Capitals and corporations

Influence in the world is a capital that must be carefully guarded if it is not to disappear. – Leo Tolstoy

Something I think that is remarkable is how few people foresaw the massive increase in value in living in a capital city. Even people who bought a house in Central London 20 years ago never thought that the increase in value would be so large. At the same time, the stock market (as measured by the FTSE 100 Index) has treaded water for 20 years. I don’t know anyone who has really explained this, even with the benefit of hindsight.
The FTSE 100 index is made up of the 100 largest companies in the UK. When it started in Dec 1983 these companies in the UK were indexed to 1000. 16 years later, Dec 1999 the value of the index had risen to 6930. But then for the next 16 years the index did not increase in value and is now below that Dec 1999 level, currently 6083 at the time of writing.
By coincidence that Halifax Regional House Price Index also goes back to 1983, and that indexed the price of a house in Greater London to 100. By 1999, when the stockmarket was at 6930, the London house price had risen to 317. About half as good as the returns from the stockmarket. But fast forward to 2016. And the London house price is at 995, well ahead of the FTSE.
No one seems to have a good explanation for this. Indeed everyone would have thought you were mad, if you had suggested 20 years ago that the FTSE index would have been a poor investment, but that borrowing large sums of money to buy a house in the City of London would be a great idea. Surely the stockmarket and London property should be related. That is, the trends that benefit a house in the City (globalisation, urbanisation, the collapse of the Soviet Union, falling interest rates) should have benefitted companies that have their headquarters in the City. But no. It hasn’t happened.
My explanations for the difference are
• Globalisation has been bad for the UK stockmarket, but good for London property. Companies like Tesco and Sainsburys compete with Amazon and also Aldi and Lidl. But a house in London is not in competition with a house in Paris, Amsterdam or New York in the same way that companies headquartered in these cities are in competition.
• Urbanisation has been bad for the UK stockmarket, but good for London property. The supply of houses in London is constrained, but more and more people want to live in the cities. According to Geoffrey West at the Santa Fe Institute there are a million people around the world moving into cities each week. Hence house price rises. But this has not benefited shareholders in companies.
• The collapse of the Soviet Union has been bad for the UK stockmarket, but good for London property. The FTSE has attracted foreign mining companies like Kazakhmys. Imagine is as if a Russian oligarch had bought an expensive house in London, for £50m and it was now worth £5m. Yet that is what has happened to many high profile listings on the FTSE 100.
• Those same individuals that float their questionable businesses on the stock exchange also buy houses in London. So there is a double effect of exchanging something of dubious value (shares in a mining company) for something valuable (a house in Chelsea). Hence the value of the stockmarket is reduced, but the value of property market is increased.
• Falling interest rates have been bad for the UK stockmarket, but good for London property. Most people understand that a “cheap mortgage” (ie low interest rates) is good news for borrowers, but bad news for savers. This is true for people with interest earning deposits in banks, but it also true for people with longer time horizon savings in equities. For instance low interest rates have increased the future pension obligations of companies, which is good for former employees, but less good for current shareholders.  Cheap debt and the ability to take on massive leverage has increased the price of houses, but it has not been good news for companies like Glencore which floated at 530p several years ago, and is now currently worth around 90p
• There is also the important matter of management at the top of companies paying themselves large sums of money, which was not justified by the performance of their share prices. This obvious in the case of banks like Barclays and Standard Chartered, but more generally it is a theme with most companies.

• If you had spotted that Buy to Let was going to be a huge opportunity – you could have borrowed lots of money from banks and bought houses to rent out.  Or you could have bought shares in the companies that were providing the mortgages to landlords.  As it turns out if you had done the latter, and bought shares in HBOS, Bradford & Bingley and Northern Rock, you would have lost everything.   No one I know who did BTL did so because they realised that they were getting such a good deal from the banks lending them the money, that the banks would go bust.  But this is what happened.

There is definitely something valuable about living in a capital city. Otherwise people wouldn’t pay so much to rent or buy there. I like Geoffrey West’s* explanation

The great thing about cities, the thing that is amazing about cities is as they grow, so to speak, their dimensionality increases. That is, the space of opportunity, the space of functions, the space of jobs just continually increases. And the data shows that. If you look at job categories, it continually increases. I’ll use the word “dimensionality.” It opens up. And in fact, one of the great things about cities is that it supports crazy people. You walk down Fifth Avenue, you see crazy people. There are always crazy people. Well, that’s good. Cities are tolerant of extraordinary diversity….
This is in complete contrast to companies…. If you go to General Motors or you go to American Airlines or you go to Goldman Sachs, you don’t see crazy people. Crazy people are fired. Well, to speak of crazy people, is taking the extreme. But maverick people are often fired.

Financial Indices are more like cities than companies. You need maverick companies in an index, because occasionally those companies which are doing something that everyone else thinks is crazy, go on to be really successful. Because they are doing something no one else is doing.  If everyone spotted a commercial opportunity, it wouldn’t be an attractive opportunity by definition.  So you have to invest time and money in things other people think are crazy, or at least that they won’t work.  
I do think it is troubling that the Halifax House Price Index is doing so much better than the FTSE share price index.
A final explanation I think comes from Paul Moore’s book Crash, Bang, Wallop. Paul Moore was fired from HBOS (the merger of Halifax and Bank of Scotland) because he tried to highlight deficiencies in the risk management at the bank. HBOS was not at all tolerant of diversity, he was too much of a maverick. So they fired him.
And I wonder if high house prices and the large mortgages people find themselves under have meant that employees are less likely to be like Paul Moore. You simply can’t risk losing your job if you have a half a million pound mortgage debt hanging over you. And so companies are more hierarchical, and less likely to let employees take a risk. And this means the companies do not invest and grow. They stagnate.
The question now is, what will the future look like? Will any of these things change? If we extrapolate the performance of the last 20 years into the future a house in London will be £5 million, and the stockmarket will tread water. This seems unsustainable.
Particularly if interest rates ever do start to rise.

  • See http://edge.org/conversation/geoffrey_west-why-cities-keep-growing-corporations-and-people-always-die-and-life-gets

1 Response

  1. Ivan

    It’d be interesting to compare the performance of the 1983 index components alone- though not totally straightforward. You’d have to make some assumptions, probably that you’d reinvest just in the surviving ones each time one was taken over. But removing all the frictional costs of things moving in and out would be instructive- there’s no reweighting in a property basket, nor allowance for depreciation and tax costs of holding property. It wouldn’t I’m sure radically change the picture, nor the inflection point, but it’d certainly flatten the differential.

    London property vs Long Gilts is presumably an awful lot closer?

    Agreed that a change in interest rates could be a trend changer. As could changes in migration patterns (Brexit presumably the only likely reason), in inbound investment (personally I suspect this would affect the top end but maybe not so much further down); changes in tax treatment (property is proving a sitting duck even for G Osborne, would certainly be so under a hypothetical Labour govt)- but the total reversal of the trend back to the artificially depressed levels of the post-war decades seems highly unlikely even if the reversion to mean advocates think that that’s what ought to happen.