233: Deflation - of an Asset Bubble
It's also worth noting that US interest rates are now 0.5% - a massive 4% lower than the UK - despite similar GDP and inflation figures. Normally, the UK has an approximate 1% higher interest rate than the USA - hence this implies UK rates could drop quickly to 1.5% or thereabouts. Difficult to believe - but if oil prices remain low, we expect this to happen.
In summary, what we are experiencing is the deflation of an asset bubble - all assets. It’s not just house prices that will deflate, it will (and has been) stocks and shares, oil, wheat, copper, metals, the price of antique cars and artwork etc. This is likely to be followed by services charges like a hair cut, food prices and travel costs etc.
For too long the Western World has been borrowing money to fuel spending and this has led to asset prices escalating. Wages have also risen. Whether most people deserve such high wages is a contentious point – one could argue we’ve all been paid too much for too long and the governments have then taken advantage of this and increasing the tax burden, spent it on inefficient public sector jobs and projects and wasted a great amount of value in the process. The
One area of concern is
So – regrettably – we’re in for a rough ride. The big question is whether jacking down interested rates to 2% and massive injections of borrowed capital by the UK government will stimulate the economy and lead to positive growth after a short while and thence stabilize house prices. We rather hope it will, but we fear it will not. It could even create deteriorating productivity and further pressure on Sterling. Certainly investment in industry has been meager over many years of 3+% GDP growth, so its hard to envisage industrial production improving in productivity as investment is slashed and private enterprise budgets are reduced.
Clearly unemployment will rise – it could even double from current levels. As borrowing costs rocket down, and employed tenants become harder to find, we predict rents will also drop. Rental yields on newly purchased property will probably rise, but house prices will continue dropping. We hope prices will start to stabilize by mid 2009, but the downside is they will continue sliding after this. Much depends on how quickly interest rates drop and how quickly unemployment rises.
The worst case scenario is that deflation starts to set in for a prolonged period - with a prolonged recession. At this point, borrowing costs almost nothing in interest rates, but the value of the assets may decrease by 2-5% a year as happened in
A particular concern is whether banks will have any money to lend to anyone. If borrowing remains very difficult, house prices will continue to decline as first time buyers disappear completely. Buy-to-let investors would be shy of entering the market in anticipation of future price drops and bargains to be had further down the line - leading to further price declines.
The good news is that the overall mortgage gearing on properties was 38% early 2008. This means assets were valued at almost three times borrowing on the overall
The other positive news is oil prices crashed from $147/bbl in mid 2008 to $60/bbl 28 October - then recovered to ca. $68/bbl. They will rise again in future, but this could be a few years away after the slowdown in the global economy knocked the stuffing out of demand – commonly referred to as “demand destruction”. Demand in the western economies has plummeted by 1 million barrels in the last six months, partly because of high oil prices and partly because of the slowing global economies. It’s now likely demand in 2009 will also drop, just as new oil production comes on-stream. Please note however we still maintain that the world is on a bumpy plateau of peak oil production – production (or supply) cannot rise much further. So as oil investment drops in the next year, this will sow the seeds of the next oil price skyrocketing when the global economy finally starts coming out of recession – whether this is in six months, 2 years or 5 years its difficult to predict at this time. It's more likely to be after 6 months than 5 years.
Also note, we believe the massive increase in oil prices from $70//bbl in June 2007 to $147/bbl in April 2008 added to the sub-prime crisis August 2007 was the key trigger for the current recession in the USA and UK. Whenever oil prices skyrocket, the world goes into recession. This happened in 1971, 1981 and 1991 – now its happening now in 2008. If you can imagine the
We believe there will be a correction, consolidation of industry/companies – a shake out of large proportions. Ultimately in a few years time, these companies and private enterprise may well be far stronger and more sustainable. Expect the mergers to begin, but don’t expect large prices to be paid – it will be mergers, takeovers and consolidation based on crisis and necessity to survive rather than speculative asset price increases and opportunism. The competition commissions will likely go very quiet as political and public pressure to prevent unemployment and companies going under will allow mergers to take place in many business sectors that would not have been allowed a few years ago. Airline companies, finance/banking, energy and manufacturing are all examples of industries that are likely to consolidate in the next few years.
If interest rates drop and borrowing starts to become far easier, it could kick-start the housing market, albeit this relies on unemployment remaining relatively low – something that could change quickly as the private sector starts laying off employees.
Warren Buffet has started purchasing US stocks – he’s an expert – but may be even Warren Buffet is being too optimistic and stocks will continue to slide. The FT100 most likely bottomed out at 3650 around 28 Oct 2008. Remember it was 6600 in March. That’s more than halving in value in six months - that about 40% down in it's level ten years ago. This demonstrates how poorly the UK stock market has performed over many years - particularly compared with the ca. 250% increase in house prices. In the last week, the FT has risen back to 4400 but this could be temporary – whatever happens, the market is very turbulent. Only the experts make money. The average person stands litle chance. But we’re not experts at stocks and shares – we tend to avoid them for obvious reasons. A halving in value in six months is pretty dramatic – some argue this could also happen to property, but we doubt it (we expect peak to trough declines of about 22%-30% in the
As you can see, we’re rather downbeat and we don’t advise buying property at present – simple reason is we expect prices to be lower next year. So the trick is to watch the asset bubble deflating then step in when you think it’s reached a bottom. Beware since many troughs occurred in
We’ve modelled what we think is most likely to happen to interest rates and inflation in the next year. As people pulled their money out of the stock market, an estimated $12 Trillion globally in the last four months, some of this money will likely end up in property – considered by most as a safe haven – despite the scare stories. West London - despite the financial meltdown - is probably one of the safest places to invest in property at present. London's global centre of the wealthy is not going to go away. Kensington, Mayfair - you wont find much hardship in these places! Remember at the end of 2001 – the stock market crashed, New York thought it might suffer a recession and interest rates in the
UK Inflation and Interest Rate Forecast - Nov 1st 2008
In summary, our feeling is that one should "hold off" from big investments until mid 2009, then build-hold until 2012 - then be very careful after this (consider selective divestments) - since a prolong slump could kick-in after 2012.
We hope you have found this Special Report helpful – if you have any comments, please contact us on email@example.com