Towry’s Andrew Wilson: The Great Crash vs the Great Recession

Wilson Andrew Towry 2014

It is said that that you can’t step in the same river twice, though you still get a wet foot.

The strong disinflationary forces in the world today are proving disquieting for investors, and at a time when the consequences of influences from globalisation to big government are unfolding in front of voters and tax payers’ eyes.  However, these circumstances may not be as unusual as they might feel and previous generations of investors have been through equally challenging – often far worse – economic times.

There has been a macro-economic shock and the UK Government is trying to consolidate its finances, as debt to GDP rises. Employment and wages are headline topics and the economic backdrop is deflationary. There is serious concern about a lack of productivity in the economy, low rates of capital formation and a sense that the UK is not just being out-competed by the rest of the world, but is slow to turn to the industries of the future.

The north-south divide is widening and income inequality is high. The demographic group suffering the most is adult males supporting large families on on low incomes. Their situation is not improved by a growing supply of unskilled workers.  Financial markets are under pressure and some sort of wealth tax is mooted.

Sounds like 2014? Actually, welcome to the early 1920s. Today it may be disinflation rather than deflation and zero hour contracts rather than unemployment.

It is the “austerity” of a slowdown in the increase in the rate of government spending, rather than the fiscal consolidation of a one-third cut in government spending. GDP fell 6 per cent during the recent financial crisis, not the 10 per cent of 1921, itself a cumulative post-war 25 per cent loss.

So, the amplitude is a bit different, but the parallels are still real. 

Interest rates started the 1920s at 6 per cent and ended the decade at 4 per cent. Equity dividends and gilt yields were at similarly high levels. This did mean that investors were able to “earn” their way out of trouble, in nominal terms, but also in a time of deflation these were of course huge real yields.

It helped to be an owner of capital and the 1917 5 per cent War Loan had fortunately been relatively widely taken up by the populace, with 3 million holders.

A broader benefit was that wages – even though falling – were able to rise in post-inflation terms by the later 1920s and consumer purchasing power was therefore able to increase. That said, jobs were scarce, and nominal pay cuts were unhelpful when dealing with fixed debt and rents, especially when post-inflation pay was in some cases still little different from pre-WW1 days.

The equity market had fallen 30 per cent by Christmas 1921, but investors ended the decade up about 35 per cent, which was double their money in real terms. This was despite the difficulties of 1929 and the Great Wall Street Crash, the impact of which was slightly less severe this side of the Atlantic as the UK had not experienced a similar credit boom.

Investors in government bonds also doubled their money, again in real terms and assuming reinvestment of yield. Thus the 1920s was actually one of the best decades for UK investors – not bad for a period that started with deflation, depression and an unemployment crisis.

It is also noteworthy that the economy may well have bottomed as early as May 1921, which, as ever with these things, would have surprised those there at the time (unemployment had just doubled in seven months) and even many years later people may well have said that they still weren’t “feeling the benefit”; but recovery it was.

As with the depression of the early 1930s when industrial production also fell by about a third, it took about four years to gain a new GDP high. The 2008 crisis in contrast for the UK was not as severe as the 1920s and didn’t contain (in the end) the double dip of the 1930s, but did take six years to recover the lost GDP, rather than four, and even with the help of quantitative easing and “financial repression”.

From the perspective of 2014, we have seen less destruction of GDP and employment and no deflation. Government spending is still growing, we have not balanced the budget and QE, on a global basis, has meant that there has been little destruction of Joseph Schumpeter’s “creative” type, which may not be healthy longer term.

In 1924 The Wheatley Subsidy kicked off a long surge in house building, and many would argue that this is one particular parallel that would be welcome in 2014, especially as it was focused on houses for rent by low paid workers. 

The 2014 financial markets have not contained the yields available to investors in the 1920s, while real returns will be lower, assuming current disinflation doesn’t turn into deflation.

So although in some ways we have been far better off than our counterparts in the ’20s, it is not clear that investors will have such a happy outcome without taking a more proactive approach, especially to asset allocation.

The ’20s do also remind us that, despite a backdrop of economic turbulence, it can still be prudent to sit tight when in possession of sensible investment philosophy and a diversified portfolio.

Andrew Wilson is head of investment at Towry.