Sohn Conference Speaker Serra Sees UK Gilts as a Short Play

Dependency on imports, stagnant productivity, and growing social imbalance prompt negativity from Algebris Investments founder.

Davide Serra sees the United Kingdom as the “divided kingdom,” one with a broken growth model, and says shorting the country’s government debt, or gilts, is a good bet.

Speaking at the Sohn Investment Conference in New York, the founder & CEO of Algebris Investments waxed negative on the UK’s prospects, with its “Brexit” from the European Union putting the country at an inflection point.

Within the EU, the country had the “best of both worlds,” as he sees it—an independent currency along with the benefits of participating in the EU. He expects that Brexit will cost the country about £140 billion, or about 7.5% of its gross domestic product (GDP).

Among the reasons for Serra’s negativity on the UK are:

  • Its dependency on imports
  • Weak public finances
  • High level of household leverage
  • Stagnant productivity
  • Growing social imbalance

Expanding on these aspects, he explained that while half of the UK’s exports go to the EU, only 15% of EU exports go to the UK. In fact, about half of the UK’s food and energy are imported, according to Serra.

The country’s fiscal deficit sits at about 2.8% of its GDP and its public debt is about 89% of its GDP. Pointing to high credit card dependency in the country, according to Serra, “100% of sales equals a 100% rise in credit card spending debt.”

Moreover, the country’s productivity is stagnant, with UK productivity being well below the G7 average. And the top 1% of the country’s taxpayers pay 27% of the taxes, which makes for social imbalance. In addition, asset prices are high but productivity is low, and the gap between home prices in the country and consumer incomes is one of the highest in the world.

Considering all of this, he observed, “You are overinvested in the UK” and recommends shorting gilts. The yield on the 10-year gilt is more than 200 basis points below 10-year inflation expectations, according to Serra.

Another Sohn Conference speaker, Kevin Warsh, a visiting fellow in economics at the Hoover Institution and lecturer at the Stanford Graduate School of Business, is concerned about the “uniformity of opinion about what’s going to happen next” among policymakers. The last time that happened was 10 years ago,  before the onset of the global financial crisis.

Warsh wondered if the current economic climate, which is reminiscent of a second gilded age, is nearing its end. While the Federal Reserve’s actions and dominance have been good for asset prices, and beneficial for those with risk appetites who have parlayed their balance sheets to benefit from the situation, these are not good times for people living on a fixed income.

He advises that investors be open to both upside and downside risks around the world. The indicator Warsh is paying the most attention to is capital expenditure spending, considering that if businesses are investing, it is a forward-looking indicator the economy is doing well. This is also a data-based indicator, not one based on sentiment.

Warsh is concerned about what will happen “when the next shock hits and it is time to loosen.” In fact, the Fed’s “institutional credibility is at stake” whenever the economy faces its next shock, he said.

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