Those of us who remember the 1970s, even when we were kids, get nervous. No decade is entirely bad, but very few of us would like to see a repeat of inflation, endless financial stress, poverty – and, in the case of many families (mine included), migration to looking for a job. Unfortunately, so far the 2020s are too much like the 1970s for comfort.
Dario Perkins of the TS Lombard Research Group – our latest guest on the MoneyWeek podcast – lists the ways: The 1960s saw one of the longest booms on record and a flattening of the Phillips curve – that is, say that falling unemployment was not correlated with rising inflation in the way one would expect.
This encouraged policymakers to prioritize full employment over low inflation (inflation did not seem to be the relevant risk) and to develop more militant fiscal policy.
This was the backdrop for a fabulous bull market. The FTSE All-Share Index doubled in the two years to January 1969, when it peaked at a record price-earnings ratio of 23 times.
Then came a huge energy shock that built on earlier inflationary rumblings. The Phillips curve normalized, wages started to rise and the money supply jumped. Policymakers blamed temporary factors – and removed them from the inflation numbers they used as a benchmark. It was “transient”, you see.
It’s not the 1970s…
Sounds awfully familiar, doesn’t it? Especially now that, despite last Thursday’s sharp drop in oil prices, the energy price shock of recent weeks is comparable in magnitude to that of the 1970s.
Perkins isn’t convinced we should be as tense as I’m beginning to feel. There is, he says, a huge and crucial difference between now and then, in the UK at least: then labor had power; Now, that is no longer the case. Our population is not so young and “activist”, our unions are weak, our markets are much more open (companies cannot get away with price hikes in the same way) and hardly anyone – pensioners and Members aside – does not have their income indexed in any way to inflation. All of this means that a wage price spiral cannot start in quite the same way.
He may be right. I would say workers will rebuild their bargaining power fairly quickly in the face of CPI inflation hitting 10%. It is worth recalling that in the 1960s wages lagged inflation for some time before pressures appeared. There were rumblings in 1966 in the railroads and coal mines and then things got seriously worse in late 1969 when Ford Motor workers went on strike.
…but it’s not the 2010s either
Yet, whoever of us is most right – forecasters are rarely quite right – one thing is certain: we will not return to the 2010s.
The deflation machine that has been the driving force of the past decades is properly broken, which quickly proves to be a terrible shock to fund managers who have only ever worked inside said machine, and who were therefore hard-wired in their behavior. an assumption that moderate inflation and low interest rates would last forever.
With the reversal of globalization, labor costs at best no longer falling, and the structural problem of material and energy supply increasingly evident, the prices of just about everything must now rise. . A quick reminder for those who think there is an easy way out: it takes fossil fuels to make wind turbine blades and solar panels and it takes a lot of nickel – up to 90% in two weeks – to make electric car batteries.
The question is how far prices should rise, how fast and with what volatility. That we cannot know. The war in Ukraine is giving us some nasty near-term clues (very quickly and with a lot of volatility) but the layering of uncertainty means we can’t guess much more than that. Who knows, for example, what might result from attempts by money-printing governments to shield households from the sharp rise in food prices caused by the horrors in one of the world’s most trusted grain producers. ?
How can you invest?
Where are the financial safe havens? You might think that as long as inflation stays around 1% to 4% (Perkins estimate), you will be safe in stocks. This is what we are often told, but it is not always the case.
Inflation in the UK only exceeded 5% in 1969, but investors still lost hugely in the 1960s: the market rose by 20% and prices by 43%. Extend it into the stagflationary 1970s and things look pretty bad too: From October 1964 to May 1979, a period that encompassed two Labor governments and a Tory, UK stock investors lost 31.7% of their money in terms of adjusted for inflation.
So much for the idea that a stock index can protect you from inflation, stagflation – or anything else. The good news is that the only way a stock market can protect you is to buy it low – the best long-term returns come from buying cheap markets.
It would be nice to think that some markets are almost there – especially the United States, which is less at risk of a war-related recession than Europe – but they are not. For that, we would need to be sure that there was another wave of central bank money on the way, to know that energy prices are coming down, and to be sure that the valuations are attractive. None of these things are true, or close to being true. For example, Shiller’s price-to-earnings ratio in the US is still over 30x, compared to a long-term average of over 16x.
Waiting for them to be true is a slow process. Russell Napier, a market historian, likes to point out that the four major bear markets in the United States lasted an average of nine years each. In the meantime, you should get some protection against commodities and against gold – you did in the 1970s.
But you’d also be wise to look into multi-asset funds run by managers who have long known the deflationary machine would break and are invested accordingly. Look Ruffer Investment Company (LSE: RICA)which has been up slightly since the beginning of the year, Personal Property Trust (LSE: NLP) and Capitalization Trust (LSE: CGT). They are more ready than most.
• This article first appeared in the Financial Times