At the MoneyWeek conference a few weeks ago, we spent a lot of time on financial repression (where interest rates are lower than inflation) and the best asset classes to hold to survive it. I looked in particular at some research from Tim Bond at Odey Asset Management. One thing is pretty clear: you might want to hold cash for short periods (it gives you the option to pick up other assets on the cheap), but you don't want to hold it for the long-term during periods of repression. Say you can get 1% in the bank, but inflation is 4% -keep your money in cash and you'll lose 25% of your purchasing power in just ten years.
You also want to avoid gilts. Bond looks back to the aftermath of World War II, when Britain had a government debt-to-GDP ratio of 250%. Britain kept rates at 2% (the previous record low) from 1940 to 1950. That was well below the rate of inflation (and rates only turned positive in real', after-inflation terms in 1956). If you'd ignored the low-rate environment and persisted in thinking that gilts offered you safety, you would have faced a loss of 5.5% a year in real terms. By the end of the decade, 46% of your wealth would've been gone. If you'd been fool enough to hang on until the 1970s, you'd have lost over 70%. Nasty. The same happened in the US from 1933 to 1951 when the Fed "operated a semi-formal cap on bond yields at 2.5%" (this was a bit like today's Operation Twist). Investors lost a total of 41% of their wealth and that was even with inflation averaging under 4%.
So no bonds and no cash. What of property and repression? There isn't much data, says Bond, but if you look at the US experience, you can see that from 1933 to 1951 property does seem to have offered a positive real return (around 2% a year). Unfortunately, we can't extrapolate that to today's British market. The US gains came from a post-crash bottom (prices fell 25% from 1929 to 1931), not from a bubble top. So that doesn't help.
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But there is good news. Between 1940 and 1956, UK equities returned 6.5% a year in real terms. And between 1933 and 1951, US equities delivered 7.3%. Nice. Will it happen again? It might. But if it does, it will have a sting in its tail our regular investors might be tiring of: very high volatility. As Bond notes in the Citywire Strategy Guide, "financial repression usually arrives at a time of high macroeconomic risk".
Right now, no one is quite sure what is going to happen anywhere, but everyone also knows that the risk of something bad happening is higher than usual. So it makes sense that the market which is nothing more than a mechanism for processing expectations should bounce around rather a lot. And that is exactly what it does: in times of repression, says Bond, markets are twice as volatile as usual. So while what happened last week might have felt scary, the truth is that it was a perfectly normal thing to happen in abnormal times. Expect it to happen again.
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