Economics and strategy
Time to catch our breath!
As our last report was being issued, the Prime Minister Mrs May, had just announced that she was to hold a snap election. There is nothing truer than the saying that a week is a short time in politics, as the current shenanigans tell. Books will be written and theses presented, on the June 2017 General Election, but we will leave that job for others to comment. What is certain to UK investors, is that the strong and stable platform that investors wish to have to enable businesses to plan ahead, looks very far away indeed and therefore caution is the watchword.
You would expect bonds, which typically offer a degree of certainty, to have increased in price and correspondingly yields to have fallen, but 10 year gilts now stand at a yield of just over 1.3%. Far from being the leading economy of the G7, the UK is now the laggard, with business confidence hitting an historic low. The strong mandate that May set out to win, was not returned by a fickle electorate fed up with austerity. It appears that the Government will try to hang in for a year or so with the cynics pointing to favourable changes effected by the Boundary Commission to take effect.
In Europe, things are recovering from the initial shock of Brexit and the cloak of political uncertainty there is gradually receding. The electorate in the Netherlands did not throw up any surprises and Macron’s win in France points to more stability, just in time for Germany’s election in October. French bond yields have reduced sharply to reflect this.
The US economy continues forward with interest rates expected to continue their upward trajectory. Investors are keeping an eye on a possible reversal of the US bond yield curve which has accurately predicted every recession since after WW2. Typically, the yield on longer dated bonds should be higher than short term money. A reversal happens when short bonds yield more than long bonds. The Federal Reserve is forecast to raise interest rates two or three times over the next 12 months and this could cause a reversal. Equally, there are plenty who believe that this time is different and who dismiss the signals given by the bond yield curve.
You will be familiar with our theme of the elephants in the room.
The first elephant we refer to is Global Debt. Across all economies the amount of debt continues to climb and if interest rates do rise much more, Governments will not be able to pay the interest on their debt. Yes they can print more money but, as we have said here before, you can’t fix a debt crisis with more debt. Expect more of this harsh reality to feature over the next few years.
Brexit negotiations have started and the true scale of the task is slowly becoming clear and the weaker majority of the UK Government will probably result in a more collegiate approach being taken. The timescale for Brexit is two years from the UK serving its article 50 notice and given that much of the European decision making will be led by Germany, we do not expect much to happen before Germany’s elections in October. In short, The Great Muddle Through continues both at Brexit level and the wider global economy.
After nearly 9 years of very slow expansion, the economy has delivered record levels of employment and demand for offices (we are increasingly a service sector economy) remains robust, particularly in London and the South East. The consumer sector remains in turmoil, with on-line sales eating away market share from the high street. The latest manifestation of this can be seen in the USA, where Amazon has bought the grocery chain Whole Foods as a way of accelerating its delivery platform. There are rumours that Amazon could also buy one of the UK supermarkets to further its ambitions here. The outlook for retail property in this environment is unclear. What can be said is, that with growth weak and the uncertainties of Brexit ahead, occupiers are looking for efficiencies across all sectors of the economy. Making a saving is just as important as growing the top line and in many cases, may be more achievable.
Rents according to MSCI, are growing at 1.4% p.a., which we expect to weaken and we forecast total returns will average around 4% to 6% p.a. over the next few years, largely comprising the strong income yield from real estate. The headwinds to that will include whatever Brexit throws up and the tailwinds could include a further yield reduction, as yield hungry investors continue to pour money into the sector.
Following the Grenfell fire disaster, we have undertaken a desktop review of all properties owned by the Trust. There is one property within the Trust portfolio which has cladding (Leyton Orient) but as a football stadium, robust checks are undertaken annually. We will watch out for any increase in fire compliance requirements.
Annual MSCI Report
We receive an annual analysis of Keills Property Trust’s performance. On request we can make this report available to investors. It is pleasing to note that last year, the total performance at the property level was in the 9th percentile as measured by MSCI. More pleasing still, is the income yield premium over the market yield which investors receive and which will continue to increase as our rents grow independently of the expected weak growth in rents generally.