Global Market Insights | A Fisher Investments Blog

A Word on “Lost Decades”

According to one research firm, the British housing market faces a “lost decade” of falling prices. The Telegraph has the scoop:

UK Housing Market Heading for ‘Lost Decade’, Warns Collins Stewart

Graham Ruddick, The Telegraph

There’s already a rather colorful debate over the forecast, with some in the banking industry calling its claims about mortgage lending suspect. To us though, those who focus on the specifics are perhaps missing the bigger picture: Very long-term forecasts are seldom accurate and rarely mean much.

Why? Two main forces will affect British home prices over the next 10 years: supply and demand. And many drivers will influence supply and demand along the way. In the near term, the success (or potential lack thereof) of the government’s efforts to increase mortgage lending will indeed impact demand. But there’s simply no predicting what other forces materialize further out. Any number of economic developments, regulatory schemes, population changes, etc. that we can’t even fathom today could arise, impacting home prices. Any time you see a very long-term forecast for anything finance-related, whether good or bad, we suggest keeping that in mind.

 

Merlin’s Magic

The Bank of England announced the results of Project Merlin on Monday. As you may recall, this was PM Cameron and Chancellor Osborne’s scheme, introduced in 2010, to increase lending (particularly to small businesses) after corporate lending took a hit in and after the 2008 credit crisis.

Project Merlin had a healthy, sensible goal—help businesses finance expansion and hiring, theoretically boosting GDP growth and employment over time. The government sought to accomplish this through lending targets. The UK’s largest banks signed a pledge to lend £190 billion in 2011, with £76 billion going to small businesses. The results? Banks exceeded the total lending quota by nearly £25 billion but fell short of the small-to-medium business goal by £1.1 billion.

Some are saying the small-business lending shortfall rendered Project Merlin an abject failure, but we’re inclined to disagree—it’s a very small miss, and the overall lending increase is a much bigger positive. Lending more to larger outfits might not have been the goal, but despite governments’ best intentions and efforts to foster certain economic activity, sometimes markets still behave otherwise.

Why’d that happen in this case? Remember, there are two sides to every loan: lender and borrower. Banks made credit available—there was sufficient supply. Small-business demand is what fell a bit short. Neither banks nor the government can force firms to take out loans; they’ll borrow if it makes sense in light of interest rates and borrowing terms. Otherwise, they’ll probably delay financing or find alternative means. And that’s likely what was at work over the last year: A few less small firms than hoped found conditions favorable, while more large companies found the lending terms perfectly palatable. Sometimes, that’s just how capitalism works.

 

In Pictures: Quantitative Easing

As expected, the Bank of England (BOE) announced it is increasing its asset purchase program, otherwise known as quantitative easing (QE) by £50 billion. To put that in non-industry terms, the bank will purchase €50 billion in gilts from commercial banks, giving banks more money to lend, which ideally helps the British economy grow faster.

Why did the BOE think this necessary? British GDP growth was rather sluggish in 2011, as shown in Exhibit 1.

Exhibit 1: UK GDP Growth, Q4 2007 – Q4 2011

Source: Thomson Reuters, as of 1/25/2012.

Simultaneously, M4 money supply has contracted for 14 straight months, as shown in Exhibit 2, and corporate lending has been negative since 2009, as shown in Exhibit 3. (M4 measures all cash in circulation, held in private-sector retail and wholesale bank and building society deposits, and Certificates of Deposit.) Though the decline in corporate lending has eased lately, suggesting credit is slowly becoming more available to businesses, it appears that wasn’t happening fast enough for the BOE’s comfort.

Exhibit 2: UK M4 Money Supply Growth, December 2007 – December 2011

Source: Thomson Reuters, as of 1/4/2012.

Exhibit 3: UK Annual Loan Growth, 2007 – November 2011

 

Source: Thomson Reuters, as of 1/4/2012.

As the theory goes, if banks have more cash, they can lend more to businesses, who can use the money to finance expansion—whether that’s investing in new equipment, hiring more workers, opening more locations, etc. The result, over time, should be faster economic growth, provided all works as intended.

However, it’s too soon to say whether more lending and faster growth will follow more QE. In the US, the Federal Reserve similarly expanded its QE program in 2010, and banks ended up holding much of that new cash in excess reserves at the central bank, rather than lending it. And last year’s drop in corporate lending coincided with “Project Merlin,” under which the banks agreed to increase lending in 2011.

Thus, we suggest taking the BOE’s announcement with the caveat that even well-intentioned economic policies don’t always work out as planned. No matter how the government tries to facilitate lending and economic growth, market conditions ultimately dictate whether banks lend and how companies deploy cash. That said, we’d consider it positive that the BOE remains accommodative, with an eye toward increasing liquidity at a time many perceive that as necessary. (For more on the topic of central banks, see our recent commentary on iStockAnalyst.com, “Central Bank Accommodations.”)

Also, because the QE increase is small (and M4 has been contracting), it seems unlikely to materially impact the inflation rate, which has eased in early 2012. Exhibit 4 shows the breakdown of the BOE’s balance sheet at yearend. A £50 billion increase in the asset purchase facility (pink) is marginal compared to the overall increase since mid-2008. (Remember, though inflation accelerated in 2011, that was largely due to the VAT increase early that year, as described here.)

Exhibit 4: Bank of England Balance Sheet, June 2006 – December 2011

 

Source: Bank of England.

 

Gaining Notice

Hat-tip to Hamish McRae at The Independent for his excellent piece on underappreciated positives in the UK :

You’d Better Sit Down—Stock Markets Are Doing Rather Well

As he points out, January’s improving manufacturing numbers and narrower deficit suggest Britain ’s economic and fiscal situations are firming up a bit. January’s robust service sector expansion, reported Friday, seems like further evidence of this—services, after all, comprise about two-thirds of the British economy. Granted, one month’s data don’t mean a long-term trend is unfolding, but a strong January is encouraging after Q4 2011’s small GDP contraction.

And, just as important for global equity investors, he mentions some sensible reasons to be optimistic about shares—like strong economic growth in Emerging Markets and the US , which we also think are two factors likely to help equities’ recent momentum continue. And the momentum is even stronger than the article suggests. Not only did global markets rise more than 5% in January, but the MSCI World index is up over 17% since the recent correctional low on October 4, 2011 ( in US dollars, as of market close last week). That fact might make even more people need to sit down!