A Historical Perspective on the current Economic Situation

Apart from a couple of recommendations in the very last paragraph of this letter, this is not an investment advice letter There are no easy or risk-free solutions at the moment and anyone who says there are can be safely jettisoned.  Read on for our take on how history informs our current situation. 

As global stock markets drift in a southerly direction, I have been ruminating on the extent to which our current financial crisis mirrors that of the UK financial crisis of 1972 to 1975. And whether, despite the many challenges that face our new Prime Minister, there are any reasons to be cheerful?

I will start with my own memory of the mid 70’s. During this period, I was a young accountancy trainee with Binder Hamlyn, newly married and on £500 a year. Unsurprisingly, I had no spare cash to invest for a rainy day but even if the situation had been different, I had zero knowledge of the stock market, thanks in part to my parents whose interest in investment begun and ended with a Post Office savings account. So engaged was I in trying to pass exams that I have little or no memory of the financial earthquake that was about to unleash itself on the UK. That said, my ignorance didn’t stop me from giving my mother some rather good investment advice. She had inherited a small amount of money in January 1975 and asked her newly qualified son what I thought she should do with it. “The Bank of Scotland provide you with a very good service, don’t they? Why don’t you invest in their shares?” She did and for a bit I was her favourite child!

As a born optimist, I want to believe that the present crisis is just another of those inevitable bumps in the road. These bumps include, Black Monday 19th October 1987, Black Wednesday 16th September 1992, The Dotcom Bubble of the year 2000 , the Global Credit crisis of 2008 and the most recent, The COVID 19 pandemic, March 2020 to December 2021 – a brief description of these crises can be found in Annex 1. What I don’t want to have to contemplate is that our present financial predicament could be, a few years hence, up there with the greatest post war crisis of the lot, the one that transpired between 1972 -1974.

Let’s start with a graph for the 7½ year period from April 1972 to December 31^st, 1979 – a period ending more or less with the start of Margaret Thatcher’s Premiership in May 1979.

FT 30 INDEX OF UK STOCKS – APRIL 1972 TO DECEMBER 1979

You can see how the FT index of 30 UK companies tanked by 78% (or 83% in real terms) over a period of nearly 3 years and how it took a similar period afterwards to recover. What were the causes of the 1972 – 1974 crash?

Edward Heath’s government inherited a lacklustre economy – simultaneously high inflation and high unemployment against a backdrop of waning economic growth. Anthony Barber (Heath’s Chancellor) believed that the way out of this stagnation was his infamous “dash for growth”.  He introduced a series of income tax cuts and an overhaul of Purchase tax, the precursor to VAT.

Alongside this fiscal stimulus (fiscal relates to government tax and spend measures), Barber introduced a series of monetary measures (monetary relates to money supply and borrowing costs) liberating the banking system. Bank lending and government borrowing soared as a deluge of new money was released into circulation. A series of subsequent events conspired to undermine confidence in Barber’s plans.  These included a deterioration in the balance of payments, a “temporary” abandoning of fixed exchange rates and a consequent decline in the value of the pound.  The 1973 Yom Kippur war resulted in a 400% hike in the price of oil which, as inflation soared to 24% and the stock market plunged, dismantled Barber’s growth strategy.

If you haven’t had a chance to listen to Paul Johnson of the Institute of Fiscal Studies being interviewed by Nick Robinson (Political Thinking) I strongly recommend you do.  Johnson is a self-confessed economics “nerd”. But he is deeply critical of Kwasi Kwarteng’s 23^rd September mini budget in which eye-watering tax cuts were announced without a clear plan as to how how they would be paid for – more borrowing, spending cuts or a combination of both?  Johnson’s position: “I do think growth is what is needed to revive the economy, but not without announcing any compensating measures. There isn’t a free lunch out there.” Kwarteng’s mini budget caused a mini crisis, resulting in the pound falling nearly 10%. This was wholly avoidable. (As I write, the pound has recovered to 1.10 to the US dollar, thanks to a rare but necessary intervention by the Bank of England).

There are many economic writers who have already written off Liz Truss’s “dash for growth”. To be realistic, it is unlikely that her growth policy will yield positive results in time for the next General Election in May 2024. Add to this the fearsome problems coming down the track: higher interest costs, a drop in consumer confidence (already in force) a cooling property market, an NHS under acute strain, queues of worker groups threatening strike action. Are there any reasons to be cheerful?

Without being stupidly optimistic, here are a few reasons to suggest that the UK is in a much better place today than in the 1970s. I am grateful to Alex Hammond Chambers, Chairman of the Hamilton Financial Investment Advisory Board, for reminding me that the 1970s were indeed “much, much worse”. We really were the sick man of Europe, viz:

• Rampant socialism
• Large swathes of the economy nationalised
• Price and wage controls
• Exchange controls
• Income tax between 40% (lowest) and 98%(highest)
• Restriction on working practices
• UK stock market down by 83% in real terms

Alex goes on to say that today our problems are “much more of a global nature, especially the breakdown of democracy, China, global inflation, Putin’s war, abysmal leadership and a very divided United States.” He adds; “Not that we haven’t brought problems upon ourselves. For years we have been living way beyond our means on the elixir of QE (money printing.)”

Before I finish, I am going to reproduce a recent article by economist and journalist, Alistair Heath.  In it he summarises how Quantitative Easing has egregiously damaged our economy and how Liz Truss is right to try and set us on a new course:

“For the past 25 years, and especially since the financial crisis, the global economy has taken a disastrous wrong turn for which we are about to pay a hideous price.  In one of the gravest intellectual errors since communism, many of the world’s cleverest people thought that they had discovered the secret to perpetual prosperity.  Forget about hard work, deferred gratification, tackling post-industrial wastelands or actually earning one’s keep by creating, building and exporting: there was an easier way.

Cheered on by politicians, central banks kept interest rates low, favoured borrowers over savers, printed money with abandon and engineered an artificial boom in house prices, tech firm stocks, crypto-currencies, bond markets, art and more.  This ersatz “wealth” was meant to encourage spending and investment, the tax receipts would fund a generous welfare state, low rates would allow rising government debt, and there would be no need for difficult conversations on ageing, science, tax, competitiveness, incentives or productivity.

Yet it was a Potemkin economy, a facade, a con. Much of the “growth” and wealth were not real.  The UK was stagnating, not booming.  House prices “enriched” the haves while infuriating the have-nots.  It was a bubble at best, and a Ponzi scheme at worst, keeping zombie projects alive and fuelling obscene malinvestment.

This madcap experiment is now ending, killed off by a money printing overdose from Covid, the supply-side dislocation that accompanied the virus together with the attempt to put the economy into a coma and most recently Putin’s war, all of which have sent consumer prices rocketing.

The PM must hold her nerve. Her vision is exactly right for managing the transition to a post-Brexit economy built on a sustainable expansion, rather than debt-fuelled mirage. We must hope the Bank’s belated intervention will stabilise the markets and give her some cover. Andrew Bailey, the Governor, must start doing his job properly.

The great danger is that the Left is trying to turn our surging interest rates into an “ERM 2 moment” (Note 1), pinning the blame on the PM’s tax cuts, while in fact the end of cheap money would have happened anyway, albeit more gradually.  The stakes are extremely high, and there can be no back-pedalling. Tory MPs must back the Prime Minister to the hilt.”

Alex Hammond Chambers concludes in similar vein: “All Western countries, not just Britain – are living on Debt Prosperity”.  The question is whether we can get off this journey without a crisis or, alternatively, whether change can only come after a disaster. The jury is out.

I started out by asking myself whether there were any grounds for optimism at this difficult time. I am left to agree with Paul Johnson that there is no escape route which is free from painful consequences.  Liz Truss and her team have chosen growth and investment as the path to economic revival but first she has to bring inflation under control and that will not be without both political and economic risk. I am wishing her well, but I am also keeping my fingers crossed!

You can easily argue that this has been a self-indulgent ramble with nothing really to be cheerful about. I would disagree and here is why:

• The recent death of Queen Elizabeth – that wonderful example of selfless service to our country – has brought us together and given us back much needed pride in our values.
• We live in a free and democratic country; ask any refugee trying to come to our country why they prefer Britain above any other country in the world.
• We are a generous nation – just consider all the wonderful work done by volunteers in the charity sector.
• We have a free press and the BBC – often mocked by extremists on both sides, but the envy of the world – ask the people of China Iran, Russia or North Korea.
• We care for our countryside and our animals.
• We led the world on finding a vaccine to combat COVID 19
• Our towns and cities are full of buildings which have been largely protected from ignorant developers.
• We tolerate religions and faiths of all kinds
• We have begun to address racism and homophobia
• We have water, thanks to our climate!

I could go on. And I am sure you can add to the list!

To finish, I’d like once more to reiterate the Hamilton Financial Investment Style

I have said on many occasions that our investment style is to assemble a diversified portfolio of actively managed funds and resist the temptation to “twitch”. Occasionally we do and I am using this letter to announce that we will shortly recommend to clients  the sale of Aberforth Split in favour of the purchase of two new overseas investment trusts namely:

1. JP Morgan Global Growth & Income PLC on a discount to asset value of 3.5% managed by Helge Skibeli, a Norwegian fund manager with over 30 years’ experience. (Occasionally, one meets a fund manager who stands out from the crowd – I believe that Helge is one)
2. A Vietnam fund (VinaCapital Vietnam Opportunity Fund) on a discount to asset value of 20%. (And yes, the switch from a UK fund to 2 overseas funds is quite deliberate).

In the meantime, remember to set aside cash for an emergency, and also remember that regular contributions to a savings or pension plan in a falling market indirectly exposes you to Dollar-Cost-Averaging (a process by which you continuously lower your average buy price for stocks).

 Thank you for taking the time to read this and on behalf of the team, I send you our very best wishes,