When central bankers come out in public giving much the same message, something must be up. Last week both Ben Bernanke of the US Federal Reserve and Mervyn King of the Bank of England warned of a tougher economic climate ahead – with Mr King using the "R" word for the first time. A recession in the UK, he said, was "perfectly consistent with our projection" for the economy.
Good, cheery stuff, isn't it? But it sounds like tail-covering to me. If there is going to be a recession, you want some public statement that the boss man saw it coming. My own view is that the Bank's forecast of a slowdown this year to around 1.75 per cent growth, but with the possibility of a couple of negative quarters, will turn out about right. But the Bank may also be too optimistic about 2009, when it thinks there will be a slow recovery.
But those are just opinions. It is the job of financial markets to look forward, and in their disorganised and incoherent way, they do try to give some indication of what might happen in the months ahead. So let's get away from the economists' predictions and see what the markets are trying to tell us.
Last week, two annual studies of very long-term investment trends were published – one from Barclays, the other from ABN Amro. They use slightly different methodology but the broad conclusions are much the same, and I find both of them rather comforting for two reasons. One is that the 100-year view is the sort of perspective that is most helpful when looking at investment trends. The other is that pre-1914 investment conditions seem much more akin to present-day ones than the mayhem between the wars and the great inflationary boom from the 1950s onwards.
So what do they say? Well the big message remains that over a very long period, equities are the best investment, particularly if you look globally. Share prices have been so battered this month and last that we tend to forget most markets ended last year up on the end of 2006. Here in the UK, shares were up by only by a whisker and the best investment was cash, but historically it is very unusual for cash to be the best investment. Globally, shares were up some 5 per cent year-on-year in real terms.
Shares the best investment? Yes, but only on the long-term view. We have just had five years when the main indices ended up, but then before that we had had three years (2000, 2001 and 2002) when they ended down. That was the worst bear market (or, on some calculations, the second worst) since the Second World War. This bumpy ride is a useful reminder that world markets had only just about recovered that lost ground before things slipped badly in January.
Seen in the context of the past 100 years, what we seem to be having now is a pretty classic bear market – just the sort of reverse you would expect after five years of gains. Such bear markets typically last between nine months and two years, and since this one only started last autumn, we probably have a way to go. But it would be odd were the next bull market, whenever it begins, not to pull the main indices well above their early 2000 and late 2007 peaks.
All cycles are different. In the last downturn, telecom shares were particularly hard hit; this time, it's the banks. So you have to get sectors right. The best-performing sector over the past seven years (ie, including both downturns) has been tobacco; the worst, computer hardware. Sadly, this is no guide to the next cycle but both investment studies carry some comments that deserve a wider audience.
The main message from the ABN Amro team is that momentum matters. Once a group of shares are heading in one direction, they tend to keep going for quite a while. Shares that have gone up one year tend to rise the next, and vice-versa. This happens in property as well. I suppose this is why markets tend to push beyond their rational limits and why contrarian strategies are very difficult to manage.
The main theme of the Barclays report is rather different, examining the present global situation in the round. Its conclu- sion is that scarcity of resources will dominate the world for the foreseeable future. It warns:
"We are depleting the global stock of natural resources ... at an accelerating pace. This process is creating negative feedback in the shape of rising real resource prices and a degenerating ecosystem, in turn catal-ysing changes to the fundamental structure of the economy."
Its argument is that pressure of demand, particularly from the developing world, will mean that resource prices stay high for a generation, and this will limit the ability of monetary authorities to cope with speculative excesses and smooth the economic cycle. It argues that this will change investment strategy – that people and institutions will borrow less and diversify their risks more effectively.
The Barclays team is surely right as to pressure on resources. It argues too that the past 20 years of disinflation are now over as a result. And it could have made the further point that Asia is savings-rich and will use its financial power to scoop up natural resources from all over the world, putting pressure on living standards in the over-borrowed parts of the West. But while the environmental outlook is deeply troubling, I don't think the macro-economic situation is as fragile as it was in the 1970s, when the developed world had to cope with the first oil shock at a time when inflation was already soaring out of control. What I take away from this is that market pressures will force the world to use natural resources more wisely, and that is surely no bad thing.
When you are heading into a downward leg of an economic cycle, it is important to acknowledge what is happening but also to look further ahead. It is a bit early for the latter and I can't see the markets thinking beyond the downturn for another year or so. But we will see the end of the crisis phase this year – as opposed to the slog phase – and the very long view of investment cycles gives us some reassurance that there is a world beyond even a longer-than-expected dip.Reuse content