Graham Bentley: Can we still rely on a long-term trend to growth?

By Graham Bentley

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Jan 04, 2019
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Bentley-Graham-GBII-2013In financial services, the festive season is often denoted by playful investment nonsense like the Santa Rally.

In 2018, the fact the FTSE All Share price index has risen through December in 39 of 56 years appears to have special significance, given the pasting that index has taken since May, and particularly through the fourth quarter. But while these gems of data history may give succour to many, we should be wary of being suckered.

In downturns, we are understandably assailed by market participants encouraging us to stay the course. Well-meaning as most of these are, there is a vested interest for those giving the advice – money invested produces fees.

Consequently, the industry mines historic market data to find patterns that might provide solace to grieving investors and substantiate decisions to stay put. Even those wise enough to adhere to the “past performance is not a guide to the future” mantra can be guilty of regurgitating convenient quotes such as “history doesn’t repeat, but it rhymes”.

Beware of falling into the trap of connecting dots on a chart to evidence a trend, extending the line as a forecast.

A data provider plotting the existence of Donald Trump would have noted he has remained alive for over 26,400 days. The chart implies he is immortal but we are (especially in this case) comforted by the knowledge human beings cease to exist at some point; experience and entropy tells us death or defeat is inevitable, and the grim reaper does not take pay offs.

More seasonably, consider a chart recording the quality of life of a turkey.  In the wild, the horizontal axis may cover a mere 10 years, while the daily data points corresponding to its quality of life on the y-axis reflect the relative success of its daily grinding omnivorous existence, scratching for variable sources of food and avoidance of predators.

Compare that to the chart of the farmed turkey, growing ever fatter on a plentiful supply of corn and complete absence of predators. The statistician unfamiliar with UK tradition might suppose a stable continuation of the trend and cannot factor in an exogenous shock – Donald Rumsfeld’s “unknown unknown” – so is surprised when a two-legged predator makes a single appearance, heartbreakingly in only the turkey’s fifth month, and just in time for Christmas.

The investment history books are replete with examples of trends that were steady until they weren’t. Property funds returning 10 per cent per annum for 16 years – until they didn’t. The 45 per cent fall between May 2007 and May 2009 has yet to be recovered on Aviva’s property fund.

In the 1980s, my colleagues and I professed astonishment at the rising industrial might of Japan, seeing the market rise by 25 per cent a year for seven years. At Christmas 1989, predictions of continued growth were persuasive – until they weren’t.  In yen terms, the market fell by over 80 per cent over the next 19 years.

On an economic scale, we are persuaded there are long-term trends that cannot be broken. One such axiom is that, as night follows day, economies grow. Stockmarkets may have bear phases, temporary corrections or pauses for breath, but the fundamentals of capitalism will hold true.

I have seen this argument used as the final line of defence to customers’ concerns over every bear market, flash crash and recession during my 40-odd years in the markets, and for all that time the axiom has held. In essence, the argument reduces to “over this mountain, there will always be a higher peak”.

But “capitalism” is not a natural state of affairs. Unlike mercantilism, where goods are traded for profit between merchants, capitalism involves markets for land, labour and money, along with commodities manufactured on an industrial scale. In that sense, capitalism as we understand it is less than 200 years old.

We are encouraged to adopt a capitalist view of economics and hence investment marketing strategy generally worries us with the spectre of inflation. Since our purchasing power will be eroded by inexorably rising prices, investment in real assets is cited as a sensible means to protect our capital and hence our living standards, particularly in retirement when earned income has subsided.

Thirty-odd years of falling bond yields and concomitant rising bond prices demonstrate how falling inflation has been rather less of an investment negative for most portfolios. Inflation may indeed return with a vengeance through events as yet unclear, but then it may not. Not only is there the alternative outcome of price falls – i.e. deflation – but also where there is no inflation at all.

Inflation is not a feature necessarily associated with capitalist or even industrial societies – ancient and medieval history shows us new sources of silver and gold, or currency debasement, have been associated with wider price increases.

The main driver of inflation may not even be money supply but rather changes in the relationship between demographics and population growth, with money supply changes being a by-product.

Over hundreds of years, data evidences long periods of stable prices, on average 110 years, followed by inflationary periods of similar length. We are in the 118th year of an inflationary period since 1900 – perhaps our grandchildren may come to see price stability as the norm.

Investment markets are capricious and one of the few handrails we have on the journey is that, despite the worst the world has to throw at us, growth is the natural long-term scheme of things. We’ve become used to market downturns being temporary breathers on a longer climb. Let’s hope there really are higher mountains over the horizon, at least in 2019.

Wishing you a prosperous New Year.

Graham Bentley is managing director of gbi2

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