HAMISH MCRAE: Big question at this stage of economic cycle is always the same – to what extent is market turmoil a warning of disaster to come?
Where to find safety? We have had another of those scary, rip-roaring weeks that you get in bear markets.
There was the warning of an ‘apocalyptic’ rise in food prices by the Governor of the Bank of England. Consumer prices were up 9 per cent on a year ago and, less publicised but more scary, the Retail Price Index was up 11.1 per cent.
Shares in the US slithered down further, making this the worst start to a year for something like 80 years. And let’s not talk any more about Bitcoin being a store of value.
Be patient: To what extent is the financial market turmoil a warning of economic disaster to come?
The big question at this stage of the economic cycle is always the same. To what extent is the financial market turmoil a warning of economic disaster to come?
Not all bear markets signal economic recession – and let’s remember that this is a bear market in US high-tech companies, which because they are so huge affects the entire American investment landscape.
It is not a bear market in the share price of large UK enterprises, for the FTSE100 index is just about square on the start of the year. Nor is it a bear market in UK house prices, which are still edging up.
I think three things are happening. One is that the madcap exuberance of the high-tech boom is well and truly over. Companies such as Netflix will be ranked on their ability to make profits, not to increase the numbers of subscribers. Real profit matters more than imagined prospects.
The second (which applies to the UK as well as the US) is that free money is also over. The experiment of near-zero interest rates (below zero in Europe) is finished, and I suspect will not happen again in our lifetimes. And the third is that there is a general awareness that the present bout of disruption has big economic costs that as yet cannot be quantified.
But these three negative forces will not necessarily result in a serious recession. There is a huge difference between the miserable, frightening plunge in economic activity that occurred after the financial crash of 2008, with unemployment shooting up, or indeed the even nastier recessions of the early 1980s and 1990s, and the grungy couple of years that lie ahead.
So this is certainly a time to look for safety, and that is what we will all do. But it is not the time to allow ourselves to be frightened, even if the Governor of the Bank of England is frightened enough to use what I think is silly, inappropriate language to describe the problems ahead. So where is safety?
Well the first area is not one about investment – how to manage a stock of wealth. It is about income – how to ensure the flow of resources. The answers will be different for people at different stages of life, but the point is the same. If you have a secure flow of income, you are in a safe position, despite whatever happens to your stock of savings.
There have been many stories about investors, mostly young ones, who put their savings into cryptocurrencies and have lost the lot. That is horrible, and I feel angry when I look at the ways in which people were lured into investing in them. But if they have solid earnings they have time to dig their way out.
And safety in savings? Cash is terrible, in that it will lose 10 per cent of its real value in a year. Bonds are terrible, and I have seen some calculations that this has been the worst start to the year for investors in gilts (UK Government bonds) since the 1970s. The 30-year bull market in bonds is clearly over and it may well be that there will be a 30-year bear market ahead. Even if that is overly pessimistic, there is no safety there.
So we come back to the basics that global equities and property have been better investments over the past 150 years than anything else. Well-managed companies produce profits and pay dividends. Property in growing economies produces rental income. And both give some protection against inflation. I think in the months ahead it is quite likely that share prices worldwide will slide down further, and it is hard to feel confident about property prices either.
But the big lesson of previous investment cycles is that it is very hard to get the timing right.
So safety is in spreading risks, not selecting a single asset type, and safety is being patient. To urge patience may not be uplifting. Sorry about that. But at a time like this I think it is wise.