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It is never an easy job being a crystal ball gazer, but even some of the best economic minds are struggling to come to terms with events at the moment. Rising budget deficits, inflationary fears, pinball stock markets and threatened house prices are posing significant problems for UK plc. Much like the combination of the moon, wind and tides, these factors have the potential to produce a perfect storm. This may or may not happen, but with many prices still at relatively high levels, investors find themselves faced with few asset classes that actually look rock solidly attractive. Fortunately, there is a road map since the markets have been here before; welcome to the 1970s.
For those struggling to recall Brut 33, Marc Bolan, and brown and orange furnishings, it was a gloomy time. The first oil shock of 1974 took the price from $3 to $12 a barrel (now $95). The financial system was hugely overgeared, particularly secondary banks and the housing market, consumer credit had also become widely available to the masses for the first time. Then a key Arab ‘ally’, AAA rated in the bond markets, collapsed and went loopy within 18 months as the Shah of Iran was booted out.
Electorates were restless, hugely dissatisfied with bloated and incompetent governments, so voted for fringe and extremist parties, tax rates soared, black markets boomed, while equities and valuations tumbled. All the while pundits predicted sustainable recovery. For the record, the Dow Jones index staggered from 1,000 at its peak in 1968 to... 1,000 in 1982. Brilliant!
For investors, these were 14 years of worse than nothing, since inflation gnawed away at the real value of assets. Governments thrashed around, setting up national and supra-national forums full of highly paid talking heads to solve world problems, with little impact. So, for a decade most countries suffered sub-trend line economic growth, governments were forced to slash their work forces and to hard-prune welfare, benefits and subsidies, leading to deepening labour unrest as inflation went up, and stayed up, while wages fell.
Now I’m no economist, nor am I a stock market historian but the similarities between the problems then and now look too close to ignore.
One of the outstanding features then was perennial optimism in the face of deteriorating facts, and this is perhaps becoming evident today in energy markets, where there remains a belief that energy prices will magically retreat back to more acceptable levels despite many indicators suggesting the opposite.
Saudi Arabia, the only country in the world which theoretically has large surplus capacity allegedly holds the key, and so it does, but only in a negative way since it has sloppily failed to invest in new production facilities for 20 years in any significant way, thus leaving its real ability to set prices muted while the world’s safety margin for oil comes under threat.
Constraints in the energy pipeline can be found everywhere, from the lack of seriously large new oil discoveries to years of under investment in refineries, leaving us woefully short of capacity. With a nuclear option still largely unpopular we are left with little more than a handful of ‘touchy feely’ windmills and wave machines to pick up the slack, which they are clearly in no position to do.
The world has yet to wake up to high energy prices, even though the impact is already visible. Look at the US, where petrol taxes are extremely low, so every increase in the price of oil is a direct tax on the consumer. Wage growth has been low for several years and household incomes are under further attack from rising prices of basic food stuffs, such as milk, bread and eggs, because these industries are intense users of energy.
The key for investors is to trust what they see with their own eyes and not assume that ‘in the know’ experts in the City have any greater savvy about the future, because mostly, they don’t. Perhaps a cycle is about to repeat, one in which stores of wealth (gold, silver, diamonds, etc), reliably high yielding companies and a few new businesses (perhaps healthcare) will prove the best places to be. But there will also undoubtedly be a few new twists along the way, history never repeats itself exactly, and that’s about as accurate a prediction as I can make.