such, are keeping property prices well over where they should be. This can be seen by looking at the average rate of the UK Consumer Price Index (CPI) over the last couple of decades - this has been at around four percent. The present rate is just over 2.5%. The implication is that the correct base rate should be about seven percent per annum. However, the lenders have to make money too and will add on between 1% and 2% for themselves and this is why many mortgage rates are approximately a couple of percent over the base rate.
To put things another way, the Standard Variable Rate (SVR) should be about double of where it is now. This would mean that your mortgage payments would be double what they are now and nobody would be walking around saying there is a recovery or “the market is stabilising”. Whilst prices are not volatile at the moment it must be recognised that there is a massive underlying weakness. The amount of completed purchases is almost half of what it was five years ago. Theoretically, this is ridiculous as potential purchasers should be able to take advantage of lower prices but the lenders have been tightening their purse strings - they have returned to the pre-sub-prime era of high deposits and lower income mortgages. (Maybe they have learned something after all?)
Buyers are not the only ones with problems. The drop in the average price means that many people who bought when near the peak of the housing market cannot now afford to sell as it would mean they would get into negative equity and so sell the house for less than they paid for it. This not only affects the sale of the present property but also, potentially, any new one they want to buy since they would have to find money for the move and also cover the deposit for the next property. Not an attractive proposition when you have just had to take a hit on what you have just sold.
The problems do not stop there. The re-mortgaging of present property has dropped by more than a quarter in comparison to what it was last year. This may not sound too important but what it does do is tell us that there is not enough equity in the property to be able to re-mortgage it.
Even property owners who do not have a mortgage could be affected as prices are invariably linked to available credit so if the price of property heads south then so does the value of what you own.
To be continued…
Ronald Niebuhr’s ‘Serenity Prayer’ talks of having the serenity to accept the things I cannot change, and granting the courage to change what I can. It is with this in mind, that I write this article.
Global investment in commodity-based exchange-traded products, structured notes and index swaps totalled approximately USD100 billion in 2006. Six years later, this number had risen to a record high of USD415bn. This is largely explained by the fact that commodities are now standard components of strategic asset allocation as they generate equity-like returns in the long run, act as risk-diversifiers, and serve as an inflation-hedge.
Recently, my business partner, Paul Gambles, appeared on CNBC’s Asia Squawk Box when he was on a trip to Singapore. At MBMG Asset Management, we have been talking about the Fiscal Cliff for some time now. This is where the combination of automatic spending hikes and tax cuts expiries that will happen at the start of the year unless US politicians finally rediscover the ability to compromise. The negative impact on GDP could be around 2%, sending the US and, mostly likely, the world into another recession - though many in Europe might protest that they have not yet come through the first one.
People may have seen a recent article in the UK Financial Times which pointed out that, for the first time in half a century, British pension funds now hold more bonds than equities.
The investment industry has long become conditioned to the view that the “risk” of a multi-asset portfolio can be readily defined by its broad asset allocation across the major five or six asset classes. It is a generally accepted rule of thumb that bonds are less “risky” than growth assets, so are UK pension funds less risky today than at any time in the past fifty years?
Two recent articles in the Financial Times Fund Management (FTfm) highlighted the importance of the multi-asset investment approach to institutional investors. The first article¹ focused on the recent growth in third-party-managed multi-asset funds on the back of its risk management capabilities; while the second² provided an excellent illustration of its application through an interview with the manager at the University of Cambridge’s endowment fund. Both of these clearly resonate with us as they reflect a growth in support for our investment philosophy. However, these articles also highlight some nuances of this approach which are worth pointing out.
There are three investment mistakes that most investors will almost certainly make over the coming years, all of which are eminently avoidable.
So there you have it folks. The US elections are over for another four years, and we now know that America has chosen Barack Obama to lead them for another term. But are we any closer to truly discovering the true colours of money… remember it could have been Romney. The way his campaign was going at times it looked like he could not even spell the word ‘tax’!