What triggers the end of a bear market? With the benefit of hindsight, it always seems obvious but, at the time, much less so.
The analogy between the present time and the inflationary 1970s makes the lessons from them highly relevant, particularly as it has disappeared from folk memory.
How the 1970s bear market ended
6 January 1975 marked the day when the worst bear market the UK has ever seen ended. From its peak in 1972, the market had fallen 70% in actual terms, and 80% adjusted for inflation.
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Half of all stockbrokers had lost their jobs, and being a partner in those days meant not drawing a salary, but writing a cheque each month to keep the firm afloat.
The cause of the bear market was no mystery: inflation had been rising steadily for ten years, but in 1973, it accelerated, ending 1974 at 19%. The oil price quadrupled, as a result of the Arab oil embargo that followed their defeat by Israel in the Yom Kippur war. Almost all other commodity prices multiplied too.
Inflation was a global phenomenon, but Britain proved to be exceptionally vulnerable. Long-term economic performance had been poor, expectations (as always) ran well ahead of the nation’s capacity to create wealth, and a highly unionised workforce was able to force up wages in line with prices, resulting in an inflationary spiral.
Shareholders weren’t the only ones to suffer. Bond yields, already 8.3% by the end of 1971, rose to 17%, resulting in a “real” (after-inflation) loss on gilts of 48%, while even cash lost 9% in real terms. Both these figures ignore income tax at a rate of up to 98% for private investors.
There was no escape. Although in the US, the S&P index fell “only” 42% (rather less in sterling terms) and US bond yields reached just 7.4%, exchange controls meant that overseas markets were closed to domestic investors unless they were prepared to pay an exorbitant premium of up to 60% on an officially sanctioned black market.
There were few winners. Stockjobbers Ackroyd & Smithers, later to become the market-making arm of Warburgs, made large profits shorting shares and bonds all the way down.
The Labour government, which had scraped a tiny overall majority in the election of October 1974, was able to nationalise at knock-down prices, including taking majority control of BP by buying a further 25% from Burmah when it ran into financial difficulties.
Labour’s chancellor, Denis Healey, had vowed to tax the well-off “until the pips squeaked,” but instead secured the long-term future of the Channel Islands as an offshore financial centre.
When the market turned, it did so dramatically, rising up to 15% in a day and doubling in a matter of weeks. Since all the jobbers were short, they simply widened their spreads to dissuade buyers, and investors had no chance to get aboard. Only those who had bought on the way down, when the market seemed to be heading for oblivion, profited from the recovery.
A long, slow slog back to bull market territory
The turning point gave rise to a variety of myths. It was claimed that a group of major institutions, with Bank of England approval, had acted in concert to rescue the market, but no evidence was ever produced that they invested significant sums.
The hindsight traders always maintained that the market was blindingly, obviously cheap, yielding 11% and on a price/earnings ratio of about six, but pessimism was so extreme that investors just couldn’t see it.
It was never that easy. Inflation went on rising, reaching a peak of 30% in 1975, and the economy went into recession. Inflation destroyed cash flow, and after adjusting falling profits for the effect of inflation on the replacement cost of fixed assets, stock values and working capital, profits disappeared, the p/e was infinite and the dividends unaffordable.
After doubling, the market indices made no progress in real terms for another seven years. Bond yields fell to 14% in 1975, returning 10% in real terms, but gave a zero total return in real terms over the next six years.
The real bull market didn’t start until 1980, when both bond and equity investors came to realise that the new, business and investor-friendly government really was determined to squeeze inflation out of the system, and that policy makers in the US and Europe were doing the same. In the next 20 years, the UK market indices trebled relative to nominal GDP, but remained well below the lowest level of the 1960s.
It seemed that UK investors would never be faced with such a nightmare again. The UK market became far more international and less dependent on the domestic economy than ever before. Globalisation and the collapse of communism brought more freedom of movement of people, capital, companies and savings, with disinflationary and wealth-creating consequences.
This, and memories of the 1970s, seemed to make a significant rise in inflation unlikely.
Still, there has been back-sliding on globalisation, repression has returned to significant areas of the world, Western governments have become complacent about deficit spending, and central bankers believed that they could print money without consequences.
Hopefully, the cost of the back-sliding is now evident and can be reversed without more than a scare as opposed to the 1970s nightmare of embedded inflation.
Five lessons from the 1970s for today’s investors
For investors, there are important lessons. Firstly, equities are not “a good hedge against inflation,” as popular wisdom claims. Quite the reverse; the prospect of lower inflation is a wonderful tonic. If investors believe that central banks are determined to fight inflation, bond yields will stabilise, then start to fall.
This is much more important for equities than the trend of earnings. Turning points are often marked by recessions in which corporate earnings are falling but investors look ahead to the return of economic growth and the rebound in earnings that will bring. Jerome Powell, chair of the US Federal Reserve, appears to understand the importance of quashing inflation, but Andrew Bailey at the Bank of England doesn’t.
Secondly, turning points in markets are not visible in advance. Don’t wait for a clear peak in interest rates or inflation to be visible. Markets turn when marginally more investors decide that things will get better than will get worse.
Thirdly, this can easily turn into a stampede so buying on the way up is not an easy decision. Markets always stay ahead of the fundamentals and there is no certainty that the trend is now upwards rather than just a rally in a bear market.
Fourthly, the bears never change their mind. For them, the market recovery is always premature or ahead of events and valuations are too expensive.
Finally, remember the maxim that “those who forget the lessons of history are condemned to repeat them.”
Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.
After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.
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