The pandemic in context

The link between used-car sales in the UK since Covid-19 got into its stride and the centuries-old trend in falling interest rates may be tenuous, but it is interesting, nonetheless; and it tells us something about what investors might expect in the decades to come. ‘Decades’ is the key word because the chief finding of research by the Federal Reserve Bank of San Francisco, part of the central-banking system of the US, is that the aftershocks of a major pandemic persist for up to 40 years, with real interest rates depressed throughout that period and inflation-adjusted wages slightly elevated.

In simple terms, that is great for investors holding long-term assets whose value rests on discounting a likely stream of future income; pretty good for wage slaves; but lousy for those whose savings go no further than interest-bearing accounts.

Three academics from the University of California produced the research early last year* when it was unclear whether Covid-19 would qualify for the moniker ‘major pandemic’. Now that it has – with 2.1m deaths globally and counting – it seems right to re-iterate their findings.

The research focuses on 15 pandemics in Europe where the estimated death count was at least 100,000. It starts with the Black Death in the late 14th century and runs through to the swine flu pandemic of 2009. On the way, it takes in the Great Plague of London of 1665-66 and the Spanish Flu pandemic of 1918-19.

On average, the findings show that real rates of interest (ie, after deducting any effect of inflation) bottom out around 20 years after the end of a pandemic at about 1.5 percentage points lower than they would have been had the pandemic not occurred; they are still half a point lower after 40 years. True, there is a lot of variation around that average, but even with the most modest impact, interest rates are still half a point lower after 20 years and, at worst, they are 2.5 points lower. Nor are the averages altered by separately removing from the data the two most lethal pandemics, the Black Death and 1918’s Spanish Flu. With the Black Death absent, average real rates still bottom out 1.5 percentage points lower, though for Spanish Flu the floor is closer to 1 point.

Meanwhile, the response of real wages is almost the mirror image of the fall in interest rates. Presumably because labour becomes increasingly scarce in the wake of a pandemic, wages gradually rise for three decades afterwards and, at the peak, in real terms workers receive £105 for every £100 they would have done in the absence of the pandemic.

It is unrealistic to imagine that the pattern of past pandemics should already be emerging from the present one. However, it is possible to say that the fiscal and monetary response of governments and central banks throughout the developed world has aided the trend towards lower real interest rates and, in the process, has stimulated the value of most income-generating investments. Put bluntly, it has bolstered the balance sheets of the affluent much more than it has helped the current accounts of the poor.

Hence the table for new-car registrations for 2020 in the UK, which illustrates that point anecdotally. Naturally, car dealers had a miserable time in 2020. Over all, according to the Society of Motor Manufacturers and Traders, registrations – a decent proxy for sales – were 29 per cent down at 1.63m, the lowest total since 1992. What’s interesting is the relative performance of the up-market niche marques and the volume brands, catering for demand down the social scale. To emphasise that, three of the four marques whose 2020 sales held up the best – Porsche, Lexus and Bentley – are all decidedly up market, while the bottom three – Vauxhall, Mazda and Citroen – all focus on the mass end of the market. Is that just a coincidence?

Yet the San Francisco reserve bank paper is also notable for the issues it barely tackles. The authors note that the decline in interest rates stimulated by pandemics occurred against an ultra-long trend in falling real rates that can be traced back to medieval times. So marked are some of the variations around this trend – many of which endure for decades – that the trend is obscure. However, its existence is now conventional wisdom among economists and the authors of the San Francisco paper note that their research shows “the now well-documented pattern of a secular decline over the span of centuries from about 10 per cent (real interest rate) in medieval times to 5 per cent at the start of the industrial revolution and nowadays hovering near zero”.

They offer brief explanations for the variations around the trend, but not for the trend itself. So just why are interest rates on a seemingly inexorable course downwards? For one explanation, we can turn to The Great Leveller, a panoramic view of history by Walter Scheidel, a professor at Stanford University. The sub-title explains much of the subject matter: Violence and the history of inequality from the stone age to the 21st century.

The underlying point of Professor Scheidel’s much-admired book is that the essence of civilisation is to produce inequality. Except for the effect of major wars and the occasional epoch-making political revolution, the natural order of things is for society to become less equal. So a process that began when agricultural surpluses were first generated in Mesopotamia, has got to the stage where, in 2010, the world’s 388 richest people owned wealth equal to that owned by the poorer half of the planet’s 7.2 billion people, but by 2015 just the 62 richest managed to gobble up the same share as the poorer half. Or, as Professor Scheidel points out, in 2010 it took a Jumbo jet to hold them all, by 2015 you could have loaded them onto a double-decker bus (mink lined, I suppose).

Technology is the key – that is how surpluses are generated. The first were based on agriculture – the domestication of plants and animals – and agriculture was based on land, which was passed from generation to generation, producing wealth that was increasingly skewed to the few. The process, amplified by social norms, the use of political power, luck, ruthlessness and brilliance leads to the likes of Bill Gates or Jeff Bezos today in countries where the rule of law more or less functions, or to Vladimir Putin or Kim Jong-un in those places that use law much as Caesar Augustus did 2,000 years ago.

Sure, that’s a grand sweep, to put it mildly. But it leads to progressively lower interest rates because, as more wealth is captured by the affluent few (the 1 per cent as well as the 0.001 per cent), there is a greater propensity to save. The poor have no choice but to spend all they have; the rich have little choice but to save, despite lavish spending.

We currently occupy a toe print in this march of history, but if there is a moral to be had, it is that investors should favour assets that offer a ready-made stream of income, especially if that comes with some degree of inflation-proofing. Future-proofing is pretty useful, too; which would mean favouring industries whose goods and services will always be in demand (food, medicine, vice and housing are pretty obvious). Perhaps arms makers should also get a look-in if, via war, they really are the agents of a more equal future. Most of all, though, it means sticking with equities and being wary of fixed-coupon bonds.

* Longer-run economic consequences of pandemics, Oscar Jordà, Sanjay Singh, Alan Taylor, University of California, Davis; Federal Reserve Bank of San Francisco Working Paper, 2020-09

● Meanwhile, there is the prosaic matter of the Bearbull Income Portfolio to run. An anomaly in the fund is that one of the dullest share-price performances is coming from a company whose trading performance is among the brightest. The company concerned is Air Partner (AIR), basically a specialist travel agent whose niche is to charter aircraft when and where needed.

Investors’ initial response to the pandemic was to slaughter Air Partner’s share price on the simplified logic that no travel meant no flights, which meant no business for the group. As it turned out, the comparative absence of scheduled flights was a boon for the broker as first-half results made clear – underlying pre-tax profits showed a 250 per cent uplift on the previous first half to glide in at £10.5m. Thus, the share price, which had dropped as low as 17p in March, rose to 78p in November, but since then has wafted downwards.

Nor was there a share-price reaction earlier this month when management told the market that underlying profit for the year just about to end would fly in above City expectations at over £11.5m.

With most of the year’s profit coming in the first half, perhaps that good news was baked into the share price, hence the market’s indifference. However, that does not address the point that the shares basically look undervalued. Even when I do my usual trick of valuing a company based on the weighted average of its past five years accounting profits or free cash flow – so as to avoid the distorting effect of using an exceptionally good performance as the value driver – then valuation figures come out at anywhere between 100p per share and 115p, compared with a 69p market price.

Nor should we forget the cash the groups holds. Much of that is deferred income relating to its JetCard private jet-hire business, which will be worked out. Even excluding the up-front JetCard payments and after deducting lease liabilities, Air Partner still had about £11m of cash in its end-July balance sheet, which works out at about 19p per share. Deduct that from the share price and, in terms of a conventional earnings-multiple valuation, the stock trades on a PE ratio of less than five times for the year just ending.

Sure, the future still looks uncertain. The postponed Tokyo 2020 Olympic Games – due for late July – now look all but cancelled. That would mean lost business for the group. Ditto if the re-scheduled UEFA Euro 2020 football tournament, which will take place a month earlier, happens behind closed stadium doors.

The Bearbull fund is fully loaded with Air Partner stock – currently it takes 8 per cent of the portfolio – so I won’t be adding to the holding. Granted, the holding also means I’m probably biased. Nor can I label this a ‘buy’ recommendation since the comparative illiquidity of the shares makes for small dealing size and wide spreads. Even so, you get my drift – the shares look cheap.

Email: bearbull@ft.com