True, judged by the progress of UK share prices, investors were willing to sideline those political concerns in 2017. As I write, the FTSE All-Share index, the widest measure of quoted-company values, is up 5.4 per cent on the year. Throw in 3½ per cent or so by way of dividend income and the total return from UK shares is approaching 9 per cent. In the long-run scheme of things that’s an above-average year and from the perspective of returns so far for the 21st century – arguably more relevant – it’s pretty good, so what’s not to like?
From a global perspective, it gets even better – UK share prices have lagged well behind the rest of the developed world. With 2017 almost over, the S&P 500 index of leading US quoted companies is up 18.4 per cent and the MSCI Europe index, which includes some UK companies, has risen 19.6 per cent.
Two linked factors lie behind this divergence. Some of the UK’s pedestrian performance is down to the spirited – yet arguably fanciful – recovery in sterling during the year. So, from the perspective of a US investor, a holding in the FTSE 100 index would have risen 13 per cent during the year, thanks to sterling’s revived purchasing power. Conversely, had the sterling/dollar exchange rate remained unchanged, then the dollar investor would have had to live with a 4 per cent loss in value.
Sterling’s revival also accounts for the gap in the share-price performance between FTSE 100 companies, whose activities have a greater global spread, and those mid-sized companies of the FTSE 250 index, whose orientation is more towards the UK. The diminished sterling value of overseas profits meant that the Footsie’s 4.1 per cent gain so far in 2017 pales beside a 10.6 per cent gain for the 250 index.
However, the exchange-rate effects should not obscure a wider point that part of the comparatively dull performance of UK shares is most likely because the UK’s economy is growing slower than the rest of the developed world and is expected to continue in that vein for 2018 and beyond. For example, the Bank of England forecasts that the volume of the UK output will only rise 1.7 per cent in 2018 and 2019. In contrast, global output is forecast to rise by about 3.5 per cent for each of those years and, even for the supposedly sclerotic economies of the euro zone, City economists forecast output to grow by over 2 per cent.
That pace of growth – in which the US will play its part – at least partly explains the market’s relaxed view of the world’s political risks. However, in the Bearbull scheme of things, political factors have had a growing impact on investment returns since the 2008-09 financial crisis and that trend will become more marked as the years roll by.
As to why, the charts begin to tell the story. They sketch the reasons behind what we might label ‘the great disgruntlement’, the feelings of frustration and anger that affect electorates in the UK and throughout the developed world. GDP growth – despite the upward blip in 2014 and 2015 – is trending downwards (Chart 1). The last time it grew by over 3 per cent for a second year running was in 2000. Companies have maintained the marvellous gains in profitability that they made in the 1980s (Chart 2). That has contributed to the outsize performance of equities since the financial crisis, but it has been increasingly achieved at the expense of companies’ employees whose drop in inflation-adjusted wages is the main reason that real disposable incomes have been on a downward trend since 1992 (Chart 3).
Of the three charts, the third is the one to focus upon because the lack of growth in real disposable income – the funds with which affluent people plan their lives and have their fun – lies behind the great disgruntlement. It may be significant that the 1970s actually produced the highest average growth rate of the five full decades since data were first compiled for household income in 1955. Despite – or arguably because of – industrial strife, real disposable income grew by 3 per cent a year on average during the 1970s, better even than the golden decade of Thatcherism when growth averaged 2.8 per cent.
By the 1990s – average growth 2.6 per cent – progress in real disposable income was starting to tail off, not that anyone really noticed for another 10 years or so. True, Britons were not actually getting poorer, but they were getting more affluent at a markedly slower rate and – at least from a psychological point of view – the effect was much the same as being poorer. What diminishes is the feeling that progress is being made, what does not diminish is the sense of entitlement that affluence brought in the first place.
In that context, one of the world’s most successful investors, Ray Dalio, who founded and heads up the Bridgewater stable of £120bn-worth of hedge funds in Connecticut, has an insight into this process. He suggests an ultra-simple model in which a nation moves through four phases on its journey from poverty to affluence and back again. Schematically, it’s as follows:
■ Phase 1: a nation is poor and its citizens think of themselves as poor.
■ Phase 2: a nation starts to become wealthy, but its citizens continue to think of themselves as poor.
■ Phase 3: a nation is wealthy and its citizens think of themselves as wealthy.
■ Phase 4: a nation starts to become poor, but its citizens continue to think of themselves as wealthy.
It does not take a genius to figure out in which phase of the cycle the developed world currently finds itself. In which case, the question might be: how much chaos could ensue as folk adjust to the new reality that – globally speaking – they are also-rans?
We already witness incipient chaos in, say, the respective forms of Donald Trump and the Brexit process. True, a phenomenon such as President Trump continues to defy belief. As thin-skinned as Richard Nixon, as vain as Bill Clinton, as intellectually lightweight as Gerald Ford; with no knowledge of – or interest in – the political processes of the United States or the conduct of diplomacy on the world stage, there could be no end to the damage he might do. Yet the greater likelihood is that the long-tail horrors won’t happen; that events will stay close-ish to the average and that a combination of the dysfunction of the Trump administration and the nature of the US constitution, which tends to marginalise the president, will limit the damage. Sure, The Donald will continue to collect the column inches, but, in substance, he will be a side show. Meanwhile, life will go on.
Something similar could be said of the Brexit process. Even if the UK faces its most unsettling peace-time moments since the abolition of the Corn Laws in the 1840s, it is unlikely to face an existential crisis. Besides, there won’t be a counterfactual of the UK remaining in the EU to make the comparison of its progress both inside and outside the union (whatever ‘outside’ will mean in practice). However, we can be fairly confident that, as 2018 progresses, Brexit will present UK investors with an idiosyncratic factor that puts them at a disadvantage to investors elsewhere. In which case, what should they do?
■ Lower expectations. My mail bag clearly shows that too many investors are trapped in the past, imagining that the equity returns of the 1980s and 1990s are – if not the norm – then the benchmark against which success should be judged. In UK equities, those decades featured just two losing years when capital returns (before dividends and as measured by the All-Share index) topped 20 per cent nine times and averaged 15 per cent. Sorry, those years were the exceptional ones and their like won’t come again; at least not before an almighty-great shake-out. For individual portfolios, hitting a 20 per cent return now and again remains perfectly likely, but it will be very much the exception. To imagine anything else is to invite disappointment and averaging a total return of 8 per cent a year from a portfolio of diversified equities is perfectly good going.
■ Diversify more. I have said this before and most likely I’ll say it again – affluent, private investors are rarely as diversified as they imagine. The rigidities and distortions of the UK’s housing market – especially in south-east England – see to that. Too much wealth is trapped within illiquid bricks and mortar that one day will prove too tempting a target for hard-pressed politicians to ignore – and probably rightly. In the context of equities, diversification means paying more attention to overseas markets, especially those of the developing world. True, that can be achieved via UK-based global companies, which abound within the FTSE 100 index, as well as by collective funds. But the point is that, one way or another, it should be done – too much of the globe’s future growth is likely to come from emerging economies for UK-based investors to ignore them. Sure, that statement is hedged about with caveats, chief of which is that equity returns are driven by risk as much as by growth, but even so.
■ Avoid fixed-interest securities. It may be remarkable that interest rates on long-dated government bonds have been so resilient to political worries – at 2.4 per cent, 10-year rates in the US are lower now than at the start of 2017. Yet the trend in interest rates is surely upwards because rates are still at a level from where they can hardly fall but the process of raising them has started and central banks warn us to expect more, albeit very gingerly. Simultaneously, those self-same banks face the huge task of reducing the size of their balance sheets, which means losing trillions of pounds-worth of fixed-interest stocks. They will do that incredibly slowly and chiefly by not replacing bonds that mature. But that also means they will no longer vacuum up fixed-rate debt as they were doing until recently. Thus the momentum of fixed-interest markets – especially for government debt – has swung towards selling.
■ High-street interest rates won’t rise. Or, at least, not so that savers will notice. Still, if that’s the worst that happens to investors in 2018, it will probably be a decent year. So I am a bit more optimistic than I was a year ago, but let’s not get carried away – the best may not be too much to shout about even if the worst looks slightly less likely to happen.
