Investing in 2023

While filing my tax return on Thursday and claiming a sizeable refund (the effect of amending the Polski Ład reform in 2H2022 which retroactively decreased the PIT rate in the first bracket from 17% to 12%) I thought how to make the best use of money, other than spending it.

The current year does not seem to be easy for holders of pecuniary assets, since preserving purchasing power of money has become a challenge. Let’s look at the most popular alternatives at hand.

With the current real interest rate of -10% in Poland, bank deposits (whose quotations fell recently) still offer a solid alternative to putting money in a drawer, but even with expected disinflation, a real return in a few months is very likely to be negative anyway.

Poles are generally wary of fancy investments and therefore those who possess sizeable surpluses often turn them into tangible assets, i.e. residential properties. Between October 2021 and October 2022 mortgage instalments rose by around 100% and repayment capacities shrunk, hence the number of new mortgages granted was falling by nearly 70% year-on-year in 3Q2022. Property transaction prices only nudge up these days, but with inflation of over 17% (the January 2023 reading), value-wise they have produced a real negative return of 15% over the recent year. If prices stabilise in nominal terms over the next quarters, in real terms they will begin to be getting cheaper and cheaper. My forecast for this asset class (I dislike the term, since I believe properties should meet people’s housing needs rather than constitute a haven for their money) is not optimistic. With factors driving their prices potentially up and down in the near future, I believe the rent yield and price appreciation might be at the level of bank deposits, with higher risk and lower liquidity.

The equity market reached its low in Poland and on most markets in early October 2022. It seems at that time stock prices already discounted all negative scenarios on the horizon, especially pertaining to problems with energy supply during the winter. I believe stocks might be a good, but if you purchase them on a temporary low. My strategy would be to wait for a correction and get some exposure to equities and if the correction gets deeper, buy more to bring down the average purchase price.

Government bonds seem to be a safe choice credit-wise, since most governments benefit from the inflation, as the real value of their debt shrinks. With the anticipated decrease in interest rates, fixed-coupon bonds might be a good mid-term investment, but mostly in terms of price appreciation, not the interest income. The yields on Polish 10Y gilts were quite volatile in recent weeks. Even in recent days the yield increased from 5.9% to 6.3%, which given the 10Y tenor must have resulted in a substantial loss in value.

For some foreign currencies are an alternative. Here it seems that Polish zloty is already weak against major currencies and little room for depreciation is imaginable. In practice the negative real interest, disturbingly low for a civilised world, might send the Polish currency even lower.

I have no idea about alternative investments, since I do not track them, but definitely must advise you not to jump into a train which has already departed. Chasing missed opportunities is one of major mistakes investors make. Stocks? You should have bought them in October 2022. Polish gilts – too. Inflation-linked bonds – you should have purchased them in 2021 at the latest. As a proud (of my skills) holder of those securities I do not believe they will continue to fetch extraordinarily good returns for more than a few quarters ahead. Or actually with the governor of the central bank who does not fulfil his duty to shield purchasing power of Zloty, those bonds might outperform bank deposits for 2 or 3 years.

Off for late-winter holiday next weekend. A coverage due on 12 March 2023.

Stagflation

Some time ago I believed the term coined in 1970s would become the thing of the past, explored by students of economics and occupying few pages in their textbooks. The stagflation in 1970s arose from a negative supply shock and was successfully combated by tight monetary policy and drawing back on economic liberalism. The price to pay was a rise in unemployment and downfall of inefficient, uncompetitive industries.

Rings a bell? In 1970s real negative interest rates were prevalent in developed economies, as they are today. In 1970s a surge in oil prices contributed to the stagflation; today disrupted supply chains and shortages of several components might produce a similar outcome.

The two comparisons might misguidedly suggest the today’s situation is parallel to what was witnessed over 40 years ago, while it is not.

The COVID-19 pandemic, especially in its early phases, prompted unprecedented government stimulus programmes. As several sectors of economies were brought to a halt to curb the spread of the virus, the governments had to feed mouths of those who were forbidden to work. If the link between the output and the money is broken, it means the supply of money on the market is not counterbalanced by goods or services produced and so prices inevitably rise. This has happened with a delay of a few quarters.

Frail economies of several countries were propped up by ultra-loose monetary policies, giving relief to debtors and inducing those holding cash to spend it. I suppose there are other precisely targeted measures to help out those devoid of stream of revenues. If you earn no money it does not matter much whether the interest rate on your debt is 3% or 0%.

Although the pandemic has been brought under some control in several countries, supply chains continue to be disrupted. Lack of semi-conductors, disruptive for several industries, brings supply of several goods down, which, holding everything else unchanged, pushes their prices up.

Also the climate change and efforts to slow the AGW down begin to have impact on prices of energy and fossil fuels. The time has come to pay the bill for exploitation of the planet. Prices of several goods will need to incorporate the harm done to the planet by the consumers.

As a banker I have industry insights which are out od reach for an ordinary man. I closely see how soaring prices of some raw materials send profitability of some companies up and others down. On some markets where prices increased by a few hundred percent over the recent year, buyers said they’d had enough and would rather cease to manufacture rather than produce with a loss if they are unable to pass the rising cost of raw materials to off-takers. Such phenomena are a clear signal stagflation might be in the offing.

The inflation will always have its beneficiaries, but most economic actors lose on it. Usually those better off are debtors and worse off are their creditors. On top, the poorest suffer the most. Prices of dwelling upkeep and basic food have risen by more than 6% over the recent year, hitting the wallets of the underprivileged.

I am grateful for my wisdom and intuition thanks to which I invested my savings in inflation-linked government bonds which in 2022 will pay me coupons up to 8%, with risk and liquidity profile far superior to a residential property which is considered the main alternative to bank deposits in Poland

Inflation creeping in

The inflation reading in Poland for July 2021 hit 5.0% year-on-year; the highest since May 2011 and the second-highest in the last two decades. Probably I would not gripe much about it, had the monetary policy been conducted in a proper manner. Sadly, it is not. Despite the rising price level and rapid recovery in the economy, benchmark interest rate in Poland stays at 0.10% (which in fact means the real interest rate is almost -5%, perhaps the lowest in the civilised world).

Interest rates in Poland were slashed to a record-low (by historical standards) level of 1.50% in March 2015, when Poland struggled a deflation. Then such move, with real interest rate of nearly 3%, was justified. Despite economic expansion, the central bank kept its rate level until March 2020, when it responded to the pandemic-related economic standstill by a rate cut of 50 basis points. In the next weeks the current level of 0.10% was reached. I will refrain from commenting on the legitimacy of such move in a situation of an unprecedented supply shock. I believe tools different than the cost of money should have been used to help businesses and customers out.

Customarily, I am referring you to my essay on harms inflicted by too loose monetary policy. Times have changed, economic principles have not, albeit some are intent on setting new paradigms.

Astonishingly many people realise why the Polish central bank does not react to the price growth which exceeds the statutory goal of monetary policy (i.e. inflation target of 2.50% +/- 1 p.p.). They do it to help the government finance its debt cheaply and pay negative interest on a large portion thereof. Not only the debt service spending is lower thanks to lack of monetary tightening. Higher prices mean higher tax inflows, predominantly from VAT. Inflation which spirals out of control always at least temporarily translates into negative real interest rates which facilitate transfer of wealth from creditors to debtors, including the biggest debtors in the world, i.e. governments.

Those particularly worse off are savers who now either accept a depletion of their savings kept in bank accounts by 5% yearly in real terms, or search for havens which might shield their money from inflation. Unlike me and my parents, not everyone noticed the opportunity of inflation-indexed 4Y government bonds in 2019 (which has turned out to be an excellent nearly risk-free investment making me give up on my resolution made a decade earlier). Folks with substantial savings have rushed to buy properties, as they believe tangible assets should store value. I am putting it down to Poles’ inability to invest in any other asset class than properties. Had flats purchased for investment reasons been put on the market for rent, this would have been quite okay, since thosee dwellings would meet someone’s housing needs. Horrifyingly, a growing number of flats stay vacant, as the purpose of their purchase was purely speculative, i.e. to benefit from value appreciation, despite bearing upkeep costs.

Moving back to the core topic of the post, i.e. to inflation, we should understand what drives prices up and why there is little chance the price growth decelerates.

1. Far too much hollow money has been printed during lockdowns. If goods or services are not produced, but economic actors receive a pecuniary compensation for being idle from a government, the link between a payment and goods or services offered in return is broken. A first-year student in economics would recognise it!

2. Recovery programmes run by governments to stimulate economies – they raise prices of specific goods and services, i.e. construction materials and services if a programme is aimed at such sector.

3. Broken supply chains, which have not been fully restored since early 2020. This problem affects several industries and strikes several markets off balances. These days the shortage of brand-new cars or bicycles is driven by shortage of components, without which vehicles cannot be manufactured.

4. Deferred demand – after several sectors were shut for months and as the general uncertainty seems over, customers rush to catch up on spending and business want to make up for losses incurred during lockdowns.

5. Lack of incentive to save. As people see their money evaporating on real terms from bank deposits, they are more eager to spend it, i.e. consume rather than invest.

6. Climate change and environment protection. This is the foremost reason. The time is coming to bring the price of several planet-destructive goods real and make them reflect the harm caused to the planet. For such reasons cars will have to be less affordable, prices of electricity generated from burning coal are bound to go up. Same needs to happen about rubbish collection charges, plane tickets, packaging, clothes and other goods humans thoughtlessly use in excess.

Having written that, I am happy I bought and furnished my dwelling in 2018, do not need to purchase a car, nor a bike and price growth of several goods does not affect me.

The last good year for the Polish economy

If you claim PiS has a macroeconomic agenda for Poland, I am afraid you would find it hard to convince me. The economic agenda of the ruling party rests on social allowances, this one pillar is fairly sufficient to prop it up and buy off several voters who, for the first time since 1989 have been given tangible cash into their hands.

The previous governments were pursuing systemic reforms, while this government neglects important spheres which require attention and investments, such as education, health service, efficient public administration. This is all done at the expense of money spent on social transfers. A new system of roads, modern trains, an improved schooling system prove not to improve the comfort of living as good as five hundred zlotys held in a palm.

Allowances generously given out by PiS are not correlated with what products or services put out in an economy nor anyhow linked to productivity. With the same amount of goods and services delivered, incomes of individuals rise. This in the short run spurs consumption and propels economic growth, but in the long run, as any student of economics should know, would spark off inflation, the phenomenon has already begun to materialise and apply most to basic products, such as fruits and vegetables, as well as to services.

The continuous price growth is consistently ignored by the central bank, whose officials obstinately point at its temporary nature, while in fact the inflation has not been caused by external shocks, but is driven predominantly by rising wages which are the component of a price of nearly any product or service. The central bank, by keeping its benchmark rate over one percentage point below (official) inflation rate not only facilitates transfer of wealth from savers to borrowers (including the biggest debtor, i.e. the government), but also fails to fulfil its statutory task which is ensuring price stability.

Savings of those have put some money aside are eaten up by inflation or actually the savers lose in real terms. When such situations occur, cash holders flee their cash and attempt to invest in assets which can potentially protect their savings from inflation. The biggest victims are first homebuyers priced out of the market, since the property market is the mostly afflicted by cash fleeing.

The cost pressures are hitting results of enterprises which have to raise wages (this pertains mostly to manufacturers), bear higher costs of energy (to be unfrozen in 2020) and transport. As an analyst covering corporate clients I have access to portfolio statistics which clearly show 2017 was the best year for corporates in Poland, then profitability of businesses dwindled in 2018, first half of 2019 have brought a further decline and number of distressed companies is further rising. With quick growth of minimum wages and increase in social security contributions the trend is unlikely to reverse.

Fellow bankers and I in unison are confident the Polish economy is anywhere but in the balance. It is overheated. I blame the Polish government, precisely their pursuit of policies of adding fuel to the fire and the central bank for not raising the interest rates when it should have been done, i.e. in 2017 for the overheating.

Regardless of my gripes, PiS is bound to win the election due in two weeks. As I once pointed out, it ought to win to pay the price for its reckless policy, but we have to mobilise ourselves to minimise the scale of their victory, at best not to let them win simple majority. Keep the faith!

Half-year musings on economy

Late June. The time of year when days are the longest and it is a shame to stay indoors while the sunlight is out until 9 p.m. or later. After nine hours spent in the office and some household chores, there are still two hours left to enjoy the beginning of the summer.

On Wednesday I went to a swimming pool, for the first time since ages not during the weekend (few people had the same idea), on Thursday I took a bike and rode over 30 kilometres, making ac circle around Chopin Airport, which in a decade might be non-operational if idiotic plans of building a giant transport hub half-way between Warsaw and Łódź are carried through. The ride was a good time to ponder on the current state of economy, on macro and micro level.

The press reports say despite the rising crude oil prices, summer of 2018 will go down as the time of cheap airplane tickets. Checked out some offers at Wizzair’s webpage to learn the prices are indeed quite attractive. As it can be witnessed, tight competition exerts pressure on margins, which in the long run will not be beneficial for travellers. The weaker airlines might not withstand the price war and might easily go under or be taken over by stronger competitors. With fewer flight operators on the market, competitive pressure can ease and the era of low prices might draw to a close. On the other hand, prophets of doom have outlined such scenarios for many years and despite some bankruptcies cheap flight are still easy to find.

Although for nearly four years I have kept my savings away from the stock market, nor even investment funds, I recently began to keep track of stock market performance. WIG, the broad-market index of the Warsaw Stock Exchange on Thursday was 19% down from its peak reached in the third decade of January 2018. It rebounded on Friday, but the 5-month rate of return is below -17%. After one or two trading days marked with red colour, the broad-market index can enter the territory of bear market (20% decline from peak). Several factors bring stock prices down: fear of trade wars (say thank you to the insane president), fears of global economic slowdown, but also imminent lower GDP growth dynamics in Poland, as the peak is by all accounts behind.

I cycled past the recently built housing estates in Mordor and near ul. Kłobucka within the borders of Ursynów. New blocks of flats are erected between recently built ones. Proximity of the airport, S79 expressway, railway tracks, prison and old warehouses, lack of decent infrastructure and public transport links, high density of development are crucial downsides of that location, but despite that flats are selling like hot cakes out there, even before construction commences. Second-hand (nearly new) flats in the area have asking prices in the range of PLN 10-12k, same as in areas of Ursynów superbly linked to the city centre by underground. Nevertheless, data from residential primary market show 2% q/q and 2% y/y decline on six biggest markets, shows the demand is not infinite and buyers are sensitive to price hike. On the other hand, the recent NBP report shows profit margin of developers have not shrunk despite rising costs of building materials and shortages of labour force.

Sales of brand-new automobiles still rise, but the growing supply of 3-4-year old used (mostly post-lease) cars constitutes an alternative to a purchase of a brand-new vehicle. Though I personally see several drawbacks of such cars, many people will go for a used cars which cost half (or less) of what they would have to pay to drive out of dealer’s showroom as first owners of a shiny vehicle. Car dealers’ sales targets are exorbitant, besides stocks of unsold cars are rising, so the tensions in among distributors begin to emerge.

Last week the central bank of Czech Republic jacked up interest rates for the fourth time in a year. Currently the benchmark rate is 1%, still 0.5 percentage points below the benchmark rate in Poland, yet it has to be noted the central bank of Poland’s southern neighbour is acting ahead of inflationary pressures and overheating economy and cools it down, while it is going strong and easily absorbs the higher cost of money.

Lessons from the crisis have not been learnt. I recently heard property prices in Denmark rose by 100% since 2012, so a classic bubble has emerged there. Reasons: firstly, negative interest rates, secondly, adjustable-rate (interest-only for up to 10 years) mortgages, in which a borrower pays only interest (laughably low), but principal repayments begin after 10 years. Such product, similar to toxic mortgages which a decade ago blew over the US economy and spilt worldwide, is a ticking time bomb, waiting to go off. Frotunately, in terms of mortgage lending regulatory constraints in Poland are far tighter and ward off a serious crisis.

One only ought to bear in mind nothing lasts forever. The business cycle theories still hold true and after a few years of boom time of growth deceleration ensues inevitably. This should be borne in mind and taken into account while taking forward-looking decisions.