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History’s heart beat

The list could go on, but the point is that, among all the stuff that agitated financial markets during 2019, most was barely mentioned this time last year. It was ever thus. Those events that have the biggest impact are rarely widely forecast. How could it be otherwise, since to forecast is to discuss, to discuss is to adapt and to adapt is to avoid. Meanwhile, the dire events – the ones that aren’t avoided – don’t get discussed, except by swivel-eyed loonies who are ignored until we see, too late, that there was method in their madness.

So why bother to look ahead? Largely because that’s what investors do anyway. We commit our capital to the future, so, at the very least, we want to give the impression we know why and where we are saving it. It offers the appearance that we are smart and prepared for what’s ahead. It gives us a feeling of confidence, and that’s nice.

Besides, some possibilities are both significant and discernible, so their likelihood and their impact demand to be assessed. For starters, take that global recession. Maybe it didn’t show up in 2019 because so many dogs barked. They’re not making such a racket now, although a pack leader, the International Monetary Fund, says that “the outlook remains precarious”.

Table 1 indicates why. Throughout the G7 group of the wealthiest major economies, growth has been anaemic for some time. Out of those nations, Germany has come closest to slipping into recession. Only by the skin of its bratwurst did it avoid recession in the third quarter of 2019 (defined as quarter-on-quarter output dropping two quarters running). More difficulties await as the German export machine – though still mighty – struggles against the twin forces of a global slowdown in auto production and China’s declining need to import high-value engineering goods. Meanwhile, domestically, demand remains depressed by the reluctance of Germany’s ageing population and its government – both federal and state – to spend their wealth, let alone to borrow.


Table 1: Anaemic or what?
Quarter-on-quarter percentage change in GDP. Source: OECD 


No such qualms about borrowing at the other European economy shown in the table. The UK’s propensity to borrow from abroad is exceeded globally only by the US; although in relation to the size of its economy the UK’s reliance is much greater – its current account deficit runs at 4.3 per cent of output compared with 2.4 per cent in the US.

So perhaps it’s odd that there should be national equanimity about such dependence on the kindness of strangers. The UK’s current account deficit, which was a national obsession in the 1960s, barely gets a mention nowadays even as the UK prepares to distance itself from wealthy nations that, in terms of both geography and trade, are its nearest and dearest.

Sure, from time to time one hears the phrase 'sterling crisis', in the context of Brexit and its consequences. And it’s true that sterling has been a comparative weakling among global currencies since 2016’s referendum – 13 per cent down against the US dollar; even 8 per cent down against the deeply flawed euro. Yet that might be nothing compared with the damage that could be done by a messy Brexit and the consequent deterioration in an already yawning current account deficit.

For investors, the expediency must therefore be to keep a decent chunk of savings account and Isa money in foreign currencies and to have plenty of exposure to overseas economies in an equity portfolio. How those proportions work out in practice is more about intuition than science but, say, 20 per cent of cash savings outside sterling and 40 per cent of equities’ profits coming from abroad (a proportion, incidentally, that’s about average for the FTSE 100’s component companies).

Meanwhile, there is no doubting that one very obviously discernible event of 2020 will be significant – November’s US presidential election. In the short term that should maintain growth. At least, put it this way – you have to go back to 1932 and the pit of the Great Depression to find a presidential election year in which the US economy shrank (by 14.6 per cent, if you’re asking). Small wonder, then, that the incumbent, Herbert Hoover, was driven from office by Franklin D Roosevelt, who won almost 90 per cent of the electoral-college votes.

Few expect the US economy to go into recession this year, even if growth will be lame. True, there are always unforeseen factors, but a combination of undemanding comparables to beat and Mr Trump’s bullying of the Federal Reserve to cut interest rates should see it through.

Which shifts the debate to whether the system on which the prosperity of both the US and the developed world rests can withstand another four years of Mr Trump; not just that but, one imagines, a president who gets less restrained as he approaches the close of his second term and grumpier as he gets closer to his 80th birthday, yet no more inclined to govern by the standards accepted by his recent predecessors.

Perhaps that dramatises the situation. After all, the US has had its share of bad presidents and survived. For example, go back to arguably the country’s finest moment – the abolition of slavery in 1865 – and the assassination of Abraham Lincoln was followed by three of the worst presidents in succession. First came Andrew Johnson, who – much like Mr Trump – was impeached for using his office to do down a political opponent; Johnson survived by a narrower margin than Mr Trump is likely to. Then came Ulysses S Grant, a military hero of the civil war who proved inept and corrupt in public office and – perhaps appropriately – was wiped out in a financial scam. He was followed by Rutherford B Hayes; that Hayes was known as ‘Rutherfraud’ Hayes probably says it all. Hayes’ successor, James Garfield, showed every sign of being as venal and corrupt as his three predecessors, but no one discovered whether he would live down to expectations. Six months into office, he was shot, although his death 11 weeks later owed as much to the incompetence of his doctors as the competence of the assassin.

However, these four governed during the US’s ‘gilded age’, when the country turned itself into the world’s biggest economy. So perhaps the benefits of economic growth offset the damage done by corruption on an industrial scale. Maybe. Yet actually growth during this period was not that fast. Propelled by recovery from the civil war, the US economy grew by 6.3 per cent a year during the 1870s, according to the University of Groningen’s national accounts database, but slowed to just 1.5 per cent a year in the 1880s, after which the pace picked up again.

All of which indicates it may be risky making connections between the standard of political governance and economic growth (and, by implication, investment returns). Risky, but many try, one of which is Ray Dalio, a hedge fund manager who has made himself a billionaire running Bridgewater Associates and making big macroeconomic calls based on the health of nations.

Mr Dalio’s notion is that nations go through a five-stage cycle from poverty to wealth and back again. It starts where a country is poor and its citizens think of themselves as poor and progresses to a pinnacle where the country is rich and its people behave as if they are rich. Most likely, Mr Dalio has been influenced by the US sub-prime mortgage crisis since he reckons that, during decline, excess borrowing sustains the illusion of wealth then adds to the pain in the final reckoning. The effects of a rich but ageing population determined to save plus the wonders of monetary policy at its most creative mean reality hasn’t quite worked out like that – but it may.

In fact, Mr Dalio’s ideas are not new. Go all the way back to Ancient Greece and we find Plato outlining a cycle that shifts from rule by monarchy, to aristocracy, to democracy then dictatorship. For Plato, democracy is the most irksome since the self-entitlement of the newly rich clashes horribly with the envy of the poor. Democracy also accelerates the shift since, according to Will and Ariel Durant, great popularisers of history and a stated influence on Mr Dalio, it allows the most freedom – and freedom means the opportunity for one group to lord it over the others. Initially the group does that thanks to its greater ability, but increasingly it rewrites the rules in its own favour.

The Durants concluded that “the concentration of wealth is natural and inevitable”, adding that it is “periodically alleviated by violent or peaceable partial redistribution”. In that they draw an analogy with the giant heartbeat of a social organism – “a vast systole and diastole of concentrating wealth and compulsive recirculation”.

Poetic stuff and presumably the UK is in the recirculating phase. Where that leaves investors is to tone down expectations, if they haven’t done so. As to what those should be, Table 2 offers some help. It breaks down the performance of the UK’s FTSE All-Share index and the US S&P 500 into their averages of each of the past five decades and then sums the whole 50 years 1970 to 2019.


Table 2: Averaging down
 FTSE All-ShareS&P 500
 Ave (% pa)St'd dev'n (% pa)Ave (% pa)St'd dev'n (% pa)
Source: S&P Capital IQ   


Note that the figures are for capital returns only (ie, they exclude the contribution of dividends). Also, they ignore the effect of inflation, which is why the All-Share’s overall returns are slightly higher than the S&P’s. Correct for inflation and the S&P is the better performer. Adjust for sterling’s decline and it would be better still.

The table tells us that UK equities are now at the stage where even a 10 per cent annual return (including dividends) can be considered good, especially as, one year in three, the UK indices are likely to lose money. It highlights the need – one way or another – to get overseas profits into an equity portfolio and it makes for a miserable backdrop against which investors go into Brexit. Still, maybe this is what happens when democracies go into decay.