Stumbling and Mumbling

The sales-wealth puzzle

DSG International - Dixons as was - says sales are booming. But people aren't flocking into Dixons because of the charm and efficiency of its staff. They're doing so because spending generally is picking up; the British Retail Consortium says sales grew 9.8% (doc*) in the year to April.
This chart shows one reason why sales should rise - the ratio of sales to house prices is at an all-time low.
This is not a quirk of the strong housing market. The ratio of sales to households' bank deposits is also at a record low, whilst the ratio of sales to share prices is below average. The overall sales-wealth ratio is therefore very low.
Why should this point to sales rising? Simple. Over time, wealth and spending should rise together - if they didn't, we'd all end up as either misers or bankrupts. So, when spending is a long way below wealth, spending should subsequently rise. It's like a drunk walking her dog home (pdf); the two might wander a long way from each other during the journey, but they end up in the same place.
Which raises the question: why, then, might sales not rise much? There are some mundane answers.  People are using housing wealth as a form of pensions saving. The positive effects of the low sales-wealth ratio will be offset by rising unemployment, low wage inflation, and rising utility bills depressing spending.
But there's a more interesting possibility. Sales and wealth can converge not merely because sales rise, but because wealth falls. There's evidence from both the UK (pdf) and US (pdf) that the consumption-wealth ratio can predict equity returns. For example, high sales-house price ratios in 1970, 1982 and 1994 led to  rising share prices, whilst low ratios in 1973, 1987 and 2001 led to falling prices.
This might reflect the wisdom of crowds. Consumers in aggregate. tacitly, see bad times coming and spend little (relative to their wealth) in anticipation.
The bottom line here is that either retail sales might be surprisingly strong, or share prices surprisingly weak. If I were into the judgment-futurology business, I'd say which.
* The link is to the document because news reports merely rehash the BRC's self-servingly downbeat gloss upon the report.

A housing puzzle

In my day job, I point out that a single person must be in the top 3% of earners if s/he is to afford the average house. My gut instinct is that this is not a desirable state of affairs.

But I try not to think with my gut. Here are some attempts to rationalize this instinct. They start from the premise that an average house, unlike say a Ferrari, is the sort of thing which a reasonable person might strongly want.

1. It’s welfare-inegalitarian. For most people, houses are only affordable if you are in a meaningful relationship. People with such relationships, or the illusion thereof, are happier than others. In giving these greater opportunities for home-ownership, we are giving more to the better off.

2. Home-ownership, as Thatcher realized, is a material stake in society. Should this be confined to a rich minority?

3. Adverse incentives. For many people, the way to afford a house is not to work hard - £50,000 is out of reach for many hard workers – but to get a partner. Efforts to do this, however, require one to work less hard – to do less overtime, to wake up later in the mornings.

Also, if you don’t own a house, it’s even harder to convert income into welfare; there’s a limit to how many books you can read or CDs you can listen to. This too limits one’s desire to earn more.

4. There’s something undesirable about being a tenant – about handing money over to a landlord, and being dependent upon his whims. It’s unmanly.

This raises two questions. Are my instincts right? If so, what should be done? A few months ago, I’d have said: “nothing, prices will fall and the market will solve the problem.” But this looks less likely now.

* Here are the numbers. According to HBOS, the average house price is £175,215. Assuming a loan of 90% of the price at 3.11 times income (the averages for first-time buyers according to the CML) this means you need an income of £50,700 to buy it. This neat tool shows that such an income would put a single person in the top 3% of earners. 

Getting retailing reports right

The FT shows how easy it is for the MSM to be captured by vested interests. Its lead story today is:

Fears that Britain might be facing a fresh consumer slowdown will be stoked up on Tuesday by a retail survey showing the weakest high street sales for more than a decade.
High street sales last month were the weakest in 11 years according to a survey published by the British Retail Consortium...The BRC/KPMG retail sales monitor shows like-for-like sales, which strip out the effect of additional floor space, increased by just 0.2 per cent last month compared with January 2004. The consortium said January was the worst start to the year since its survey began in 1995 and urged the Bank of England to cut interest rates this week.

"High street sales last month were the weakest in 11 years." This is just plain false; the very fact that like-for-like sales rose since last January should tell us this. What the survey shows is that the annual increase this January was the weakest January annual rise since January 1995. Looking at like-for-like sales in all months, January's 0.2% rise was the lowest since...October. Like-for-like sales were actually falling year-on-year in the spring, so growth has picked up - a fact the FT omits.
What's more, like-for-like sales are depressed because retailers have opened new shops in the last year. Low growth on this measure is therefore a sign not of weak sales, but of retailers' misplaced optimism. If we look at total retail sales, before adjusting for floorspace, these are up 3.6% year-on-year on BRC figures. That's only the weakest growth since September.
And because prices are weak, this number is consistent with decent volume growth. If the recent relationship between the BRC survey and official figures continues, next Thursday's official numbers will show a year-on-year rise in sales volumes of around 2.9%. That'll be a big pick-up since the autumn; it'll mean 3 month-on-3 month growth of around 1.6% unannualized.
Now, not much of this is in the BRC press release. But a quick call to any neutral economist would have revealed it.  Such a neutral economist would also point out that the BRC will always want a cut in interest rates.  Should an uncritical report of this demand  really be a lead story?

No to compulsion

David Blunkett, we're told, is thinking of forcing us to contribute to pension funds. This is a stinkingly bad idea.
For one thing, as I've said before, it's not clear that there's a problem. Claims that there is a huge "savings gap" are scaremongering by an industry that's so incompetent and dishonest that it cannot attract business except through state help.
But let's say I'm wrong, and that people aren't saving enough for their retirement. Why does this require a policy response? What's the externality? Why is your lack of savings a problem for anyone else but you?
Of course, there's an externality in the sense that poor pensioners will take up means-tested benefits, which means the rest of us must pay higher taxes. But it's the existence of these benefits that makes saving irrational for millions of lower-earners. To force people to save because the state gives them a disincentive to do so is the sort of crack-brained nonsense that only governments could come up with.
Aside from this, there's no evidence that a savings shortage is harming third parties. Certainly, it's not restricting corporate investment. Real interest rates, as measured by yields on index-linked gilts, are now at an all-time low. And the last CBI survey found that only 8 per cent of manufacturers complained that a shortage of external finance was limiting their investment.
However, compulsory savings would impose an externality onto others. If the state compels people to save more, consumer spending will fall. As there'll be no reason for corporate investment or government spending to rise, aggregate demand will therefore fall. That'll throw people out of work and reduce aggregate savings in the economy. This is the paradox of thrift. It should be well-known.
Compulsory savings then, might create a problem where none exists.
There is, though, another reason for resisting compulsion.  The very idea of compulsion depends upon the idea that the state should treat us as if we were infants, incapable of making sensible decisions about our own futures.
Granted, there are some publicity-hungry airheads of whom this seems true. But these are just well-publicized exceptions. And, of course, even if stupidity were widespread, it would  be no case at all for state intervention; the same cretins that cannot run their own lives are those who elect the government.
And herein lies the real evil in compulsory savings. To accept this policy is to accept the idea that the state should treat people as if they were children. Once you swallow that, you'll have destroyed the foundation on which our freedom lies.

Who's to blame for low savings?

Another day, another report claiming that Britons aren't saving enough. This has prompted the usual bleating from the financial "services" industry. Foreign & Colonial say:

The poor health of the nation's personal savings is simply not getting the attention it deserves...The 'savings time bomb' is a long-recognised problem but things appear to be getting worse rather than better. With access to final pension salary schemes rapidly disappearing, the British public are going to have to become even more reliant on making their own provisions whether through pensions, ISAs or other means. Yet alarmingly the household savings ratio has fallen dramatically since 1997 from over 9% to under 6% now. A combination of factors are behind this fall, not least the state of investment markets, but the problem has also been exacerbated by public policy moves such as the abolition of dividend tax credits on equity ISAs. Furthermore, one of the Chancellor's first acts was to reduce the tax advantages of pension funds which will undermine the long-term return on these schemes.

What F&C don't say - and nor does any other  fund management company - is that fund managers are themselves partly to blame for low savings.
These figures show that retail investors bought £4.7bn of unit trusts last year. That's 0.6 per cent of disposable income. That's the same proportion as in 1972, and  barely half the proportion of 1985.
Decades of rising incomes, and an ageing population, have therefore had no obvious effect in raising the demand for unit trusts.
Why? One reason is that there has been almost no technical progress in the unit trust industry. The typical unit trust is the same thing it was back in 1972; a middle-aged man with a second-class degree from a second-rate university uses accounting information to try to spot good shares.
If cars or computers were the same today as in 1972, demand for them would be tiny. Why, then, does the fund management industry expect decent demand for its products?
In truth, though, even this question is too kind. Even in 1972 cars were at least designed according to sound engineering principles. Conventional fund management has no such intellectual foundation. The notion that you can use accounting information to spot good stocks is just absurd. One group of economists who stopped laughing long enough to test the theory concluded that:

There is no persistence in long-term earnings growth beyond chance, and there is low predictability even with a wide variety of predictor variables. (full pdf here)

It needn't be like this. Behavioural finance emerged 20 years ago, but it's only in the last couple of years that fund managers have been thinking about it. And in my day job (subs req, I'm afraid), I've shown that portfolios based on simple Markowitz mean-variance optimization techniques - which are over 50 years' old - have out-performed the All-share by 90 percentage points in the last five years, beating all but 3 unit trusts. 
If fund managers want more customers, they should abandon failed managerialism and start thinking about proper economics. Until they do this, their call for the "savings time bomb" (which is of course no such thing) to be an election issue has as much credibility as my belief that the real issue should be society's appalling under-valuation of tall balding Leicester-born Oxford-educated economists.

Finding a silver lining

Why is Gordon Brown promising to create a million new home-owners in the next five years?

It’s not because he’s been converted to the merits of a property-owning democracy. Instead, the reason is hinted at here:

Officials suggested that…500,000 new homeowners to make up Mr Brown’s million would be first-time buyers helped by the reduction in stamp duty and “macroeconomic conditions”.

What could these “macroeconomic conditions” be?

A fall in house prices, that’s what. This would price potential first-time buyers into the market, and create a supply of property from distressed buy-to-let punters.

Mr Brown’s target is therefore an attempt to create a silver lining from the cloud of lower house prices.

And house prices could fall a lot, even if macroeconomic conditions remain benign.

House price inflation feeds on itself. When prices start rising, people jump onto the bandwagon, sending prices further upwards. This is what happened in 1989 and 2002.

But if people can jump onto a bandwagon, they can jump off. Once house prices start falling – as they already are – potential buyers will delay buying in the hope of a bargain later. This creates a lack of demand which drives prices down further.

What’s more, sellers’ price expectations are backward-looking. Asking prices don’t fall immediately as the market deteriorates. In the early stages of a downturn, therefore, house remain unsold; this too is happening now. It is only later, when the full extent of the market’s weakness becomes obvious, that asking prices decline. Again, this drives prices down*.

There’s a third source of momentum. As house prices drop, so does consumer spending; retail sales were lower in February than in September. This could increase job insecurity, which further weakens house prices.

Now, these mechanisms don’t mean there’ll be a house price crash. Rather, they suggest prices could fall steadily for 2-3 years.

At these lower levels, though, first-time buyers will be able to return to the market. (At least, those still in jobs will do so – such as people working in the public sector.) The upshot is that, after five years, Mr Brown will be able to claim that the numbers of home-buyers has increased**.

Now, you might find the prospect of the Chancellor gloating over falling house prices an unpleasant one.

But there is a greater cost of falling house prices. It could mean we see fewer property programmes on TV. And this raises the possibility that we’ll see less of Sarah Beeny. This, gentlemen, is surely a truly appalling prospect.

* Remember – house price indices are measures of the properties that change hands. This means indices are biased upwards at times when only the best homes are sold, which is what happens early in a downturn.

** The danger here, of course, is that rising unemployment might force some home-owners to sell up. However, if they sell to first-time buyers, there’s no net fall in home-ownership. And anyway, as interest rates come down, such forced selling might be limited.

The micro-macro error

Housebuilder Persimmon reports today that sales of its houses are up strongly so far this year. Does this mean the housing market slowdown is over?

No. It is a howling error to infer anything about macroeconomic conditions from the experience of one particular company. No sensible person would infer from the bankruptcies of Courts and Allders that retail sales collapsed last year. Why then infer from Persimmon’s success that the housing market is strong? The fact is that many companies thrive in downturns and many fail in booms; even in the 1990-91 recession, huge numbers of firms did very well, as this book shows.

Maybe Persimmon’s results merely demonstrate this fact.

Indeed, aggregate numbers suggest housing turnover is has fallen sharply. Figures from the Bank of England show that the number of mortgage approvals in December were 37.1 per cent down on last December (page 3 of this pdf – more figures are out tomorrow). And this pdf from the Inland Revenue shows that property transactions in January were 28.7 per cent down on last January.

This matters, because falls in housing turnover can be a leading indicator of falling prices. The house price falls of 1989-90, 1992 and the slowdown in 2000 were all preceded by downturns in turnover.

There’s a simple reason for this. Sellers’ asking prices tend to be stickier than buyers’ offer prices. This is because asking prices depend partly upon private valuations of one’s own house as well as upon market conditions, whereas offer prices are a purer reflection of market conditions. The upshot is that if the outlook for the housing market deteriorates, offer prices will fall relative to asking prices. The result will be fewer transactions as buyers and sellers fail to agree a price. It is only after a few months, when sellers’ asking prices adjust, that house prices will fall.

This stickiness of asking prices can also mean that house price indices overstate the true strength of the housing market when turnover falls – because the houses that change hands are a biased sample of all the houses on the market. This pdf by Will Goetzmann estimates that this bias can cause measured price indices to overstate true prices by around 5 per cent in a downturn.

Of course, it’s still a matter of debate whether house prices will fall sharply or not.

What we can say though Persimmon’s results don’t add much to the picture.

They do, though, look like perpetuating one of the stock market’s more curious anomalies – the seasonal pattern in house-building stocks.

Since 1986, Datastream’s index of house-builders has out-performed the market 17 times out of 19 in the first quarter of the year. In the other three quarters it has out-performed only 21 out of 57 times.

What's a fact?

It looks like the consumer boom is over. Today’s official figures show that retail sales volumes fell a seasonally adjusted 1 per cent in December, the fourth biggest drop in the last five years.

If we look behind the headlines, though, a different picture emerges.

Before seasonal adjustment, sales volumes rose 17.5 per cent in December; the figures are in table 2 of this pdf. The previous December, unadjusted sales rose by 18.9 per cent (this number is itself revised down).

So, comparing December 2004 to December 2003, there was a 1.4 per cent slowdown in unadjusted sales growth. However, there was a 2.6 per cent slowdown in adjusted sales growth; in December 2003, seasonally adjusted sales grew 1.6 per cent.

Why the difference? It’s because National Statistics adjust for calendar effects. This “December” was in fact the period from November 28 to January 1. “December” 2003 ran from November 30 to January 3.

Sales before Christmas are traditionally stronger than sales in the days after Christmas. National Statistics adjusts for this calendar pattern. It therefore, in effect, deflated December 2004 sales by more than December 2003 sales – because December 2004 contained fewer post-Christmas days of weak sales. This adjustment, it says, wiped 1.2 per cent off annual sales growth from December to December.

Now, here’s the catch. National Statistics uses historic patterns to deflate the data. But what if consumer behaviour is changing, with people doing less shopping before Christmas and more afterwards? If this is the case – and many people believe it is - then National Statistics will have deflated this December’s sales by too much.

Sales might, therefore, be stronger than the headline adjusted data suggests.

This doesn’t mean consumer spending won’t slow down. It almost certainly will. The only reasons to doubt this are the strong growth in households’ bank deposits and the permanent income hypothesis, which warns us that spending should be unpredictable.

What it does mean is that economic “facts” are not objective things, independent of theory. The “fact” that sales fell in December is partly the product of a theory – that consumers’ seasonal behaviour hasn’t changed. As Mark Blaug said in the Methodology of Economics: “All empirical observations are necessarily theory-laden.”

Leave the Bank alone

I don’t expect decent coverage of business and finance from the BBC (“Money? That’s what comes from daddy, isn’t it”). And I didn’t get it from the Today programme this morning.

In an interview with John Clare, Dixons’ chief executive, neither Jim Naughtie nor Jeff Randall challenged him when he called for the Bank of England to cut interest rates. Recent rises, said Mr Clare, are “biting”. Warning of a slowdown in sales, he added: “we’d look for a reduction in interest rates and that might just give us a glimmer of light.” (7.15 here – about 4 minutes in. Dixons’ statement on Christmas sales is here.)

Mr Clare is not alone in calling for a rate cut. Kevin Hawkins of the British Retail Consortium said yesterday that: “the MPC can no longer dodge the issue of cutting interest rates to help ease consumers’ blues.”

Such statements, though, reflect a pernicious ideology that must be at least acknowledged.

The fact is that monetary policy is still relatively loose and favourable for retailers. The real base rate (based on RPIX inflation) is now 2.2 per cent – a full percentage point below the post-1992 average. And the M4 money stock has grown 8.8 per cent in the last 12 months, far faster than trend money GDP growth. Partly as a result of this, official figures show that the value of total retail sales has risen 4.4 per cent in the year.

I’ll grant that growth could slow this year, but that’s because people stocked up on new goods last year, and because real income growth is likely to slow – not because monetary policy is tight.

What’s more, even if the Bank does cut rates, and sales rise as a result, there’s no assurance that any particular retailer will benefit. As I’ve said before, the link between macroeconomic conditions and any individual’s fortunes is tenuous.

My advice to Mr Clare is: if you want higher sales, don’t pester the Bank. Try employing someone who has more IQ points than zits. And try having the goods that people want to buy actually in stock.

Why then are retail bosses whining about interest rates? It’s classic management ideology. To managers – in business or in politics – all success are due to their own efforts, and all failures due to outside forces. This is just one of the ruses bosses use to attempt to justify their illegitimate power.

But then, I wouldn’t really expect the BBC to challenge this ideology.

Oh, and one other thing. Could someone remind Jeff Randall that Chancellors no longer set interest rates? Let’s give Gordon Brown credit for the rare intelligent things he does.

Spent up?

The BBC reports that consumer borrowing is slowing down. Since August annual growth in mortgage lending has slowed from 15 per cent to 13.4 per cent, whilst consumer credit growth has slowed from 12.1 per cent to 11.7 per cent.

There’s one inference here that must not be drawn, though it probably will be – namely, that high debts are finally forcing people to cut their borrowing.

This might be true for some people – almost anything is true for some people - but it’s not a problem for the macroeconomy.

For one thing, household finances in aggregate are in decent shape. Bank of England figures (their site doesn’t support a link) show that households’ bank deposits have grown by £57.7bn in the last 12 months to £735.7bn – equivalent to 11 months of disposable income. That compares to growth of £47.1bn in mortgage debt and £13.5bn in non-mortgage debt.

What’s more, no fall in debt or spending will suffice to show that imprudent consumers have borrowed too much. Come the spring, my spending and borrowing will be hugely lower than a year ago. This isn’t because I’ve been forced to retrench, nor because my economic prospects have worsened. It’ll simply be because because I bought a TV, iPod and DVD recorder last spring that I won’t (I hope) need to replace this spring.

This raises two questions. First, could the rise in households’ cash balances suggest that retail sales growth, house prices and interest rates won’t come down as much as some people expect?

Second, and alternatively, could it be that (quasi) rational consumers can cause largeish economic fluctuations not (just) because of changes in permanent income expectations, but simply because purchases of new goods bunch together? If enough people are like me, the answer’s yes.