I wasn’t even able to enjoy George Osborne’s miserable 2011 Autumn Statement with a dash of schadenfreude.
The forecast for UK GDP growth has been lowered to less than 1% for both 2011 and the 2012. I can’t pretend I foresaw such a dramatic downgrade.
True, it’s been nearly two years since I correctly called Britain’s exit from recession, in stark contrast to invariably gloomy pundits elsewhere.
Yet even then I concluded…
Growing public and private debt will constrain consumption and tame future expansion. We’re richer now than we expected to be 12 months ago, but we’ll be poorer in five years than you might imagine.
… which sounds about right today.
I also thought markets would rise – which they did for a while – and predicted higher inflation. It’s over 5%, so I’ll take that as a win, too.
My big miss was on UK government bonds, where I expected gilt yields to rise and that – together with inflation – to send interest rates higher.
Not so far! As it’s turned out, UK government bonds have been a superb investment as yields have steadily fallen. And they’ve been much less choppy than shares.
You can bank on bankers
The truth is I was looking for a return to sustainable growth to drive the key variables I just cited, whereas what we’ve had is more like gentle stagflation.
Partly that’s down to the bludgeoning of embattled animal spirits by a succession of further shocks. In particular, I thought Europe would sort itself out sooner than it has.
I believe Europe has what’s required to deal with its problems. Don’t believe the hype! Italy, as a nation, is loaded. Germany is the sovereign equivalent of Rich Uncle Monty from Withnail and I.
But while its members tussle to discover if that’s true, Euro zone fear has hit all the banks hard (even the UK ones) and confidence has seeped away, which has compounded my bigger error – I underestimated the impact of financial deleveraging.
It’s ironic that having bemoaned the UK credit bubble for many years and predicted its messy end (though I certainly didn’t foresee the US epicenter, nor the exotic machinations), I’ve been too optimistic about how quickly we can return to ‘normal’ (whatever that means).
I partly blame the bankers. It turns out bankers, in aggregate, are even more valueless than I’d previously given them (very little) credit for.
For most of the past decade, they’d lend millions to anyone with an Irish accent and a building site. They geared their banks up to a level that would make a card shark wince.
Now, though, they’re hoarding money like Ebenezer Scrooge caught short at a misers’ convention. Financing for everything from houses to investment to factories has vanished, even for those who look a good credit risk. Today you have to be a great one.
I suspect most of the old-fashioned bankers who actually knew how to assess a loan were long ago put out to pasture. Instead, today’s rocket scientist bankers spend their days trying to figure out how to game capital ratios, and not making very much money for their employers. Meanwhile their prop trading desks have been unmasked as directional punts on the herd (or simply fantasists, in light of fraud at UBS and Societe Generale).
Why we as a society (and as shareholders) still pay these bozos billions more than they deserve for the measly value they add (in aggregate) is for another day.
The point here is that their excessive profits puffed up UK GDP even higher than we previously thought in the boom.
Now the tide has gone out, we’re even more pasty and skimpily-clad than we’d feared.
Unemployment benefits nobody
Bankers would say deleveraging is a problem for society as a whole. Some might even add that excessive debt got us into this mess.
Which is pretty rich, but true.
While I think bank lending is more subdued than it needs to be – I’d happily borrow £1 million today at 4% if I could get it – there’s no doubt many households need to pay off what they’ve already wracked up. With falling house prices outside of London cutting off the other main supply of fantasy money, consumer spending will be stifled for years to come.
While some will lose out more than others, clearly it’s not going to be a great time to be a worker in Britain. Hundreds of thousands more public sector workers are going to be dropped now we’ve belatedly realised we can’t afford them, and their pay is falling fast in real terms, which may be good news for the UK in the long term, but is terrible for the individuals concerned, as well as for GDP and the job market.
Blogger and Monevator reader ermine has posted some comprehensive stuff on dealing with these dark times, writing:
It’s time to get a personal finance tin hat – you need to electively choose to start living on less that your income even if it means doing without things, so you have space to deal with this loss of purchasing power. There’s no point in burying your head in the sand – deal with reality, otherwise reality will deal with you in its own way.
You might also read The Accumulator’s thoughts on cutting spending where it matters least to you.
Whether the government should also be quite so obsessed with its timetable for austerity, given the tiny interest rates it currently pays, is another matter.
I’m not suggesting we don’t need to hack down our debt over a reasonable timeframe and get away from the previous culture of higher taxes and higher public sector spending.
But surely now is the best time to invest in high impact infrastructure, like new railway connections and energy supply, as well as more social housing? Bold and targeted government action could create far more jobs now, when they’re needed, and many of the assets, especially housing, could be sold off in better times.
I’d far rather my taxes went on that than on higher unemployment benefit bills – let alone the other nonsense we still spend too much on.
Don’t bet on GDP
From the standpoint of a private investor, too, I also maintain that panicky action would be a mistake.
While things look dark for Blighty PLC, some of the measures being taken – such as the modestly higher infrastructure announced by Osborne – might help certain UK companies.
I wrote the other day about why housebuilders might make attractive investments, for example. Admittedly it’s already harder to see house price inflation taking off anytime soon, but interest rates also look even less likely to go up. And my main point was housebuilders are already making profits on today’s much lower volumes and prices.
More importantly for investors, though, national GDP growth has been shown to be a very poor predictor of that country’s stock market returns. The lowered outlook for the UK therefore doesn’t say diddly about what to expect from the FTSE.
I plan to write more about GDP growth and equity returns, but here’s a taster of the reasons behind the lack of correlation:
- GDP estimates national output, whereas listed company output comprises just a subset of output
- UK listed companies get most of their sales overseas, anyway
- Slow growth usually means interest low rates (good for shares) and little pressure on wages (good for margins)
- Companies may also be more careful with their cash, reducing wastefulness and empire building
- In contrast, investors get over-enthusiastic in the good times, bidding up multiples to earnings
The last point, valuation, is the critical one. Buying when shares look cheap to fairly-valued (like now, in my view) is much more important than buying when higher GDP growth – or smiling UK politicians – makes it feel good to do so.
UK companies are doing fine, on the whole. They have low debt, and the amount they pay out as dividends is already back above crisis levels. And on a P/E rating of around about 10, they’re still good value.
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