By Sam Liddle, Church House Investment Management
The current backdrop of rampant inflation, soaring energy prices driven by geopolitical tensions, and impending recession has provoked much talk of the parallels with the UK’s last big inflationary crisis in the 1970s.
Back then, the retail price index peaked in 1975 at almost 27%, following chancellor Anthony Barber’s ill-fated 1972 ‘budget for growth’ under Edward Heath’s Conservative government and OPEC’s 1973 oil embargo.
Such comparisons – particularly with the ‘Barber Boom’ that fuelled wage rises and inflation – have become more meaningful in the aftermath of this year’s so-called Mini Budget announced in September by chancellor Kwazi Kwarteng, which sent sterling plunging to all-time lows against the dollar, and gilt yields soaring.
A more useful comparison
While the economic parallels between now and the 1970s make for illuminating (and alarming) macro commentary, it is also useful to consider their ramifications at a more granular level, for the value of asset classes held by UK investors.
The focus for investors was notably different back then, as there were no corporate bond or index-linked gilt markets; we are therefore concentrating on the impact for gilts, cash and equities, drawing on the Barclays Equity Gilt Study for the 20-year period between 1965 and 1985.
It is worth setting the scene by looking first at the corrosive effect of inflation on the buying power of sterling over that time. A lump sum worth £100 in 1965 would have bought only around £10 of goods in 1985. Clearly, then, those who simply held cash under the bed suffered huge losses over the two decades.
Fixed interest pain
What happened with government bonds? Yields rose from around 6% in 1965 to peak at 17% in 1974, falling back to around 10.5% by 1985; Barclays calculates that the total real return, taking account of capital values over those 20 years, amounted to -0.3% a year on a total return basis.
But perhaps a more useful analysis is to consider what would have happened to £100 of gilts bought in 1965 and held with gross interest reinvested. That £100 would have practically halved in real terms by 1974 as yields went through the roof and decimated capital values, but it recovered much of its value through the early 1980s.
Cash savings tread water
Barclays looks at returns from both UK Treasury Bills and building society accounts, which were a much more important feature of household savings in the 1970s. It finds that over the 20-year period Treasury Bills broke even in real terms, while the higher interest rates paid on building society accounts meant they achieved an annual average return of 0.3%.
But again, that long-term average masks the real losses suffered by building society savers through most of the 1970s as a result of inflation. By the end of the decade, a £100 deposit with gross interest reinvested would have bought just £85 worth of goods compared with 1965.
UK equity investors had a torrid time during the bear market of April 1972 to December 1974. Share prices fell by more than 70%, compounded by a secondary banking crisis, falling pound and industrial unrest as well as the oil crisis and inflation.
Total return data for the FTSE All-Share index was not available until 1984, but the Barclays study (which runs an index based on data from 1899 onwards) shows massive swings in real equity values between 1965 and 1985.
Indeed, such was the impact of the 1972 slump that as of December 1974 the total real return for the previous 10 years was running at an annual average of -7.3%. But the subsequent recovery in share prices into the 80s meant that over the total 20-year period equities pulled off an average real return 5.4% per year.
To relate that to our £100 lump sum, if it had been invested in 1965 in the UK market with dividends reinvested, its real value would have plummeted to just £50 by the end of 1974, before soaring to well over £250 by 1985.
What is the takeaway?
Terrifying volatility, accompanied by many corporate and individual bankruptcies, was the price paid by equity investors for the best long-term real returns.
Closer examination of leading blue-chip companies in 1965 shows that a large number either went bust or were taken over during the following 20 years. The evidence backs up our ongoing concerns that capital-intensive, low-margin businesses are particularly vulnerable to inflation and rising interest rates.
More generally, it is encouraging to note that a focus on equities paid off over this period – but cash resources were vital to the survival of both companies and investors. The lesson remains that the surest protection for investors in such turbulent times is provided by holdings in high-quality companies with strong balance sheets and margins that can survive a significant downturn.
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