What caught my eye this week.

The US may be about to see another surge in Covid-19 deaths. This is clearly tragic from a human perspective. We might also wonder what it will do to the market.

I’ve been pretty relaxed about the UK’s de-lockdown. Daily cases have steadily fallen, contrary to – soon forgotten – warnings at every stage that we were moving too fast.

Indeed it was probably only around 4 July that we went much past where I’d have set the limits for the actual lockdown! Albeit partly with the benefit of hindsight.

My hunch is 90% of the heavy lifting of preventing a rapid escalation of Covid-19, at least in summer, comes from basic social distancing and hygiene, and perhaps wearing masks inside.

Throw in today’s testing capacity – spectacularly absent back when many of us thought we had the virus – and it looks to me like enough to at least keep the situation contained.

More or less

Shutting down the economy, paying extra billions in furlough, not leaving the house more than once a day, keeping lovers apart for three months – I doubt it made much more difference. We should have focused instead on ring-of-steeling care homes. From day one it was the elderly who were clearly most at risk.

Still, reasonable people can disagree.

Early, when total cases are very low, maybe extermination from a heavy lockdown is an appropriate goal. Maybe if you’re going to get a 15% hit to GDP you might as well take a 20% hit and try to wallop the thing on the head. Fresh flare-ups in Australia and Hong Kong reinforce my doubts on that score, but even experts debate this – and I’m far from that!

But I still believe the case for uber-lockdown ignores myriad unforeseen costs and consequences.

Something I learned from Tim Harford this week is called the identifiable victim effect.

Nuclear cul-de-sac

For example, after the Fukushima nuclear disaster in Japan, hundreds of thousands of people were made to relocate from their homes for years on end.

Obviously, right? Nobody wants citizens getting sick from radiation.

Right, except it’s now thought relatively few lives were saved by the relocation. In fact it’s possible more evacuees killed themselves from the emotional wrench of separation and upheaval than would have died from radioactive fallout.

At least 50 suicides have been recorded. And there will have been tens of thousands of smaller tragedies, from job losses and broken relationships to farms falling into disrepair.

It’s all incredibly sad – but try making that argument when the Geiger counters are going haywire. I’m sure I’d have relocated them, too. Most politicians wouldn’t hesitate.

Some more emotive arguments about Covid-19, especially in the early days, saw this identifiable victim effect loom large.

America dreaming?

Still, I know that one thing all1 readers of this website will agree on is that Covid-19 is not a hoax…

…that being asked to wear a mask isn’t a plot to turn us into communists.

…and that saying a less full-on lockdown might have been more proportionate doesn’t mean I’m saying we should do nothing, or pretend the virus isn’t happening.

Yet, incredibly, swathes of Americans appear to have reached exactly those conclusions. A lunatic fringe apparently even believes ex-President Obama created the virus and is spreading it.

(So this is how democracy dies. Not with a bang but a “WTF? Really?”)

You can understand why the saner end of this happened. The US is a huge country. Much of the US was in lockdown when it probably didn’t need to be. Local lockdowns and exclusion zones might have been more pragmatic, and caused less frustration. Although this is with hindsight – I imagine the US health officials didn’t expect things would eventually go so far off the deep end.

Anyway, the end result is the virus seems to be taking off rampantly again.

I have tried to stay open-minded about this. In particular the US is now doing over 600,000 Covid-19 tests a day. It’s a truism (not a Trumpism) that if you increase testing in a pandemic you’ll find more carriers. So it was plausible that part of the surge in US cases was down to the huge ramp in testing.

(Imagine if we’d been able to test everyone in London over a few days in early April. We might have found half a million people with the virus!)

As you test more people though, what you don’t want to see is the percentage of positive results going up. That means you’re not just finding more Covid-19 carriers through more tests – it also implies there’s a growing number of them out there.

And what you really don’t want to see is daily deaths go up.

Unfortunately the US is now seeing dramatically more positive test results:

This might not have been definitely terrible. I suspect young people have had enough of putting their lives on hold for something that will only badly affect a tiny minority. When respected US medical figures say as much as 50% of the US population will probably have had Covid-19 by the end of the year, you might well ask why not get it over with? Sure enough, the average age associated with a positive result has been getting younger in the US.

However, the counter-argument to the ‘let rip’ thesis is that eventually the pandemic ebbs up to and kills a swathe of the vulnerable.

And in my daily chart checks, that’s what I’ve noticed may now be happening:

Two questions for the market.

Firstly, is this uptick just an artifact of the natural history of the virus?

I’ve noted before it’s still not clear why thousands die in some places and other places get off fairly lightly. Maybe Covid-19 has taken a while to get embedded in some larger and more clement US environs? This is grim news for people living in such places. But it could mean a nationwide resurgence isn’t inevitable.

Secondly, is the US effectively going for a Swedish approach? Not openly stated, but de facto.

Again, this always seemed a plausible endgame to me with a virus this transmissible, and yet apparently ultimately harmless to most. The cost of repeated shutdowns is just too great.

It’s worth noting that for all the wailing and gnashing of teeth, the Swedish approach has sort of worked.

Yes, before *you* say it, plenty of people have died. As I always reply, we’ll only see in the end how premature much of this death really was.

But more importantly for this discussion, many were arguing in April and May that only stringent lockdown could curb the spread of the virus.

The Swedish experience, painful as it was, seems to show that’s not true:

Through one lens Sweden’s approach looks like a failure. It comes fifth ranked on deaths per capita from Covid-19. (Though that’s still better than lockdown-happy Britain at third).

But this isn’t the argument I’m making here. I’m simply saying a looser policy that accepts the virus will spread and run its course isn’t a catastrophic policy from the set of bad choices on offer.

The US may be about to find out, one way or another. Frustratingly, I could see the market taking this news either way.

Bluntly and economically-speaking, it probably fears another fully-loaded economic shutdown more than a higher death tempo among the elderly.

On the other hand, a return to New York-like scenes on the news is hard to square with a recovering economy let alone buoyant share prices – even if the very worst fears and tail risks of this pandemic have now been lopped off the distribution graph.

Hold on to your hats (/allocation to bonds and cash). Things could be about to get bumpy.

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1. Okay, 99% [↩]

The coronavirus crash was bad and the Global Financial Crisis unfolded like a horror movie.

But the UK’s biggest stock market crash in the last 120 years was the drawdown of 1972 to 1974.

The 1970s slump had it all. A property market bubble, secondary banking crisis, massive oil shock, falling pound, rising inflation and interest rates, industrial unrest and global recession were the toxic feedstock for a rampant bear market that inflicted bigger losses than those sustained during either World War or the Great Depression.

The UK market fell -73% from 1 May 1972 to 13 Dec 1974.1 That is 32 months of historic misery.

This chart of the FT 30 index of UK stocks sums up the sinking feeling:

Source: CEICDATA.COM / Financial Times

Not even the -52% bursting of the dotcom bubble could compare with this meltdown.

What the hell happened?

The trouble starts: May to September 1972

The drama begins in May 1972. The UK gives up defending sterling’s peg to the dollar in the face of a widening trade deficit and draining currency reserves. The pound begins a new life as a free-floating currency and heads down. (A direction we’re all familiar with today.)

Inflation and the Bank of England’s (BOE) Bank Rate creep up. The Office Of National Statistics (ONS) records CPI inflation at 7.2% and the BOE’s main interest rate at 7.6% in 1972.

After a summer rally, the market heads into correction territory in September. It’s down more than 10% since May.2

We’re five months into the decline and it’s curiously gentle in comparison to the -32% elevator drop we took in the first month of the coronavirus crash.

Meanwhile, there’s trouble brewing in the commercial property sector.

The lunatic fringe

According to a BOE paper that raked over the ashes of the crisis, rents were rocketing in the early seventies. The supply of office space had been strangled by planning restrictions since the late sixties.

This set off a chain reaction that led to a massive bailout of UK banks called ‘the Lifeboat’.

First, the planning controls were loosened by Edward Heath’s Conservative Government (1970-1974). Faced with a stagnating economy, they also turned on the credit taps as part of a stimulus known as the dash-for-growth policy. But the UK’s industrial sector was slow to take up the easy finance terms and the vacuum was filled by property developers keen to make a killing in Britain’s hottest sector – commercial real-estate.

This heady, fast-buck cocktail was spiked by the vodka of ‘secondary banks’. An emerging category of loosely-regulated lenders (sniffly referred to as ‘the fringe’ in the BOE report), these secondary banks borrowed short on the money markets and lent long to the developers.

Few questioned the strategy as long as the fringe could keep financing their liabilities. However, the risk was building.

Everything was fine as long as there wasn’t a liquidity crunch…

Going downhill: January to September 1973

The stock market opened in 1973 just 5% down from its peak back in May. But things went south from there.

The BOE described the first six months of 1973 as:

…characterised by an almost continuous international currency crisis.

The UK’s trade deficit expanded in 1973 to -2.2% of GDP. That seems routine to us now but it must have seemed mammoth at the time. Nearly 30% of the economy then was accounted for by manufacturing as opposed to just 10% today.3 We were well on our way to our worst trade deficit in the last half century, as the gap accelerated to -4.4% of GDP in 1974.

Inflation (9.4% CPI) and interest rates (9.2% Bank Rate) continued rising through 1973 as the Bank tried to dampen the overstimulated economy.

The stock market deteriorated along with everything else. Finally we hit bear country in August – down 22% over the 15 months since May ’72.

Oil Crisis and recession: October to December 1973

The market really walked off the cliff from October.

The UK had already tipped into recession when The Arab-Israeli Yom Kippur War began and ended in October.

The US and Soviet Union sat like trainers in opposite corners – backing their respective fighters – when the Arabs unleashed their oil weapon on the Americans and their allies.

The OPEC oil cartel cut supply to the US and immediately hiked prices by 17% in mid-October. The oil price was to quadruple by March 1974, deepening the global recession. North Sea oil was still in its infancy and couldn’t cushion the UK economy from the price shock.

The double-headed beast of a falling pound and swelling inflation forced another interest rate rise in November. The stock market took a 16% hit in that month alone and passed 30% in losses since the peak.

Then, somewhere in Threadneedle Street, someone must have muttered, “It can’t get any worse,” because at that moment it did…

…the liquidity crunch chicken came home to roost.

Commercial rents had been frozen by the Government in December 1972. That squeezed real-estate profits, while rising inflation and interest rates made the business of lending to secondary banks with risky exposures to the property market look dubious at best.

The pressure came to a head in November ’73 when London and County Securities could no longer raise fresh loans on the money markets.

The BOE’s report, The secondary banking crisis and the Bank of England’s support operations, records:

It very soon became apparent that some more sophisticated depositors in the money markets were taking fright at their potential exposure to any such institution.

The Bank thus found themselves confronted with the imminent collapse of several deposit-taking institutions, and with the clear danger of a rapidly escalating crisis of confidence.

This threatened other deposit-taking institutions and, if left unchecked, would have quickly passed into parts of the banking system proper.

Behind closed doors, on 28 December, the Bank quietly launched ‘the Lifeboat’. This rescue operation would eventually prop up 30 secondary banks, and be recalled by veterans witnessing the run on Northern Rock nearly 34 years later.

Back on Main Street, OPEC doubled the oil price on 23 December. In a Christmas to remember, Edward Heath declared The Three-Day Week. This restricted the use of electricity by businesses, with predictable consequences.

It would blackout Britain from midnight 31 December.

Contagion: early 1974

From November ’73 to the end of January ’74, London shares shed another 26% and were down 40% since the market top.

The oil shock, fear of contagion in the banking system, grinding recession, crumbling property values, and industrial poison of The Three-Day Week were backdropped by a ballooning inflation genie that refused to be bottled by tightening interest rates.

The miners upped the ante in February by voting to go on strike. Their battle against the Government pay cap and wages that lagged inflation had led to Edward Heath’s Three-Day Week, as the Prime Minister sought to conserve the coal supply that fuelled Britain’s power stations.

Heath sensed an opportunity to checkmate his political enemies and called a general election in February. Drawing the battle lines in stark terms, Heath asked the country: ‘Who governs Britain?’

The voters responded: “Not you, mate!” 

The Conservatives lost their majority. Britain returned its first hung parliament since 1929 – and the last until 2010. It seems the mischievous British electorate does love a bit of political paralysis in a crisis.

Harold Wilson entered Number 10 at the head of a minority Labour Government in early March. Chancellor Denis Healey – whose topiary-free eyebrows delighted a generation of school children – then administered some stiff medicine in his March Budget:

• The basic rate of income tax was upped to 33%
• A new 38% band introduced
• The top rate increased from 75% to 83%
• Corporation tax up 12% to 52%
• VAT slapped on petrol4

The stock market delivered its verdict – a 21% drop in March. The largest monthly fall of the entire drawdown.

We were 22 months in and the market had lost 50%, surpassing slumps in both World Wars, The Great Depression, and the 2008-09 Financial Crisis that lay in wait.

The worst is yet to come: May to December 1974

After a brief respite in April, and after two years of decline, the market went on its worst run yet: a five-month losing streak from May to September. This knocked another 37% off equities.

1972-74 losses mounted to -65% – a slump not even the the future dotcom bust could top.

Meanwhile, the UK’s banking crisis took on an international dimension. Massive foreign exchange losses and fraud shook confidence in the financial system across Europe and the US.

As fear mushroomed, the BOE increased its liabilities as:

There was still a significant risk that an isolated default by a UK bank, in the highly charged atmosphere of the time, might have triggered a chain reaction.

Rumours spread in November that one of the four main British banks – the NatWest – was on life support from the BOE. The NatWest issued a denial. In a remarkable sign of the quaint times, that quashed the rumours as opposed to inflaming them, as would surely happen today.

Another sign of the times was Denis Healey notching up a hat-trick of Budgets in 1974, with Labour scraping a slim majority in the October ’74 election. The market greeted that development with a further downward leg of -18% from November through December – finally hitting bottom on 13 December – with a real return loss of -73%.5

1974 was the UK stock market’s worst single year since 1900. The following stats (courtesy of the ONS and Sarasins) sketch the economic conditions that crushed business and investor confidence:

• -2.25% GDP contraction
• 12.1% interest rates
• 15.5% rise in CPI inflation
• -13% corporate profits

The rent freeze was finally lifted in December ’74 and property prices began to rebalance. Unemployment continued to rise in 1975 but the market snapped back that year with the mother of all mean reversions – a 99.6% real return.6 The rebound made 1975 the greatest annual performance in UK stock market history (dating from 1900).

However a 73% loss requires a 270% gain before you return to the black. After 32-months the market had only touched bottom. It would take another nine years to breakeven again in real-terms – a milestone passed in 1983.

Hopefully you and I will never experience anything like the 1972-74 stock market crash. But it’s a cautionary tale of the tape that shows what can happen, and why equities will only reward those who can handle the risks.

Take it steady,

The Accumulator

1. Sarasin Compendium Of Investment 2020. [↩]
2. Monthly price data for the FT 30 index from Investing.com. [↩]
3. Changes in the economy since the 1970s, ONS. [↩]
4. Not to mention sweets, ice cream, soft drinks and crisps. Those school kids weren’t so amused now. [↩]
5. Sarasins Compendium Of Investment 2020. [↩]
6. Barclays Gilt Equity Study. [↩]

What caught my eye this week.

We’re often told these days that we must take more responsibility for our own financial futures.

And we must! This site partly exists to help.

Taking responsibility is pretty straightforward – simple, but not easy – if you’re spending more than you earn, or you haven’t saved a rainy day fund.

Like a vasectomy, it’s a matter of cutting the outflow and redirecting internally.

But once you’re free of debt and you’ve got 3-6 months in a cash emergency fund, the picture gets more complicated.

Not with the part most people fret over – how to invest. That’s a solved problem.

Invest in a global index tracker fund, offset the risk with an appropriately-sized slug of government bonds, do it in tax shelters (ISAs and pensions), use cheap platforms, and add more monthly – rather than fuss daily – for the next 30 years. Tweak to suit.

Yes we like to dig into the minutia around here – exactly which fund, how much in what bonds – but you won’t go wrong if you get the basics right.

The big picture

Things get tricky not with the tactics…

• Index funds, platforms, tax shelters

…but with the strategy…

• How much to save? When can you retire? What can you spend?

We’ve written many series on everything from doing your planning to estimating a sustainable withdrawal rate.

They’ve typically come in multiple installments, because there are no pat answers.

Indeed faced with more complexity, many people are tempted to turn to professional advice.

And when it comes to issues such as taxes or estate planning, seeking advice could be very wise.

However I’m usually wary of suggesting people re-introduce higher costs and murkiness back into their core financial planning by offloading responsibility to a third-party.

Unless you’re very wealthy, such advice will probably just be outsourced to software – albeit someone charming who might spend an hour explaining the system’s output to you, and if you’re fortunate help you with the inputs.

But it won’t be truly individual advice, typically.

This is a problem, because such software models can spit out very different numbers.

Pension planning: from plenty to penury

Consider the results of an investigation into online pension planners by Trustnet’s magazine this month, pointed out to me by reader P.J.:

After almost two solid days on five platform websites, I have to say I was surprised to see there was almost no agreement at all on what my money would provide in retirement.

I am now wondering if the calculators are plain wrong, steeped in regulatory pessimism or a victim of their own complex assumptions.

The range of results is pretty astonishing, in some cases suggesting your income will run out 15 years earlier from what are essentially the same inputs.

The article’s author John Blowers fed the same fairly standard retirement scenario into all five planners. The results that came back do appear to be… a mixed bag:

There are some huge variations in there! Read the full article for more about the assumptions, and a discussion of what might be going on.

I’d suggest you do the hard miles with your own pension calculations. You can then sanity check them with an online planner or two.

If nothing else you’ll be better able to understand how these tools reach their conclusions!

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