Irregular Roundup, 1st July 2024

We begin today’s Irregular Roundup with the US labour market.

US Labour market

John Authers looked at the impact of US employment data on the prospects for rate cuts.

Numbers showing a weakening manufacturing sector, declining job vacancies and reduced increase in unit labor costs all were consistent with a narrative that the Fed’s higher interest rates are at last beginning to have an impact on employment.

So, good news.

Then came Friday’s announcement of non-farm payrolls for May, revealing that the number of people in employment had increased by more than even the highest estimate.

Bad news.

As reflected in the bond market.

This week we get CPI numbers and a new dot plot from the Fed Open Market Committee.

• The consensus is for a reduction from three to two rate cuts in 2024.

But that will depend on the data.

AI for active management

Joachim Klement remains in good form, and this week he looked at how AI is coming for active management.

• Active management – although a losing game on average – depends on the interpretation of qualitative information.

A new study trained a natural language processing model to analyse US company reports (the Management Discussion & Analysis section we’ve mentioned previously).

• The AI looked at profitability and ranked firms after correcting for the Fama-French five factors (market risk, value, size, investment intensity, and profitability).

It looks like the AI did a pretty good job.

ESG bubble

Joachim’s second article looked at the ESG bubble.

• He referenced a 2023 paper using a simulated stock market.

People trade with each other in an artificial asset. Typically, the asset pays a dividend in each round of the trading game but is worthless at the end of the game.

As in the real world, the dividend comes out of the stock’s value.

Yet people regularly trade shares at prices well above fundamental value and often create share price bubbles that then burst a few rounds before the game ends.

The recent paper split the subject into three groups:

1. the company being traded was described as “particularly good on the sustainability front”
2. the company was described as bad for sustainability
3. the company was presented as neutral

On average, sustainable stocks traded at higher prices for longer and then crashed harder than stocks with a poor sustainability performance or neutral stocks.

The researchers also found that the more the subjects had personal values aligned with ESG and sustainability, the larger the bubble.

• Groups with a higher proportion of women also produced bigger bubbles.

Joachim also notes that whilst “brown” stocks avoided the bubbles of “green” stocks, they did this by trading at consistently lower prices, which is also not great for investors.

Narratives matter. A positive, emotionally uplifting narrative about a stock helps increase its share price while negative stories suppress share prices. Just look at the current AI boom.

Retiring abroad

For the FT, Moira O’Neill wrote about how it’s becoming more difficult to retire abroad.

According to Moira:

Nearly three in five wealthy individuals in the UK are already considering relocating abroad, the main reason being a desire for an improved standard of living. Wealth managers report most interest in Spain, France, Italy and Portugal.

Portugal was top of my list when it looked like Corbyn could become PM, but I think the recent socialist government closed the tax break for UK pensioners.

• Spain also plans to retire its golden visa, which was on offer to anyone spending €500K on a property.

Moira also highlights problems with withdrawing money without a UK bank account (which usually means a UK address).

• And she points out that in Spain, France and Portugal, children and grandchildren get prescribed portions of your estate, whatever is in your will.

Post-Brexit, Annuities are no longer available to those living abroad.

• And issues around the abolition of the LTA mean that transfers to foreign pension schemes (QROPS) are on hold for now.

One bit of good news is that the government is making it easier to shed UK domicile, which means that those who have lived abroad for more than ten years won’t be subject to UK inheritance tax (subject to a change of government, of course).

LTA watch

Labour – or possibly just Rachel Reeves and Kier Starmer – have decided that bringing back the LTA on pensions is too much trouble.

• This is great news – we already have an annual contribution allowance, so having an output cap as well just makes planning very difficult and disincentivises saving for retirement.

In any case, the cap on the tax-free cash lump sum at £268K already penalises large pension pots.

• And there’s no guarantee that Labour won’t reduce that further.
• Or perhaps they will bring in a lifetime cap on contributions.

What they should do is increase the mandatory contribution levels into workplace pensions from 8% to at least 15%.

• I don’t expect to see this in the manifesto.

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Labour (and the OBR) had previously claimed that bringing back the LAT would raise £800M in tax (though the latest figures for 2021-21 showed that “only” £440M in penalties were paid, by 11,000 people).

• Now they say that this £800M had not been allocated to Labour’s spending plans, so no alternative tax will be needed to fill a “black hole”.

It seems to be protests from the doctors – or possibly the optics around a carve out solely for doctors – that have persuaded the Shadow Cabinet.

• The scrapping will raise fears that Reeves will resuscitate her old plan for flat-rate relief of 30% or 33% for all pension contributions.

A more likely target to me is the IHT exemption for pensions (as well as the IHT exemption for AIM shares), though a 30% flat rate of relief would be workable.

• A lower annual allowance also seems probable.

For Hargreaves Lansdown, Helen Morrissey said:

The game of lifetime allowance hokey cokey looks to have finally drawn to a close. The news will be greeted with a sigh of relief by people who can now plan ahead for their futures with more certainty.

The lifetime allowance affects more than just ultra-high net worth people. It could be an issue for many who have saved diligently for their future.

Any reform of the pension tax system should be done with the aim that people are  properly incentivised to save for their futures without having to worry about being tripped up by complex rules.

For AJ Bell, Tom Selby said:

Labour deserves credit for rowing back. The policy would have risked hitting senior public servants, including doctors, with huge tax bills, added unwelcome complexity to the pensions tax system and unfairly penalised those who enjoy strong investment growth.

Any pension tax reform taken forward by the next Governmentshould focus squarely on simplification and encouraging more people tosave for the long-term.

Tory watch

I only spotted a few tax policies in the Tory Manifesto:

1. No stamp duty for first-time buyers up to a £425K limit
   • That limit is not much use in London, and stamp duty needs to be abolished in order to free up the property market
2. Another 2% off NI
3. A pensioner tax-free allowance to ensure the State Pension doesn’t tip you into taxation
4. A beefed-up Help to Buy scheme (which Labour is also offering) plus a loophole where landlords selling to tenants could avoid tax on profits.

It’s not very radical, or even particularly Tory.

Stamp Duty

Dan Neidle from Tax Policy Associate had a plan for abolishing stamp duty without pushing up house prices.

• Of course, his answer was to get rid of both stamp duty and council tax and replace them with a land tax.

Stamp duty land tax (SDLT) reduces transactions, distorts the housing market, and often stops people moving.(because the stamp duty is “lost value”). It reduces labour mobility, results in inefficient use of land, and plausibly holds back economic growth. It also makes people miserable.

I agree with all of that.

• Unfortunately, it raises £12 bn pa.

Dan’s idea that abolition would lead to higher prices comes from the impact of previous stamp duty holidays.

• I would expect that the SDLT gap would be filled by buyers and sellers agreeing on a price in the middle (between the total cost to the buyer and what the seller actually receives).

Which would mean prices increasing by half of the amount of SLDT. But the evidence from Australia suggests otherwise:

A detailed Australian study looked at longer-term changes than the recent UK “holidays” – it found that all the incidence of stamp duty changes fell on sellers (and therefore prices). This is what we’d expect in a market that’s constrained by supply of houses.

I think this applies more at the bottom end of the market than the top, where things will always be constrained (there are only so many houses by the sea, or in Mayfair).

But Dan’s point is that stamp duty cuts would help sellers rather than the first-time buyers they are aimed at.

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Dan’s criticisms of council tax are:

1. It tops out at 1991 values of £320K (around £2M today), and
2. The top band only pays triple the bottom band

I’m fine with things as they are because property is so expensive in the UK (particularly in London).

• Massively increasing council tax would cause serious problems for a lot of pensions living in terraced houses that are worth ten times what they were thirty years ago.

There is a problem that rates vary according to council spending, and so are often higher in poorer areas.

The really courageous answer is to scrap council tax, business rates and stamp duty – that’s about £80bn altogether – and replace them all with “land value tax” (LVT).

LVT is an annual tax on the unimproved value of land, residential and commercial – probably the rate would be somewhere between 0.5% and 1% of current market values.

One per cent of the value of my house would be around ten times the council tax I currently pay, so I’m not sure how Dan proposes to implement this.

Quick Links

I have just one for you this week:

1. Alpha Architect looked at Smart rebalancing for factor strategies.

Until next time.