Blain's Morning Porridge - Junk or Treasuries, Catalunya, and what do we do about unsold London

Blain’s Morning Porridge – September 29th 2017

“Meltdown expected, the wheat’s growing thin, Engines stop running, but I have no fear..”

For the avoidance of doubt – the Morning Porridge is unrestricted market commentary, it is not investment advice…

Quarter end, and an interesting morning! Already I’ve wrestled with the big questions of the day: the Catalan question, the Kurds, given Mark Zuckerberg a No-Sh*t-Sherlock award at his “surprised” admission malicious things might be driven through social media like Facebook and Twitter (like Russian media manipulation to destabilise the US), and pondered deeply the significance of Ikea buying TaskRabbit… FFS! Even I can assemble a Billy Bookcase.

I’ve attached a particularly scary graph this morning: US Treasury Yields and European Hi-Yield (Junk) returns. They are about the same! You get the same return investing in the full faith and credit of the USA, or in over-levered, covenant-lite, struggling European firms. Your call.

Of course it’s a bit of an apples and oranges comparison between US$ and Euro interest rates, but it demonstrates how distorted junk yields have become. I’m told the danger sector in Europe is Italian corporate debt (Wow.. who would have guessed (US Readers – Sarcasm Alert.))

Back in the real world, it’s a question of where next for bonds, the ECB dribbling out more hints about “normalisation”, and the Bank of England celebrating 20-yrs of independence with a jamboree of the great and the good.

Gordon Brown said he’d been unhappy with the Bank of England’s handling of the crisis as it developed 10-years ago. I have to agree with him – swift action and support at the point of crisis on Northern Rock could have taken much of the sentiment and drama out the situation – but the Governor of the BOE, Lord King’s put down is priceless: “I am not going to comment on a politician’s attempt to rewrite history.”

The Catalan referendum is the one to watch this weekend with much at stake for both Spain and Europe. The vote (such as it might happen) will have little real legitimacy, but will harden the mindset and likely become a step towards an inevitable plebiscite down the road. It’s a “Hearts and Minds” battle – and I suspect Madrid lost the moment they told people they can’t have a vote. Flooding the province with police and arrests doesn’t look a particularly grown-up response… although Theresa May might like to bank that thought when it comes to her next meeting with Wee Nicola Krankie up in Scotland…

Catalan Sunday has the potential of another populist moment, create a long-term distraction domestically, and add to Europe’s issues. The Northern League vs the rest of Italy is the obvious regional point of friction, but there are others. It all begs the question where do tribal/regional demands stop in a supposedly united continent. Europe simply can’t afford this kind of dissent and uncertainty – unless of course it’s in the interests of the Brussels classes.

Brexit continues to wend its weary way forwards. Zzzzz

Lets think about real assets for a moment. One of the things that keeps us elderly Brits happy is the fact our property is such a reliable store of value. As I’ve written before, we’re confident Global Residential Property will prove a superb asset class – the problem is finding ways to invest. Sector I’d like to see grow is UK Private rental property – because there is a screaming shortage of quality stuff in the market, meaning the shabby stuff is well overpriced.

Decent rental property, at the right price will yield solid, dull, boring, predicable returns – the dream investment!

The fundamentals of London Property once looked superb – lots of foreigners looking for homes and a slice of London, and big banker bonuses driving up demand and prices. Yesterday, I read about a 9*7 ft cupboard for sale in Mayfair.

But as I gaze a gazely stare from the 20th Floor of Mint Towers, I can see innumerable cranes constructing residential tower blocks to the North, South and East of us. (I’ve attached a photo – all these towers towards the Dome are unfinished resi!) If I peer to the West I can sort of discern the cluster of buildings around Battersea Power Station called Nine Elms. They all sell the dream of luxury living for between £1-1.5 mm for a two bed flat, with service charges lumped on top.

Yet, I read there are nearly 30,000 unsold off-plan London new-build flats.

For those us with property to sell, we could keep moving up the housing ladder, but for anyone with less than a £100k deposit and a £100k salary, forget being able to buy even a modest micro-flat on the fringes of civilised London. The median salary in London is around £35k. Most young folk in London stay at home or rent – and that’s not cheap. And the government decided to stamp out private landlords by making Buy-to-let less attractive, while making a move up the housing ladder unattractive by hoiking stamp duty.

Now that the Chinese and Malaysians aren’t so keen on Brexit Britain, and bankers are fleeing to Frankfurt, I doubt there are enough buyers at £1mm plus to fill more than a few floors… We have lots of unsold, very expensive flats, and lots of people who can’t afford to rent them.

Gosh.. how do we solve that..?

When there are no buyers, prices have to move – dramatically lower.

In the wake of the tragic Grenfell fire disaster, I read about the council buying a whole raft of brand new flats in a luxury Chelsea development. It got me thinking about the rest of London’s surfeit of luxury flats..

What are these places really worth?

The average rental for a 2 bed flat in prime areas of London, including Canary Wharf, is probably around £2000 per month – but that’s on very limited supply. Let’s assume a small 2 bedroom flat off Docklands could achieve a £1500 per month rental. To return a modest 4% yield, you are then talking about a price per flat of £450,000, or a 5% yield at £350k. If you can hike the rent to £2000 per month – which would be about 100% of my son’s current disposable income – then you get a 4.8% yield from a £500k flat. These flats are currently on sale between £800-1200k.. Something has to give.. Prices.

Although I’m sure buyers will haggle, 5% is a fairly decent return on a real asset, and in view of the limited risk, these might be realistic levels where institutional investors would buy low risk Private Rental Sector assets. It’s also conceivable Government might do the smart thing and fund local authorities and housing associations to buy unsold (and even incomplete) blocks wholesale at distressed prices.

Which means to shift all these flats, prices are going to have to shift dramatically lower.. which is going to really peeve the whole property market as cheap flats impact the rest of the property sector.. causing every smug Londoner to question their deeply held conviction their properties make them multi-millionaires..

Finally, got told a great story about a successful banker from a US firm in London getting a call from his accountant last night: “Do you want the good or the bad news first?” He asked for the good news. “Well your wife has just bought 2 pictures for £5000 she thinks are worth £15 mm”, he is told.

“Well that’s great… what are they?” he responds.

“You and your secretary”, replies the accountant.

(Thankyou AP!)

Have a great weekend – I’m spending it on the water as a Race Officer at the Solent Autumn Sailing Championships. I’d like to be racing myself, but time to take my turn on the committee boat. Weather looks lush tomorrow and pants on Sunday…

Bill Blain