We all need reminding of why investment returns are so important for so many in the private sector. Until the 1980s most employees retired on pensions provided by their employers and related to their final salaries. Employers put aside and invested funds so as to meet these obligations, and if these funds fell short of what was required, they were forced to increase pension fund contributions. Today these obligations have been transferred to the private sector employees themselves. Money is invested at the employee’s risk into pensions that may or may not generate sufficient income to fund a comfortable retirement. Moreover, with interest rates so low, these investments must be exposed to risk in order to have any chance of generating the returns required.
As a result we see the development of covid-19 and its effects on the economic and investment outlook through a different prism. The health of the economy directly affects investments that we make to fund our retirement, and events that damage the long-term prospects for economic growth have a direct influence on our retirement funds, and so those who do not work in the public sector, and whose pensions are therefore not underwritten by other taxpayers, follow the development of the virus with more than a passing interest.
There are industries that suffer badly from our inability to socialise and gather in numbers, such as hospitality, sport, overseas travel and many parts of the service economy. As these industries suffer, other peripheral industries are also affected – banks and building societies suffer from mortgage arrears and bad debts, insurance companies are hit with more claims, property owners and city service providers suffer from instructions to work at home, and all aspects of consumption suffer from higher unemployment and shrinking consumer confidence. There are winners too, such as e-commerce, home entertainment, takeaway food, domestic tourism and infrastructure spending – which is why the economic outlook isn’t even worse, but notwithstanding these examples and despite the immediate bounce back after lockdown, the economy remains at least 10% smaller than it was in February.
Whither from here? Hopes for a V-shaped recovery have proved wildly over-optimistic and as the second wave of lockdowns are imposed, assumptions of a U-shaped recovery seem equally unrealistic. So it’s an L? Much hope has rested on vaccines or treatments for the virus and even ‘herd immunity’, but we cannot take important life and investment decisions on the basis of such speculation.
A decade of low growth, low interest rates and high inflation is what the worst covid-affected economies will desperately need
For entirely different reasons, in the 1970s a threat to the financial and capitalist system saw share and bond markets fall dramatically. Interest rates were sky high to protect the currency and enable the government to borrow, and the top rate of income tax rose to 83%. This reflected the replacement of a capitalist system with a hard version of socialism and centralised economic management, with core industries owned and managed by the state and private ownership of economic assets threatened. The government also regulated prices, wages and even the amount of currency that holiday makers could take abroad.
But even during this calamitous era for the UK economy, over the decade between 1973 and 1982, investment banks that sold shares, bought gold or invested in other ‘safe havens’, underperformed those that held both their nerve and equity investments. ‘Nobody rings a bell at the bottom’ and ‘it is seldom darker than before dawn’ are two rather overused platitudes, but it does not make them wrong. Ibbotson’s work on the dangers of market timing showed how dangerous it has proved to attempt to time entrances and exits from stock markets – demonstrating that over a 70-year timeframe, being uninvested for the 30 best months would have wiped out all of the excess return from equity investment. The current investing environment is different from the 1970s in so many ways, with the principal advantages that we now enjoy being very low interest rates and more targeted and sophisticated central bank interventions.
Borrowers currently pay, and depositors earn, very little interest, and investors are therefore forced to invest their cash in more volatile assets to generate some level of return. So while interest rates remain low and central banks continue to print money, this asset price bubble will continue to inflate – until the music stops. Central bankers have their soft parts tightly squeezed between the need for inflation to do a 1980s Harry Houdini escape from debt, and the higher interest rates that should result and cause economic, social and political carnage to an over-indebted world.
We must therefore face east and pray for a phenomenon whose title was also spawned in that era – ‘stagflation’. A decade of low growth, low interest rates and high inflation is what the worst covid-affected economies will desperately need. Conventional wisdom would dictate that once the emergency government spending splurges retrieve economies from their covid nosedives, this will in all likelihood be followed by an extended period of austerity and relatively high unemployment.
