Is the UK the Sick Man of Europe? With Jon Mawby

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1:24And now to the top analysis of today's markets.

1:34Is the UK the sick man of Europe? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is John Moby, co-head of absolute and total return credit at Pick Day Asset Management. Hi, John. It's great to see you again. Hey, Maggie. Great to see you again. And thank you for having me. Yeah, absolutely. So if you're thinking, I think this guy looks familiar, John, you may recognize him from the first Academy sessions we did with Roger Hurst. So not only is he a killer investment manager at Pig Day. He's also a Real Vision member, which is a testament to just how awesome our community is.

2:07So we're thrilled to have you here today, John. And I tell you, it's a perfect day because we got that, wow, Bank of England surprise, 50 basis point rate hike. The market really did not seem like it was expecting that at all. What's your take on that decision? I think the UK has got a number of challenges. And for me, I think the UK could be the canary for the global economy in that it has a much more sensitive mortgage market, is a much more sensitive just general credit market. And by that, I mean credit cards rather than my area of expertise. For me, the Bank of England told everybody in the UK two years ago that rates weren't going up until 2025.

2:59And then they raised them at the fastest pace in pretty much two generations. So if you think about that, everybody refinanced, everybody refinanced on a two-year fixed, me included, whether it was mortgages or whether it was car refinancing. And that has left everybody in a fairly big hole because they're now facing, I was saying earlier to some clients that if you think about it in the context of not just where where are rates, but what it costs somebody in the UK. So just coming at it from a common sense perspective, you have gone from an average mortgage costing X to X plus£750 a month. That's huge.

4:05It's huge. It's huge. And if you think about what the average salary is, right? like after tax, it becomes unaffordable. And unfortunately, I think the government are slightly out of touch in the UK. But that's why I think that actually the UK could be the canary for the global economy. Yeah. So if I'm understanding that right, and I think this is a very important point you just made, because there'll be a lot of folks who are watching this who sit in the US, and we've discussed this at length. We're operating on a system. It wasn't so much this way back in 08, 09, 07, 08, 09. But majority are now on fixed rate, 30-year fixed rate.

4:44Very different situation in the UK. So when you say it's a canary in the coal mine, is it that the UK is just seeing the impact of that massive increase in rates much more in real time than the rest of us? So we're going to see the damage that it inflicts in a more condensed way. Is that why you think it's in the canary in the coal mine? Explain that to me. No, 100%. So I think that, okay, so the US is a much slower burn. But you also have, I guess, in the US, an election cycle coming up next year as well. And I think all the central banks, they all talk to each other. They're all coordinated.

5:26So the Bank of England raised rates. The Fed raised rates. And what I think you are actually going to see in the next six to, let's say, 12 months is a huge pivot, because economies cannot, they just cannot afford this. I say to clients, it's kind of the dirty little secret between Jay Powell and Janet Yellen. right so they say two percent inflation is their target but two percent inflation doesn't get them out of the hole that they are in with the debt they need three and a half to four percent if you look at the impact of three and a half to four percent versus two percent over a decade or a decade and a half it's ginormous in terms of what it does with the debt loads so government debt So this is that big debt bubble that we have a lot of discussions about on Real Vision.

6:34Yeah, 100%. So in terms of what are central banks really afraid of? So, OK, we've had a rate hike in the UK today. But what are central banks really afraid of? Are they afraid of inflation running at 3.5 %? Or are they afraid of inflation below 2 %? I'm going to tell you that they're more afraid of inflation below 2 % than they are of inflation at 3.5 % to 4%. Really? Yeah, 100%. Because what they did over COVID

7:18was effectively increase the balance sheets. They did MMT, right? I mean, they didn't say they did MMT, but they did MMT. And the debt balances are now so high that if you just do the math on inflation at 3.5 % to 4 % versus inflation at sub 2%, nothing functions sub 2%. Whereas 3.5 % to 4%, they deflate all that debt over the next decade. So why? So so let's let's let's let's take the UK since this is the lead car, perhaps in the worst way possible for the UK, by the way, this is not a good thing to be the lead car. So why is inflation so that so they do this surprise? First of all, why did they do it when they just said they weren't going to?

8:20What do you think they saw that prompted this surprise move? And central banks usually telegraph this stuff. They usually don't want to, at least in this day and age, totally shock markets. And they seem to have done a pretty good job of doing that. Why do you think there was such a rapid change from their rhetoric to their action? I think part of it is politically motivated. So I think the whole basis of central banks being independent from the political cycle is just wrong. So you look at the Fed or you look at the Bank of England or any of the other central banks, if you have a political cycle coming up, which we do in the US in 2024, they generally do not move monetary policy in the three to six months before the political cycle happens.

9:17Why do they not do that? because they don't want to be seen to be tampering with that political cycle.

9:28For me, in the UK, we have had so much political volatility.

9:39That's someone's putting it lightly, if we all remember back. I don't think the Bank of England know ultimately what to do at the moment because they don't know where the political regime is going to sit. Right. But if you think about where we are at the moment, you've got a prime minister that seems to be out of touch with the electorate. You have, well, we've had three prime ministers in 18 months. you have a governor of the Bank of England that, again, doesn't really seem to understand where the general consumer is in terms of cost pressure. So let's talk about that. This is, I think, very interesting.

10:41So David, David on the chat is saying, you know, we know that this mortgage hit has been, you know, this increased payments everyone's facing, as you outlined. We know that, right? That is just incredibly painful for anyone who hears that. But he's saying at the same time, the labor market is incredibly tight in the UK as it is elsewhere. Hiring is incredibly difficult still, anecdotally. We've been expecting a recession for over a year due to rate rises, but it has yet to hit. Is there a labor issue for the Bank of England? Because the UK's inflation seems to be so stubbornly high, so much more so than, say, in Europe and the US, where it's still elevated, but it's coming down.

11:28What's different that's happening in the UK? Is there a labor component here? No, it's net zero. and I love I love I love I am I am the biggest environmentalist on the planet um I will you know do everything I can to protect our planet but net zero in the UK the amount of focus that has gone into net zero given that we are effectively energy independent it's insanity in that there are so you think that's driving inflation Oh, yeah, 100%. So even though it's X energy and food, corn are still high too, though, right? Look, you look at what's happened to natural gas prices. You look at what's happened to oil prices.

12:15You look at what's happened to generic input energy prices in the last 12 months. And then you look at electricity prices, input prices for businesses in the UK. They haven't come down.

12:38And they haven't come down because we're not focusing on the right things in the UK, I think. Hey, everyone, we're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

12:59So this is interesting that you say this, John. That's what differentiates, I think, the UK from the rest of the world. And that's the one differentiating point. That's so interesting. And I'm going to thread this together because you mentioned we're going to keep coming back to this theme as the UK potentially as a canary in the coal mine. We're going to come back to this theme. And again, no one's commenting on whether these aren't political conversations about how you feel about net zero or ESG or anything else. Just like if you remember, we played that clip from you from the real estate, commercial real estate interview that ash had yesterday and it was one of the trifecta of headwinds that the professor saw affecting commercial real estate and one of them was climate mitigation just the the increased cost of that so it's not whether anybody supports it or not this is just a comment on plugging that in to the scenario here and that being a cost that's keeping in John's point that he's making inflation high in the issue for the professor feeding into real estate costs that are affecting the valuations of buildings, their ability to sort of, you know, their profit margins being squeezed.

14:09So that's really interesting if that's the case. So let's pause this conversation for one second, because all of this came up again on the flag, on the radar, I should say, flagging it in a conversation that Raoul and Julian had as part of their macro insider conversation. So for those of you who are familiar, Raoul and Julian Brigden have this once a month where they get together and really go after the sort of global macro picture, talk about their framework. In a lot of cases, there are differences. And the issue of the UK came up for them as well. Let's listen to a snippet of that. More in line with Julian's thoughts, and we don't talk about this one enough, is the UK.

14:51That's a real structural mess. Because of Brexit, they've got structural inflation that they can't really get rid of yet. Europe inflation is dissipating super fast. The UK can't get rid of it. Bomb yields are back at the highs. They already blew up the pension system once. I don't know what the UK does here. Because there's also UK housing. People are starting to get worried about that. And I saw somebody posted something on Twitter that I thought was really interesting. They're like, the next stimulus out of the UK is going to be a

15:33kind of forgiveness of mortgage payments. TINA WISDOM So as I mentioned, Macro Insider Talks is a monthly conversation. It's always great value, but I understand this once was particularly feisty. If you would like to listen to the whole one or upgrade to get that because it's pro, just scan the QR code and that will lead you down the path on how to do that. So John, a couple of things to unpack there. We've already talked about a little bit of it, but Rao bringing up the interesting point, you were just talking about the political problems this brings up. Do you think that pain on the consumer is going to result in some kind of mortgage relief program.

16:16I guess the question before that is, is this a political problem for the Sunak government? Could this cost him, the prime minister, the leadership? And does that, do they do something like mortgage relief in order to offset some of the pain, especially to those who are feeling it at the bottom of the income scales? So I don't, I mean, I don't really like to comment on politics. I think the SUNAT government, though, is under incredible pressure. So I think mortgage interest relief is probably on his register. Whether it actually gets enacted or not, who knows? Well, there's a problem, isn't it?

17:03Because then if the Bank of England is raising rates and then you come in with this is the problem, again, that many central banks are facing. if you're trying to get a handle on inflation, but the measures you take to do that are killing consumers and you come in with fiscal aid for them, it's going to only make the inflation problem worse. I mean, it is the rock and the hard place that central banks find themselves in, right? Yeah, 100%. And I mean, I have been saying to clients consistently for the last year, I would not want to be a central banker here. They literally are in a no-win situation because they're caught between the political cycle, inflation, and maybe what's right for them to do, ultimately, for the average person on the street.

17:56And the average person on the street, everybody talks about excess savings and how much excess savings are pre-COVID or post-COVID. like sort of shielding the consumer and i'm like where are those excess savings where are they because i don't see them with the average person they're they're they're in the top quintile right like everybody that could save saved and everybody that had to spend spent and so So the marginal propensity of that excess savings that all the economists talk about to actually be spent is near zero. Yeah. Yeah, I think anecdotally, we so feel it. For different reasons in different places, you've got the mortgage reset issue hitting much sooner for everyone in the UK.

18:59Here, I feel like health, that just the health inflation never stops. so people aren't protected from health care. They have to get it through their employer. Now lots of people are remote and contracting gigs. You know, switch it up. But you feel that most people are really stretched. Like it does not feel like everyone's sitting on this mountain of cash. Maggie, you look at anything for the middle classes at the moment, right? Education through the roof. Healthcare through the roof. I mean, you have kids, right? Yes, and they're soon to be going to college, so it's like shoot me through the heart with that comment with education.

19:37Education, healthcare, food, energy, right? Like car financing, everything is up here for the people that actually are meant to murder the economy, right? Yes. Yeah. The engine of the economy, the consumer, by the way, our great community has been helping me because I also had to buy a car. So I'm like smack in the middle of everything because I have a new driver that you're talking about. We are a credit based economy globally. Yeah.

20:20And that economy relies on like the credit impulse. And at the moment, I think the credit impulse has disappeared. Well, that's important. It's coming from somebody who manages credit. So that to me is, everyone's talking about how strong the economy is. When's the recession? Where's the recession? Is it coming? You say the credit impulse looks weak. Yeah. I mean, I think it's incredibly weak. And I will tell you now, I am the most bearish person on the planet, on the economy. I just see like a car crash coming with the economy. But actually with credit markets, for once in my 23 years, I actually see value across the board in credit and fixing.

21:13We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

21:24All right, this is where, all right, let's get, let's dive. So we set the, we set the stage. Let's dive into your area of expertise in the market. So that's interesting because that sounds kind of diametrically opposed to somebody who thinks there's a crash coming or there's some real, real pain ahead. So first of all, UK, in that clip we heard from Raoul, we heard him say they blew up the UK pension system once. So is there a risk that UK bond yields go back to those highs and threaten the UK pension system once again?

21:59I'm looking at my Bloomberg. You've got them up on your screen. Yeah, I think that's, we have a question that said, do you think the UK two-year gill can hit 6 % in the second half of 2023? There is no reason why not in this environment. But that said, and I will, again, I'll come back to credit and fixed income. the break-evens, and by break-evens I mean how much volatility can you actually stomach before you actually start losing money. The break-evens in credit and fixed income at the moment are better than I have seen them in 23 years. So I will be all my goals. Yields, the carry. Over a 6 to 18-month time horizon, you are being paid for the volatility.

23:03So if you assume that investment-grade credit at the moment, even if you look at the worst downside, is a 10 to 15 volatility asset class, you're being compensated for it. And that is the first time since I started my career in 2000 that you've actually been compensated for it. I will tell you there are people that I work with and that I try and sort of, I've tried to kind of elucidate this concept to where, you know, you try and talk to them about break even and they're like, well, you're not getting paid. And I'm like, but you haven't added the carryback. And as soon as you add 6 % to 7 % to 8 % carry back to this asset class, you're getting bond-like risk for equity-like forward-looking returns.

24:12And I think that's really, really important to understand. Because at the moment, in equities, you're getting ginormous potential forward-looking volatility for, I don't know, I don't know what the forward-looking return profile is. But in credit and fixed income, you are getting bond-like risk for forward-looking equity-like returns. I'm bearish, by the way. Yeah. So what do you think is, you think this is a point that's lost on a lot of people? Yeah. Nobody seems to grasp that. Look, we've all got used in the last 15 years to zero carry, right? Zero rates, negative rates, all these sort of weird monetary policy tools.

25:15And everybody's forgot about this concept of where's the carry. And if you remember a year and a half ago, two years ago, everybody was talking about crypto, right? And how crypto carried 8 % and how that made it a great asset class. And I'm not saying crypto is not a great asset class. I'm just saying that's what everybody was talking about. Well, guess what? Investment grade credit in a lot of areas now is carrying 6 % to 8 % returns. And one of the things I would say is as a fund, we have been buying really, really high-quality investment-grade companies

26:10and kind of wanting them to default because we've been buying them in the 40s and 50s in terms of the cash price. And the recovery is like 90 to 100. So for the first time ever in my career, I've been buying investment grade high triple B single A bonds and going, well, I really want you to default tomorrow because the recovery is like 90 and I'm buying the bond at 40. Which seems so, it's going to be hard for people to wrap their head around. Like, I mean, come on, even I can't wrap my head around it. So Ralph asking, what about credit risk? The real risk for the market at the moment and the real risk for, I think, the global economy is we get central banks that are so focused on snuffing out inflation that they cause a proper default cycle.

27:31I can't see it because I think the pain for that real creative disruption cycle the pain given how much debt we have globally is just too big. I just think it's too large for the politicians or the central banks to take. I think before we get there, and actually in our capital allocation meeting today that we had, that's one of the things that I was saying that, But look, yeah, we might get 200, 300 basis points of spread widening in credit. But you're kind of being compensated for it. And I think if we get there, the central banks are forced to come in and cut rates. Right. Right. Is this investment in bonds and the care you get for it, is this something that an average investor should be looking at, say an individual investor?

28:41Or is this more for the sophisticated group? Because we've got a wide range that watch this show. Right. So hopefully you'll give your usual caveat about - Yes, this is John's research only. This is not investment advice. Only know you can know your risk profile. Do not just go out and do something because someone else says it. We teach you that at the academy. Honestly, honestly, when I look at credit and fixed income here, I mean, I'm the last person ever to talk my book, right? I literally will tell, I will call the spade a spade. But when I look at credit and fixed income here versus equities, I'm like, this is the opportunity of a lifetime to invest in bond.

29:32Quality. So you're talking about investment grade. Bond-like, yeah, investment grade. You don't even have to go down to AT1s or COCOs or all sort of the higher beta sectors. Because you can invest the investment grade with equity-like forward-looking returns for bond-like risk. And do you know what? If a lot of these guys default, who cares? You're actually going to make quite a lot of money. Is that because bond holders are made hold, equity gets wiped out? Yeah, 100%. In a kind of default or bankruptcy, there's a pecking order, which is why you have to be really careful if you're on the equity side of things.

30:12because you'll hear people say that all the time. Equity will get wiped out. We heard that from guests earlier across the board, especially talking about commercial real estate. So for me at the moment, you're getting equity-like forward-looking returns for bond-like risk, i.e. you are getting a lot less risk for the potential of immense convexity on the upside. If we do go into a rate-cutting cycle, You know, a lot of these bonds have double digit plus returns. What would change your outlook? What would cause you to pause and say, oh, OK, hang on a second. The opportunity of a lifetime is swinging around here.