Few of the universals of personal finance and investing are – paradoxically – as individually experienced and feared as inflation.

That’s true both in terms of the headline inflation rates you happen to live through, and also your personal inflation rate that varies with what you choose to spend money on.

You may not even have thought much about inflation before 2021, depending on when you were born.

If you’re under 30, the most striking inflation you’ve seen is how many pints of milk it now costs to buy a Bitcoin, compared to a few years ago.

At its £48,000 high, the Bitcoin price was up about 70-fold since the start of 2017 – in pint of milk terms.

No wonder a generation of DIY-traders aim to get rich quick from Bitcoin.

Most of the YOLO crowd will never have thought much about the price of a pint of milk, though. Why would they? It’s been steady in the UK for ages.

But other people in history have seen the cost of food skyrocket in less time than it takes to recite Old MacDonald Had A Farm.

In Weimar Germany in the early 1920s:

Prices ran out of control. A loaf of bread, which cost 250 marks in January 1923, had risen to 200,000 million marks in November 1923.

The Weimar Republic 1918-1929, BBC

Such hyper-inflation is rare. But more routinely high inflation isn’t merely a ghost story from the economic textbooks.

Right now, annual inflation is running at 10% in Brazil, for example. It’s more than 20% in Turkey.

If you’re Turkish you’d be happier if some of your life savings had been in US Dollars. Let alone in Bitcoin.

How much was a Mars bar?

Closer to home, cautious 70-something fund managers have warned us about inflation ever since Central Banks began quantitative easing in 2008.

They’re still at it. Here’s 77-year-old hedge fund manager Paul Singer writing in the Financial Times in December 2021:

The global $30tn pile of stocks and bonds that have been purchased by central banks in order to drive up their prices has created a gigantic overhang.

With inflation rising, policymakers are reaching the limits of their ability to support asset prices in a future downturn without further exacerbating inflationary pressures.

– Financial Times, 6 December 2021

Younger investors too who’d read economic textbooks – for the little good it has done in the past decade – may have also have felt uneasy.

But the rest have happily bid up the multiples on equities, taken out huge mortgages, and saved into near-zero interest cash accounts in a low inflation world.

Today’s 20- to 30-somethings don’t know any different. At least not from lived experience.

In-between you have the likes of me – Generation X – who remembers inflation in my childhood and getting 7% on cash in my early working years, but who mostly invested this century. I’m caught somewhere in the middle.

Let’s recall how the generations are popularly sliced:

Source: Pew Research

Now consider a key measure of UK inflation since the late 1980s:

Source: ONS

Today’s Gen X senior banker, trader, or fund manager graduated in the late-1980s to mid-1990s with vague memories of crisps and sweets getting dearer as kids, but the cost of their lunch at work has changed little in 20 years.

It wasn’t a smooth ride. There were the Dotcom and banking crashes, the Eurozone crisis, a pandemic. Inflation fears have arisen now and then.

But as things turned out – and whether by luck or design – UK and US price rises have mostly been modest since the 1990s, when Central Banks began directly targeting a specific inflation rate.

As a result – and with hindsight – you could have done a lot worse than to buy long-term bonds in the early ’90s, and then gone to lunch for 30 years.

A truth universally acknowledged

Alas for bond managers (but fortunately for City tailors) the big win of buying a huge pile of bonds, reinvesting the coupons, and getting another hobby was only certain retrospectively.

Nobody could risk dismissing an inflation resurgence just because the Bank of England targeted a 2% rate forever. Inflation pops up all the time in the history books, so they kept an eye out for. Many suspected reports of inflation’s death might be exaggerated.

The oldest measure of inflation, RPI, (since superseded by CPI) was only introduced in 1947. However the Office of National Statistics has done some backward gazing to 1800:

Source: ONS

When I first saw this graph, I felt bad for Jane Austen’s rich men boasting about their fixed incomes.

Inflation often spiked towards 20% in the 1800s! Fixed income riches looks less attractive in this inflationary light than the Darcy-fanciers imagined.

However we can see that deflation was also incredibly common back then.1

Sure, Mr Darcy’s £10,000 income would have been inflated away for a while. But it would have surged again in real terms a few years later.

Economic life was just more volatile. As academics who’ve studied the backdrop to Austen’s novels note:

During Jane Austen’s own lifetime, the British economy experienced a series of economic crises. 

An oversized national debt, four waves of recession, two banking crises, the debasement of coins, a major economic crash, and a depression led, in combination, to a doubling of consumer prices, i.e., extreme inflation.

In 1795 […] the first financial crisis of Jane Austen’s lifetime occurred in the form of a massive crop failure brought on by a long drought and a harsh winter. 

The price of bread, meat, milk, and cheese doubled, leading to food riots across England.

The Economics of Jane Austen’s World, JASNA, Winter 2015

The 19th Century economy ran without Central Banks or government backstops as guardrails. This – along with war, disease, weather, and the industrial revolution – made for a cycle of feast or famine.

Twitter economists who rail against today’s crisis-dampening central bankers might want to ponder that graph above.

Down, down, deeper and down

A surprising number of people with arts degrees end up in money management. The English Literature graduates at least might have read plenty about financial instability.

But it was still more the 1970s than Jane Austen’s time that a Gen X bond manager would have had at the back of their head as inflation’s ‘great moderation’ got underway.

This chart shows how RPI surged in the 1970s:

Source: ONS

As you can see, a 21% inflation rate in the UK is very much within living memory.

Even more so when the benign conditions of the 1990s first took hold.

Memories of 1970s inflation was surely the main reason why UK yields took 25 years to fall to their nadir. Purchasers feared inflation’s bond-slaughtering recurrence. But as inflation didn’t surge back – and Central bankers further lowered rates – yields marched ever downwards:

Source: Independent

Near-zero interest rates are almost taken for granted today.

But for much of the past 100 years an economist would assume we were living in Bizarro world – or at least in a depression – if they saw this graph.

Even better than the real thing

Today few people who’ve worked through bouts of high inflation remain at the coal face of big financial institutions in London or New York.

They’d have to have been working in the 1970s, really. That would put them in their 60s or older.

A few (such as the aforementioned Singer) soldier on. But most by that age have headed upstairs and away from the trading terminals, or else out the door.

Which is interesting, given that in late 2021 inflation is on a tear:

Source: ONS

Some pundits argue the lack of hands-on investors with inflation experience is a blind spot. They say there are few people around who’ve seen inflation before who can spot the inflation that’s now (allegedly) taking hold, leaving us vulnerable.

But does their logic stand up?

Everyone and their FT-reading dog is worried about inflation, so it’s no secret. Along with speculation about rate rises, it’s 90% of what the financial media talks about.

Besides, perhaps someone who’d invested through an inflationary spiral could just as well spot a fake one? Maybe they’d tell us this recent uptick is a blip?

Where is the union bargaining power, they might ask? Why can’t firms continue to look overseas to cut prices in the long-term? Are the goods and services that make up the inflation basket inherently more expensive?

We may indeed be experiencing a small energy price shock. But did we also just come off the gold standard – that other hallmark of the 1970s episode?

Alternatively, is inflation just down to temporary SNAFUs at ports and factories, restarting commodity production, and perhaps even over-ordering by panicky companies trying to avoid problems in future?

A short-term supply/demand mismatch? (I suspect this, for what it’s worth.)

The reason the market wants answers to these questions isn’t just because higher inflation would probably require higher-than-expected interest rates eventually, and that could weigh on the bond market.

It’s also because our financial system has been broadly rewired for a low rate and low inflation reality.

For a very relatable example, look at how the price-to-earnings ratio for first-time buyers has soared to an all-time high as inflation has steadied and rates declined:

Source: ThisIsMoney

In 2000 a first-time buyer paid about three times their salary for the average starter home. Now they pay nearer six times.

That would not be possible without low interest rates keeping mortgages affordable.

The same relationship rolls out across the investment universe. For instance I’ve previously explained how low long-term yields and expectations for subdued inflation underwrite high multiples on equities that have boosted the indices for years.

Deflated expectations

Experienced antique dealers aren’t only good at spotting the real thing.

Much of their skill is avoiding old tat that looks like an antique, but isn’t.

We haven’t seen inflation shoot up like it has recently for a long time. No wonder it’s unnerving.

But maybe what we need is an old pro in a fedora to sniff the air, and then to turn up his nose at the scary headlines and walk on by, unruffled.

1. That’s assuming the ONS got its retrospective sums right. [↩]

What caught my eye this week.

The granddaddy of peer-to-peer (P2P) lending, Zopa, has thrown in the towel on P2P altogether.

According to the company:

…over the last few years, customer trust in P2P investing has been damaged by a small number of businesses whose approach led to material losses for retail investors.

Linked to this, the changing regulation which followed raised the operational costs of running a P2P business, as well as the cost of attracting new investors to the Zopa platform.

To offset these increased costs and ensure we have a sustainable and profitable business, we’d need to reduce investor returns to a point where they’d no longer be attractive and commensurate with the risk that investors take on.

For these reasons, we have decided to fully focus our attention on our Bank.

I think the writing has been on the wall ever since Zopa became a bank in 2020.

If you’re trying to overthrow the established order, you don’t typically pursue all the conventional trappings to make progress.

Zopa had a good run. The bank says that over 16 years – and despite two financial crisis – the average return to its borrowers was 5%. Even through the pandemic it delivered an average of 3.9%.

Given the failures elsewhere in the sector, that’s not to be sniffed at.

I did it my way

Monevator and peer-to-peer lending both arrived around the same time. I was an early adopter on Zopa and so I wrote about things I noticed, such as on a surprising pattern of a particular cohort of my loans going bad.

The zoperati smirked at my concerns on their forum. They said I didn’t understand probability.

But it turned out Zopa did see defaults spike at a higher-than-expected rate in late 2008. My hunch was right.

Zopa subsequently tweaked its processes and that rise in bad loans proved to be a blip. Overall the platform did well in the recession.

I bring up this ancient history because it framed how I viewed P2P.  You really could have visibility into how your money was lent with P2P – and the risks and rewards – in a way that was novel for nearly all of us.

But arguably, what the P2P experiment proved is most of us aren’t very good at judging such metrics – even at the level of choosing a viable platform. Many people just chased the highest yields.

Zopa-vision

Originally, peer-to-peer was all about Bob lending directly to Joe.

Bob would read a bio of Joe, look at his photo, and think: “Yeah, Joe looks like a trustworthy sort who needs a new motorbike.”

You’d already have set your interest rate. That would attract a certain cohort of risky/rewarding borrowers, which Joe might fit into.

Even if Joe seemed a bit riskier than you’d prefer, you might still see a tiny sliver of your cash spliced into a loan to Joe – with your money earning a slightly higher rate than other money in that loan – at the cost of your lending going out more slowly.

There were lots of quirks like that, and Zopa hobbyists poured over them.

Many of these early and vocal Zopa investors were more mathematically adept than me. I felt though that some lacked a survival instinct. They understood odds, but perhaps not existential risk.

A few of them had all their investment money with Zopa. I thought that was crazy. I still do, even though history has okayed their decision.

As I’ve said many times, my suggested P2P limits were far more cautious. Perhaps 1-3% of net worth across all one’s chosen P2P platforms. Maybe 5% if you’re keen, rich, or stuck for options.

Widely diversified across each platform, too, of course.

Bang goes the business model

Prudence was wise, because far from gracefully transforming into a bank (not a sentence you’ll read every day) the worst P2P lenders went kaput.

A couple went into administration. Others were consolidated. A few were part of larger businesses that put their underwhelming P2P units into run-off.

Most of these P2P experiments in the UK never achieved any scale. The vast majority you’ll never have heard of.

But there were a couple of high-profile casualties.

The failure of property loan financier Lendy highlighted risks that went beyond borrowers simply not paying you back. Lendy investors found out in late 2019 that their money had not been properly ring-fenced. Thus it could have been used to pay the firm’s creditors.

Elsewhere P2P lender and pawnbroker Collateral was closed down in 2018 when its regulatory status was thrown into doubt. Hard to plan for that.

The Financial Conduct Authority (FCA) tightened up P2P regulations. This (rightly) led to delays in granting Innovative Finance ISA status. But it also exposed another risk. Even a seemingly viable platform could suffer from adverse regulation. This could put a business model in jeopardy at a stroke.

First among less than equals

For all these reasons I graced only two of the biggest platforms, Zopa and Ratesetter, with my money. They were also the only ones I featured on Monevator.

Both seemed to me to have had sufficient scale and profile to be a problem for the authorities if they failed – and thus I hoped got more scrutiny – as well as being more transparent themselves.

Many P2P fans would count a third member of the ‘Big Three’ triumvirate, Funding Circle, as among the safe options. But I was less convinced its business loans were amenable to P2P evaluation, at least in the early days.

True, Funding Circle is stock market listed. That affords extra reassurance, because analysts and fund managers should also be kicking the tyres.

But like all these firms, Funding Circle’s offering changed over time anyway and I didn’t fell like I was missing out.

Eventually there seemed to me no great difference between what it and the other big two platforms offered from a consumer’s perspective – fixed rates, basically – but rates everywhere had plunged, and P2P returns no longer seemed very juicy.

Tails you lose

Perhaps I was too timid. There are other widely-admired P2P sites out there – Assetz Capital and Lending Works for starters – and I am not saying that there’s anything intrinsically wrong with the best of them.

But I also stuck with the big two for practical reasons. At one point it felt like I was being emailed by a new P2P outfit every week. Evaluating them all would have been a full-time job (there are people who do just that). Even as a blog owner let alone as a saver, I didn’t have the spare capacity.

What really concerned me was systemic risk. This might be something off in a platform’s business proposition or with its models, or it could even be fraud. In the worst outcome, you wouldn’t just see 8% of your loans going bad when you’d anticipated that 5% might default. With systemic risk you could potentially lose much more. Maybe everything.

Losing all your money is very unlikely with a High Street bank – even before you consider FSCS protection – or with big stockbrokers. Size, regulation, and reputation aren’t 100% guarantees. But they do help.

In contrast, most of the new P2P firms were loss-making shoestring start-ups. Some were backed by crowdfunding retail investors. One wondered how much experience of actual banking some of the bright founders had beyond using an ATM to withdraw cash on a Friday night.

Risks clearly abounded.

Banking on it

That was (mostly) then. This is now.

With Zopa throwing in the towel on P2P, the original vision of P2P is dead, at least among the big platforms.

Zopa is a bank. Ratesetter was acquired by Metro and has become a loans business. Funding Circle is shut to retail investors for the time being at least.

I suspect this retrenchment has happened because of a combination of risk aversion, market mismatches, regulation, the pandemic – and even success.

The ability of Zopa and Ratesetter for instance to deliver higher returns than cash in a bank without blowing up attracted more money to those platforms. This in itself had a depressive effect on returns. Yet the platforms had to pursue ever-greater scale for their own economic reasons. Regulation costs mounted, and the increasing vogue for insulating investors from the risk of losing any money further curbed returns.

Somewhere the P2P element went by the wayside. In the end you’d save via an aggregated marketplace in almost the same way as you’d put money into a savings account. You expected higher returns but got no FSCS protection. Ultimately you relied on the platform’s safeguards to protect you from loss.

They’d reinvented banking!

Better to be a real bank in that case, I suppose.

Are any readers using the smaller P2P lenders or mourning the loss of the big ones? Let us know in the comments below.

And have a great weekend everyone.

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What caught my eye this week.

For the past few years, being an investor in disruptive growth companies has been easy.

There’s been the odd hiccup – a tantrum in late 2018, and of course March 2020 when everything not nailed-down was sold in a panic.

But mostly, you just got richer every week.

Perhaps the biggest challenge this cycle was seeing your go-go shares only rise 5% in a month, while some meme stock jumped 300% and a crypto asset you’d never heard of rose 10,000%.

Bull markets don’t just make everyone (seem like) a genius.

They make greedy geniuses, too.

But investing in shares on ever-higher valuations is a game of chicken.

Even if you’re a fundamentals-based investor (like me, la-di-da) who buys into businesses, not stock charts, the market will eventually call your bluff.

You may own firms with fabulous futures, but one day they’re going to look about as appetizing as chlorinated chicken sounds. They will be tossed overboard indiscriminately.

The greatest multi-bagging companies – Tesla, Amazon, Apple – saw their value plunge 50-90% on their way to trillion dollar valuations.

It’s a matter of when, not if.

Under pressure

Friday was one such day. Which was remarkable, because Thursday had already seemed like one such day.

I’d actually messaged The Accumulator a screenshot from my portfolio tracking spreadsheet on Thursday showing how much the growth portion of my sprawling portfolio had been roiled.

But then came Friday, which guffawed: hold my beer.

Not one but two of my shares fell more than 25% on Friday. The worst was down 40%. Many of the rest were down at least 5%.

And we’re not talking tiny fly-by-night stocks. My biggest plunger, Docusign, was worth more than $50 billion a month ago.

Here’s how a random selection of growth companies fared last week:

Of course all of these companies – with the arguable exception of Meta (nee Facebook – have looked super-pricey for the past couple of years.

And there’s a definite ‘de-digitalization’ theme among the companies that have been faring especially badly.

Even as Omicron has loomed, the so-called work from home stocks that were winners in the locked-down world have proven too pricey for some tastes. Especially with higher interest rates on the way.

I wrote last month about how inflation expectations have been getting stickier all year. That had suggested Central Banks will need to tighten financial conditions sooner or more severely – or both. And that’s potentially bad for growth stocks because of the impact on discounted cash flows that I flagged up a few years ago in discussing the problems with low interest rates.

Twelve months ago, fanciful commentators were opining that paying multiples of 50-times a company’s sales (that’s revenue, not profit) was the new normal.

And it was – in that everyone was doing it.

Until they weren’t.

Another one bites the dust

Obviously I can’t sound too smug. As I say, a good part of my portfolio was pummeled this week.

I’ve been trimming growth exposure for much of 2021 on the back of re-openings and scary multiples.

But clearly in hindsight I kept too much and – hilariously – I’d even bought back some fallen high-flyers because they had begun to look tempting.

Oops.

However this is not my first rodeo. I know shares in growth companies can look too expensive for years in a bull market, and I was happy to book the gains in the good times. A kicking was coming someday. The snag was I didn’t know when.

But will the legions of new investors who only began trading in 2020 and have never seen a bear market be so sanguine?

Thursday and Friday felt like a panicked liquidation – of traders on margin, if not of actual funds – but at the index level prices only dipped a little. This was a very localized earthquake.

There’s a lot more selling to come if people truly get the fear.

Of course, as I alluded to above much of the fastest money has moved onto trading cryptocurrencies.

Doubling your money in a growth stock in a year was a snooze-fest for Boomers by comparison to alt-coins and the like.

I wonder what such traders made of the past 24 hours in crypto prices on checking their screens this morning:

Come back plunging growth stocks – all is forgiven!

It sure looks like the euphoria is over.

Don’t stop me now

If you’re a passive index fund investor then you’re entitled to feel pretty good about all this.

For UK investors, the Vanguard World Index Fund was down less than 1% in the week.

It actually rose on Friday!

The mega-tech companies that dominate the market (Alphabet, Microsoft, Amazon and the like, though not Meta) have barely wobbled so far.

Passive investors also save themselves a lot of grey hairs by avoiding days like Friday – albeit at the cost of rarely being able to brag about your returns on Twitter.

Most people will do much better with index funds than stock picking, which is why we recommend passive investing so much on Monevator.

But I wouldn’t get too complacent.

An interesting feature of the recent sell-off is that it’s occurred while the all-important US ten-year yield has actually been softening.

Indeed market expectations for US interest rates are flattening across all maturities recently.

Say what?

Basically, as of recent days, the market is seemingly expecting US interest rates to rise less in the future.

That could be because it foresees another recession, maybe virus-driven.

It could be because it’s thinking that inflation is more transitory, after all.

Or it could be that bond investors are growing increasingly fearful in general, perhaps due to the same flight to safety instinct that drove the mass dumping of expensive growth stocks this week.

After all, if you expected Omicron to lock us all inside again, then the likes of Zoom Video should perhaps be rising.

So there’s some circles to be squared here.

I could speculate about this all day but it’s not really our beat.

Suffice to say we’re potentially in one of those periods of dislocation for the markets, where things change and it only looks obvious how in hindsight.

It had seemed like stock markets were getting ‘healthier’ in 2021.

Last year’s returns were dominated by the biggest companies. But the spoils had been shared more evenly recently, as Morningstar reported:

Will this continue?Maybe the recent sell-off is evidence of investors coming to their senses, as value investors might put it, and dumping their growth shares for solidly profitable companies?

Or is a new bear market coming – taking out the easy targets before moving on to the biggest prey?

Who knows. Anyone being too defensive has made a mistake for most of the past ten years.

I was too exposed to growth stocks in partly because the end of the year is usually so strong, and the outlook seemed favourable until a fortnight ago. Things can change quickly.

Who wants to live forever

We’re all playing a long-term game. As an active investor, I believe I can outperform the market by discerning the best companies that will prosper over the next 5-10 years (albeit I shuffle my cards continually, which is heresy in the circles I hail from).

I even bought some growth shares on Friday – buying into boutique cloud provider Digital Ocean and adding to old favourite Mercadolibre (the so-called ‘Amazon of Latin America’, only not that Amazon…)

These still look like long-term winners to me. But in the short-term anything can happen.

Meanwhile for passive investors, the best defense is and always will be diversification. Even steep crashes will eventually look like blips provided you’re properly diversified and can hold and add through such declines.

Because a time will come – maybe next week, maybe next decade – when the sort of falls growth stocks ‘enjoyed’ on Friday will occur at the index level.

The S&P 500 will be down 8% in a day. The FTSE 100 will be off double-digits.

It’s always inconceivable until it happens. But it does happen.

Maybe this week was the market re-calibrating for a long expansion ahead. Perhaps the old companies that burn and bash stuff are due some time in the sun.

The bull market is dead – long live the bull market!

Perhaps, but I fancy it still isn’t a bad time to make sure you’ve got the right balance in your portfolio for navigating whatever comes next.

Have a great weekend.

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