Complacency and memory…
I have been reflecting on historical periods similar to that in which we find ourselves today. Of note is the post-Global Financial Crisis (GFC) period - which is fading into a distant memory, for most.
However, considering the duration of this market recovery, and the nature of where we are at this point in the economic cycle (with interest rates beginning to rise), the most similar time to this is the 1937 period. And particularly in the US.
The GFC downturn
If you compare the US (1929) depression experience to the (2007) Australian GFC experience, you can see clearly that the “all hands to the pump” approach from the Australian monetary authorities (and fiscal policy as well) had an effect. This stopped what was beginning to look very much like a 1929 experience in its track.
Make no mistake, the extreme measures undertaken by global authorities saved markets from a potentially very bad couple of years!
These measures averted the full decline and implosion of our financial system. By keeping these measures in place since (particularly quantitative easing, which has helped suppress interest rates both long and short-term), economies have gradually improved. This is to the point where today we are beginning to see coordinated positive global economic growth for the first time since 2006. The upward growth trajectory of the markets has been similar to that of the 1929 depression; a slow upward grind.
The challenge in this, however, is that the emergency measures of 2008 and 2009 are beginning to be unwound. And this is where the US 1937 experience is instructive. The pain (and potential pain) of the GFC has dulled, whilst the costs (and there are costs and inequalities) of the response have been ever present. This has caused unintended (and potentially paradigm changing) consequences.
The 1929 recovery was much like the 2009 one
In the US post the start of the depression in 1929, everything sank until the 1932 market recovery that occurred alongside the election of Franklin Roosevelt and the idea of the “new deal” (well this is the most common description of what happened, anyway). The markets then began the escalator ride to recovery through to 1937, much like we have seen since 2009.
By 1937 production, profits and wages in the US had regained the 1929 levels, but unemployment remained high. The US Federal Reserve had begun lifting interest rates in 1936 and 1937, worried about its “exit strategy”, and a number of the works programs Roosevelt had put in place suffered drastic cuts in the 1937-1938 years.
But too early action in 1937 caused a significant recession
The net result was the US experienced a significant economic recession (the 3rd worst in the 20th century) with unemployment jumping back to 19% in 1938. It lasted only 13 months (technically), however, the effect was that many of the levels reached (production, manufacturing and employment) by 1937 did not get surpassed until the US entered WWII in 1941.
The effect on markets, however, was very marked. After a slow recovery, this recession was a complete kneecapping, with the market falling until mid-1942 (by which stage WWII was front and centre). The market did not regain its 1937 high until January 1941. The 1929 high did not get surpassed until late 1954!...
Thus markets are finely poised
We are glad not to be policymakers today.
Politics and feelings aside, the global economy is on its best recovery trajectory since 2006 - this fact would surprise most people!
Whilst many exogenous events could derail this (they ALWAYS can), the biggest risk is policymakers misjudging the true strength and momentum of this recovery.
Should cuts to stimulus (and interest rates) be too early, growth will slow, and the potential for a version of the 1937 episode is possible.
On the other side, however, should cuts come too late, then global inflation will take hold and rates will eventually have to rise much faster, and potentially higher (even if only for a short period). Inflation is a hard genie to put back in the bottle once it sets in.
Neither is a terrific outcome and means the middle, inch by inch, ground is best. But difficult to achieve.
This is a difficult balance to strike. And, as it certainly seems to me that it is human nature to quickly forget, it is important to remind ourselves just how close the financial system was to ruin in 2007 so as to educate sensible decision making in 2017!
We will continue to invest only where we see good long-term returns (with low downside in the medium term), and we will not run with the crowd. We will not invest when we don’t find things to invest in. Hence, our cash balance currently remains high until we can.
This “common sense” has worked for clients of First Samuel for 17 years, and should continue to work fine for those with a medium-term time frame - no matter what conditions prevail in the short term.
Next week I will write about what a famous investor did during the Great Crash, to show how these conditions don’t necessarily need to damage your wealth.