Jupiter Merlin Weekly: A study in failure
Jupiter Merlin Weekly: A study in failure
The Jupiter Merlin team dissect the Chancellor’s Autumn Statement, which pushed many of the hardest decisions out into the future, while piling on tax in the meantime.
Investment Manager, Jupiter Independent Funds/Merlin
Investment Manager & ESG Investment Director, Independent Funds/Merlin
Was this really the best the government could come up with? Really? After six weeks of trailing ‘eye-wateringly difficult decisions’ around the newsrooms and the briefing lobbies, Jeremy Hunt’s budget under the tutelage of Rishi Sunak is one of dismal failure. And why a failure? Because it fails economically to get the government’s finances demonstrably under control, and it offers little hope for a brighter future either economically or politically. Even a firm target for debt and deficits has proven illusory: future debt/GDP targets will be assessed at the ‘end of a rolling 5-year period’. As the Chairman of the Office of Budget Responsibility concluded stingingly, ‘mañana’, a case of kicking the can endlessly down the road.
Playing politics with the economy, Hunt has tried to be too clever by half. Public spending already approved will remain as planned for the next two years and then, far from falling in absolute terms overall, it will only grow at a slower rate. Previously planned increases in departmental spending will be scaled back and some may be cut but despite the £35bn of savings out to 2028, total government expenditure will rise, just less quickly; we will still borrow, just not as much.
For the truth is this was more a budget with a cynical eye on the 2024 election than any exercise in sound fiscal probity. The Tories are trying to lay a trap for Labour: Hunt talks a good game (those ‘eye-watering choices’ etc repeated ad nauseam) but in delaying public expenditure constraints by two years he will be able to claim the Conservatives have maintained public services while trying to manage overall debt burdens, the shortfall paid for by £24bn of extra taxes. If the government finances are still in a mess, then it will be Labour’s problem to solve with all the political consequences involved.
But Hunt cannot have it both ways. The problems cannot be so ‘eye-wateringly difficult’ that they only need addressing in two years’ time. And by fleecing middle and upper-income earners now, and raiding the coffers of energy companies and electricity generators, while deferring his responsibilities to act as a responsible steward of taxpayers’ money, he takes the electorate for fools.
Under normal circumstances this would have been a horror show as far as markets are concerned. But these are not normal times. After the Truss/Kwarteng car-crash ‘fiscal event’ of only six weeks ago, and the fact that Hunt had clearly warmed us up for what was on the agenda after already eviscerating virtually all of Kwarteng’s playlist, markets were pre-conditioned to a package of economic repression measures focused on companies and taxpayers. They were not disappointed.
Playing politics with the economy, Hunt has tried to be too clever by half. Public spending already approved will remain as planned for the next two years and then, far from falling in absolute terms overall, it will only grow at a slower rate. Previously planned increases in departmental spending will be scaled back and some may be cut but despite the £35bn of savings out to 2028, total government expenditure will rise, just less quickly; we will still borrow, just not as much.
For the truth is this was more a budget with a cynical eye on the 2024 election than any exercise in sound fiscal probity. The Tories are trying to lay a trap for Labour: Hunt talks a good game (those ‘eye-watering choices’ etc repeated ad nauseam) but in delaying public expenditure constraints by two years he will be able to claim the Conservatives have maintained public services while trying to manage overall debt burdens, the shortfall paid for by £24bn of extra taxes. If the government finances are still in a mess, then it will be Labour’s problem to solve with all the political consequences involved.
But Hunt cannot have it both ways. The problems cannot be so ‘eye-wateringly difficult’ that they only need addressing in two years’ time. And by fleecing middle and upper-income earners now, and raiding the coffers of energy companies and electricity generators, while deferring his responsibilities to act as a responsible steward of taxpayers’ money, he takes the electorate for fools.
Under normal circumstances this would have been a horror show as far as markets are concerned. But these are not normal times. After the Truss/Kwarteng car-crash ‘fiscal event’ of only six weeks ago, and the fact that Hunt had clearly warmed us up for what was on the agenda after already eviscerating virtually all of Kwarteng’s playlist, markets were pre-conditioned to a package of economic repression measures focused on companies and taxpayers. They were not disappointed.
An ideological empty vessel
Back in 2020 when the government’s finances were being blown to bits by the pandemic and the fiscal and monetary splurge to save the NHS, we said in these musings that everyone would end up having to pay to get the accounts back in order. The choices were simple: raise more through taxes; spend less; grow the economy; allow some inflation to reduce the real value of the burgeoning debt. We can quickly discard inflation; anyone who still thinks allowing prices to run away is a good strategy to achieving debt relief needs to sit quietly in a dark corner with a towel over their head. As for growth, forget it: partly thanks to ‘Trussonomics’ and the significant mismanagement of its implementation, the markets have opined that pursuing long-term growth using taxation as an incentive of achieving economic vitality and endurance is a non-starter: growth as a strategy is out of the window, monetarists are in the economic gulag for years to come.
And so we come down to taxation and government expenditure where on both counts the government’s response is depressing and debilitating.
And so we come down to taxation and government expenditure where on both counts the government’s response is depressing and debilitating.
Public spending: a reform-free zone
After all the ground-laying of those ‘eye-wateringly difficult choices’, there was precious little in evidence about immediate public spending. The NHS, entirely unreformed, will receive yet another £7bn over two years to unclog the Covid backlog; health spending accounts for 12% of GDP as it is. It has reached a pretty pass when the NHS is specifically cited by the Governor of the Bank of England as being a significant contributing factor to the shortage of available UK labour while hospital waiting lists are so long (and getting ever longer) and so many are signed off as unfit to work in the meantime. Education too will receive more cash. On the other side, predictably, and despite the very obvious geopolitical threats from those who would do us harm, defence spending will not now be increased towards 3% of GDP as promised previously by the end of the decade by both Truss and Boris; it will remain at 2%, the minimum NATO requirement, which in real terms means a significant cut after allowing for a projected decline in GDP, the corrosive effects of inflation and, when it comes to procurement from the US, the strength of the dollar.
Tax: no relief in sight
Having ducked and deferred the expenditure conundrum, the burden therefore falls on taxation to do the heavy lifting of fiscal repair. Middle and upper earners (those with ‘broad shoulders’) are to be walloped with higher taxes. As if that is not the case already: the UK tax burden is the highest in its history at 36% of GDP; the top 1% of earners already pay 29.1% of all income taxes collected and the top 11% account for 60.5%. Those percentages are going higher.
The 45p tax rate for top earners has turned in to a political football (one wonders whether when he first introduced it, Gordon Brown knew he was laying a landmine for the Tories to trip on; even if not, Kwarteng subsequently detonated it). Not only was Liz Truss’s planned abolition of the 45p top rate of tax reversed immediately after Kwarteng was sacked, but today in going even further and Hunt lowering the qualifying earnings level from £150,000 to £125,140 at which it applies, potentially an extra 250,000 people become liable for the highest rate of tax on top of the 630,000 who pay it already. Add to that the changes to dividend income and CGT reliefs, other tax bands being frozen for five years and hey presto! £24bn becomes available without the nominal taxation rate being touched. And away from central government, Hunt will allow local councils to increase Council Tax by up to 5% instead of 3%, further increasing the strain on household budgets.
But whatever the sleight of hand, the fiscal drag created by such a high and rising tax burden being applied in recessionary times in addition to simultaneously rising interest rates leaves the rational observer scratching one’s head as to whether in the past two months we have been transmogrified into citizens inhabiting a parallel universe.
The 45p tax rate for top earners has turned in to a political football (one wonders whether when he first introduced it, Gordon Brown knew he was laying a landmine for the Tories to trip on; even if not, Kwarteng subsequently detonated it). Not only was Liz Truss’s planned abolition of the 45p top rate of tax reversed immediately after Kwarteng was sacked, but today in going even further and Hunt lowering the qualifying earnings level from £150,000 to £125,140 at which it applies, potentially an extra 250,000 people become liable for the highest rate of tax on top of the 630,000 who pay it already. Add to that the changes to dividend income and CGT reliefs, other tax bands being frozen for five years and hey presto! £24bn becomes available without the nominal taxation rate being touched. And away from central government, Hunt will allow local councils to increase Council Tax by up to 5% instead of 3%, further increasing the strain on household budgets.
But whatever the sleight of hand, the fiscal drag created by such a high and rising tax burden being applied in recessionary times in addition to simultaneously rising interest rates leaves the rational observer scratching one’s head as to whether in the past two months we have been transmogrified into citizens inhabiting a parallel universe.
Inept? Careless? Or incompetent.
It might not be so hard to swallow, at least in the short term, were the government demonstrably good stewards of taxpayers’ money beforehand. But a demanding situation with the pandemic was exacerbated by the unseemly rush to do something, anything, to protect the NHS as well as the public whatever the cost. Difficult decisions had to be taken very rapidly but it does not take hindsight to see that some measures were verging on reckless in their implementation. Two stand out: first, the NHS Track & Trace system which cost £37bn; it was useless at the time and is now redundant. Second, the lack of rigour in the application of the various business loan support schemes giving rise to nearly £5bn of irrecoverable money, either because it was applied for fraudulently or the companies concerned went bust (albeit arguably that was a justifiable risk). The losses on those two projects alone account for three-quarters of the fiscal hole the current Chancellor is trying to plug, a hole inherited from his predecessor Rishi Sunak, now his boss as Prime Minister.
And now for some possibly brighter news!
If all this is depressing for taxpayers, for investors the news is potentially more positive. Markets are inherently forward-looking. In the week when it was revealed that UK headline inflation at 11.1% in October was at levels not seen since 1981, markets did not flinch. At 3.3%, the yield on the 10-Year Gilt barely moved a single iota, despite the apocalyptic news headlines. Why? Because investors are betting that, if not already at the peak, UK inflation is close to it and in 2023 will be on a downward trajectory, a view endorsed by the Office for Budget Responsibility estimates of an average rate next year of 7.4% against 9.1% in 2022 (they’ve been wrong before; will they be right this time?).
This UK data and last week’s much better than expected US inflation news will inform the central bank policy committees’ debates in December about the future path of interest rates. Will it tilt the balance of power between the competing factions? The policy hawks who believe that to relax now would be a mistake, reducing the likelihood of returning the inflation rate to 2% and prolonging the time that growth in prices remains above target as wage inflation, a significant component, becomes embedded and endemic; the doves on the other hand see no reason to cripple the economy when the monetary tightening medicine is, as they see it, already having a demonstrable effect calming consumption pressures.
The way government bond yields have fallen in the week since the headline rate of US inflation fell to 7.7%, and ex-food-and-fuel core inflation fell too (the US 10-Year Treasury today yields 3.8% against 4.16% immediately prior to the US data release; Germany’s 10-Year Bond at 2.07% is down a quarter-point over the same period) is a case of markets signalling their own expectation that the central banks have had their fun, it’s now time to calm down and take a more moderate approach. Nothing is cast in stone here. We will know before Christmas how the land lies.
The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.
This UK data and last week’s much better than expected US inflation news will inform the central bank policy committees’ debates in December about the future path of interest rates. Will it tilt the balance of power between the competing factions? The policy hawks who believe that to relax now would be a mistake, reducing the likelihood of returning the inflation rate to 2% and prolonging the time that growth in prices remains above target as wage inflation, a significant component, becomes embedded and endemic; the doves on the other hand see no reason to cripple the economy when the monetary tightening medicine is, as they see it, already having a demonstrable effect calming consumption pressures.
The way government bond yields have fallen in the week since the headline rate of US inflation fell to 7.7%, and ex-food-and-fuel core inflation fell too (the US 10-Year Treasury today yields 3.8% against 4.16% immediately prior to the US data release; Germany’s 10-Year Bond at 2.07% is down a quarter-point over the same period) is a case of markets signalling their own expectation that the central banks have had their fun, it’s now time to calm down and take a more moderate approach. Nothing is cast in stone here. We will know before Christmas how the land lies.
The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.
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