The financial health of the U.K. consumer - the alarm bells are ringing but can anybody hear them?
Prior to the Brexit vote Nick Clegg, (see #MysticClegg) wrote what the aftermath of a leave vote would entail – his economic predictions were clear, a significantly weaker UK economy. Perhaps his analysis didn't go far enough. Fast-forward a year and the warning signs of a Brexit-led recession are cropping up more frequently in the markets. Investors, should remain alert to these early signs and approach the future with caution.
RM Capital are credit investors, we are a conservative bunch, we aren't rewarded by our shareholders for backing risky ventures. We invest our clients capital with the objective of generating a steady income stream, upon maturity of the investment, the capital should be returned by the borrower alongside interest due, the upside is capped, and the capital gains are limited. It is therefore important that we keep a watchful eye on the health of the economy.
Driven in part by consumers, whom have suffered years of stagnant or below inflation pay increases (if any), have been supplementing their disposable income by increased use of credit. The ever increasing rhetoric from both the EU and British governments over Brexit negotiations is causing anxiety and compounding the problems. The result? Consumers are now tightening their belts.
Over the summer we saw the Bank of England (BOE) warning banks and financial institutions that consumer lending had reached pre-2008 levels, the FCA launched an investigation into the car finance market, Zopa the P2P lender wrote to investors warning that investment returns would be lower as bad debt levels were rising. Meanwhile, mortgage lending has slowed with house prices stagnating and many high street retail groups such as Next, and Arcadia have reported a slump in revenues. The surprising turn of events at Provident Financial serve as a timely reminder as to how fast markets can turn and asset values fall.
Consumers and their respective 'household balance sheets' are already strained and base rates are at historical lows. When the markets do turn, the Central Bankers at the BOE will be limited in their ability to help, a rate cut could weaken further the currency (and further increase the costs of imports) and a rise in rates would increase the pressure on consumers cash flows as mortgage payments would rise.
The news flow around the UK consumers financial health doesn't paint a rosy picture and whilst the markets have digested the data there appears to be little concern from investors as the market keep marching forwards (at the time of writing the FTSE All-share was up c6.24 per cent on the year). As credit investors we are cautious, it feels like déjà vu, and we are back to the pre Global Financial Crisis days of 06/07. We are investing our client’s capital in businesses which support the real economy, provide essential services and are less exposed to market cycles. Where is your capital invested?
Pietro Nicholls, is the Co-Manager of RM Secured Direct Lending PLC, a listed investment trust which specialises in asset backed lending.