By mbaxter 10 Feb 2010 [0 Comments | 608 views]
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So when do you think the recession began? Did you say 2008? Well, technically you are right of course. But bear in mind that the FTSE 100 peaked on the penultimate day of 1999. And while it got close to equalling that level during the heady days of 2007, right now the UK’s main stock market index is languishing 1,800 points below that elusive peak. (Incidentally, the FTSE 100 all time high from January 30 1999 is 6930.) Put it another way, the FTSE 100 is around 25 per cent off peak. The Dow has done better, up to a point. It is a mere 14 per cent shy of its pre dotcom crash high. But the US headline index went on to hit silly heights in 2007, eventually hitting 14164. At the time of writing it is 29 per cent short of that level.
But does it matter? Some data out this week from Moneyfacts on the value of our pensions puts this appalling performance into sad perspective.
But maybe the stock market’s lost decade tells us something else, more profound.
The Moneyfacts figures are shocking. Just imagine you saved £100 per month for 20 years and the money was invested into a balanced management fund. Now assume you retired at the turn of the millennium. Your pension should have been worth £103,914, and that should have given you an annual income of £8,998. Now imagine that your twenty years of saving began ten years later and you are coming up for retirement now. Your savings would be worth £40,749, and the annual income you could expect from that would be £2,542.
Now there are lots of words you can use to describe that performance, but here is one that is quite apt: pathetic.
It is no wonder that according to the Pension Protection Fund Index, the UK’s 7,400 defined benefit pension schemes are in deficit to the tune of £51.9bn.
It is tempting to ask, with a return like that what is the point of saving? What is the point of putting money into a pension? Alternatively, you can see why Brits saw their property as their pension.
As we now know, the idea that your property can fund your pension is a myth. Well, actually that is not entirely true. On an individual basis it can work, but it can not work for the country as a whole. There is no productivity in rising house prices. All that a booming property market does is redistribute wealth from those who don’t own their home to those that do. Nationally, a surging property market only provides the illusion of greater wealth. And while this illusion can help consumer confidence and lead to a boom based on spending, it also leads to debt. And that, as we all know, is the UK’s big problem. Like all the world’s major developed countries, UK government finances are in mess. But in the UK, consumer finances are in a mess too.
And to an extent we can blame it on the 2000 stock market crash.
Back then, central banks dealt with the crisis of the day by cutting interest rates. Maybe, in hindsight that was the wrong thing to do. Maybe, all they did was delay the onset of technical recession and in the process make it a lot worse
But, expectations are important. Last year Robert Buckland, global strategist at Citigroup, put out a note saying that before 1960, US equities yielded twice as much as US bonds. He said: “The S&P would need to fall by another 40 per cent to deliver that yield on the current dividend base.”
Mr Buckland reckons it is possible the unusually good period for investment over the last few decades changed investors’ attitude to risk. But this could now revert. He says: “Since the end of 1999, global equities have returned minus 29 per cent compared to plus 80 per cent return from global government bonds. Not only have equity returns been dire, but the volatility has been brutal. Having two 50 per cent bear markets in one decade is enough to test the patience of the most determined equity cultist. Just as excellent equity returns helped to promote the cult of the equity in the 1950s, so terrible returns seem to be tearing it down now.”
In a way it was just like house prices, more recently. House prices did very well for a couple of decades, in part thanks to inflation eroding the true value of debt, which in turn encouraged the view property was an outstanding and safe investment. Much of the boom in prices over the last decade, and frankly the main explanation for the recent surges in house prices, can be explained by the public perception. The experience of two generations told them house prices always went up, therefore their behaviour acted to reinforce this pattern. And in the process, of course, we see a bubble form.
It seems one of the key factors here is that the chain of cause and effect can be drawn out. Things happen because of something else that may have occurred a decade, or maybe even several decades earlier.
There was a good reason for the growth in equities that Buckland pinpointed. In the years that preceded this equity growth, economic growth was stellar. The golden age of economic growth was the period from the end of the Second World War to about 1973. This was no golden age built on illusion. It was a proper golden age, built on productivity, as businesses learnt how to exploit the technical innovation that had occurred during the previous half a century. Thanks to two world wars and a Great Depression there was a 50 year plus time lag between the Victorian innovations and their full take up by businesses. So, once the world had stability, we saw a period of catch up, as actual production caught up with potential production.
Naturally, company results improved, and of course shares went up. This created the view that in the long run, shares always go up. This was a commonly held view right up to the turn of the millennium.
From 2000 onwards, it seems that the reality that growth had slowed thanks to the period of technological catch up ending, had finally manifested itself in share valuation. Stocks re-adjusted in value.
And today, we are paying the price.
What’s the answer?
The big problem with equity investment is that it became too low risk. Not low risk in the sense that economists describe it, but low risk in the sense that common sense describes it.
An economist would say risk premia was sky high during the boom. That company valuations were out of proportion to projected profits. Risk premia has now fallen, bringing down share price.
But there is another type of risk. It is the risk you take when money is invested into innovators or entrepreneurs.
These are the people who create wealth in the long run.
Economists and markets have ignored these people. The assumption was that we could get rich via rising share prices and rising property prices. Even during the boom, it was tough for entrepreneurs to raise money.
The biggest risk you can take, in the long run, is not to take a risk.
The real problem today, the reason why pensions are worth so little, is that the pace of innovation was too slow. And only by increasing risk, and investing the money we do have into this area, can we fix the problem
