The Rhyme of History

Though we must start with the caveat that when we trace asset prices back into the mists of time, we are dealing with both great qualitative differences and often less reliable data, we here use numbers from Robert Shiller, S&P, the various branches of the Fed, and the NBER to construct a series which mimics – with increasing faithfulness as time progresses – the relative returns to be had from holding a similitude of the S&P500 in preference to one consisting of a constantly-rolled portfolio of 10-year US Treasury notes (all absent transaction costs or taxes, naturally).

If we start our series 120 years ago, in December 1900, we find that equities have outperformed our bonds by a factor of 242 in the time since or – in slightly more comprehensible terms – by around 4.7%, compounded annually.

More intriguingly still, if we superpose the trajectory of this measure from the start of the floating-exchange rate era, inaugurated by the collapse of the Bretton Woods arrangements in 1971, on top of that for the first half of last century, there is an uncanny correspondence between the two curves.

The six years from 1923 to 1929, for instance saw stocks almost quadruple in value vis-a-vis fixed income (at ~25% CAR), while, during the similar period leading to the peak of the (first?) Tech Bubble in 2000, they managed a lesser – if still fairly remarkable – rise of 2.6 times (~17% CAR) their starting value.

This century’s subsequent plunge lasted just over three years and cost stockholders peak-trough losses of 57%: The Roaring Twenties shuddered into the Great Depression in just under three years and wiped out 83% of the gains from which superposed nadir, stocks again led the way on each occasion.

In this set-up, the pre-GFC zenith of July 2007 (just as the first CDOs started to implode) almost perfectly coincides with the onset of the great shock to Roosevelt’s New Deal, delivered in the Spring of 1937.

This time around, the Lehman debacle cost modern investors almost 60% of the intervening relative gains – appreciably more than their grandfathers’ corresponding losses of 44%.

After a few years of gyrations in both eras, in the spring of 1942, the wartime boost to industrial activity in the US, plus the accompanying pegging of both long and short interest rates, sparked a rally in our gauge which carried equities to a 2.9x outperformance over bonds during the next eight years (~14% CAR) not entirely unlike the last eight’s 2.4X lead (~11% CAR) for stocks.

Overall, from the two cycles’ November 1903 and December 1974 lows, respectively, the subsequent 4 1/2 decades saw stocks post a CAR advantage of 4.2% over bonds in the earlier episode versus an almost identical one of 4.4% in the latter, with equities thus streaking ahead by a factor of just under seven in the first instance and just over seven in the second.

The Nifty Fifty Years

There are, of course, innumerable differences between the world of the 1950s and today’s increasingly Dystopian society. Then, prosperity was slowly being rebuilt after the devastation of what some have called Europe’s “Second Thirty Years’ War” of 1914-45.

Then, too, the bond market was about to be freed of its wartime suppression, notably being given its head by the Treasury Accord of 1951, under the terms of which – in as neat a mirror image of today’s situation as one could imagine – the Fed finally freed itself of the World War II obligation to suppress interest rates and was allowed instead some leeway to combat the inflationary impact of the ongoing Korean War.

The removal of that cap was to begin a process whereby long-term yields rose – over the succeeding three decades – from 2.5% to over 15%: a level almost beyond the comprehension of those who today would often be more than satisfied to earn 15 basis points from their holdings.

Stocks, for their part, were engaged in what would turn out to be a half-century long climb – inevitably not without its intervening dramas – which saw returns trend upward at an average yearly rate of just over 11% and so effectively doubling the index every 6 1/2 years or so.

Alas, the new millennium set the high-water mark of that particular phase, as the period between the Tech Bubble highs and the GFC nadir – together with the increasingly untrammelled central bank interventions to which these two crises gave birth – witnessed equities’ worst decadal performance relative to bonds in our sample, even including that ushered in by the Wall Street Crash and ground wearily out amid the long despondency of the Great Depression.

Promised Land or Vale of Tears?

At this point the key question arises: is this uncanny shadowing of past behaviour anything more than a curious coincidence or could the parallelism continue well into the future?

If the latter, we might have to argue that the underlying causes will necessarily be different even if their outcome is not. Two such scenarios present themselves.

In the first, once we are passed the self-imposed economic disaster of the COVID19 episode, the central banks come to their collective senses and again allow interest rates to find their natural levels. Meanwhile, governments pull back from the abyss of their “Great Reset” Corporativismo (aka: a Green version of 1930s Italy) and strike off many of the shackles hobbling the world’s entrepreneurial classes.

Bond yields would naturally suffer a reversion from their present, dangerously distorted levels to at least the 2-2 1/2% above the rate of price inflation which has been their long-term norm – though, the potential would exists for an initial overshoot far beyond that point until the increasing cost of general (and especially governmental) profligacy came to effect a long overdue return to the principles of budgetary discipline and the exercise of fiscal restraint.

Bubble stocks, Unicorns, and hollowed-out, over-milked PE cash-cows would fail in droves, were this to occur, unavoidably re-shaping the equity landscape of today but also making room for a wave of genuine founders and innovators to better fulfil people’s desires to enjoy life to the full by providing them not just with new products but also with meaningful, new employment opportunities so they might contribute to others’ material satisfaction and hence, in return, to their own.

After Purgatory, the Promised Land: is that too rosy a vision of the future?

Perhaps, but the alternative is necessarily a much darker one to contemplate.

This particular tragedy starts, not with a rejection of today’s errors, but with their intensification. Central banks continue to prevent bond-holders from making any but fleeting – and collectively unrealisable – gains from capital appreciation and eventually come to monopolise the issue of all government securities. The new monies created by this intrusion naturally spread the poison throughout the universe of debt – a process of the ‘nationalisation of credit’ which the foreseeable introduction of ‘central-bank digital currencies’ and outline plans for the opening of central bank accounts to the general public can only serve to reinforce.

A continuation – and perhaps an intensification – of present policies, wedded to the growing clamour to force all finance into compliance with arbitrary Green and other, non-economic objectives will, of course, continue to favour the Davos-attending oligopolists and so further underpin our economies’ stultifying gigantism.

In so diverting a great deal of future activity to boondoggles, pyramid-building, rent-seeking, subsidy-hunting, and virtue-signalling – it will become something of what Guenter Reimann called a ‘Vampire Economy’: one heavily dependent on the will of the bureaucracy and the whim of the politicians for its cues.

Such a society cannot fail to be both inefficient and inflationary – though the latter tendency may long be hidden by a variety of repressive means, allowing the corrosion of value to take place far below the water line where it cannot easily be seen. Some of these measures will be given the wonderfully technocratic-sounding name of ‘macroprudential’ policy: others may take the form of much more traditionally brutal curtailments of freedom and property rights.

The Lesser of Two Evils

Though their real returns may be somewhat questionable in such a world, it should not be hard for equities to do far better than bonds – at least for as long as the companies in which one invests are fully obliging to the state and thus enjoy both its protection and its much-needed favour when it comes to the award of contracts or the allocation of what may well be ever more scarce resources (not least of energy!).

Thus, by buying equities, not bonds, you may still become poor, but your descent into poverty will be far less rapid than if your money were devoted exclusively to ‘certificates of confiscation’. You might even get ‘lucky’ and enjoy the heady rush caused by a spiralling rise of nominal stock prices set in train as chronic inflation degenerates into the galloping kind.

Optimist or pessimist, if you can imagine that the past fifty years’ partial déjà vu can be repeated over the next fifty. equities would be the place to be.

Overpriced they may well be by many traditional metrics, but bonds are surely even more egregiously out of line with the reality of a world awash in finance but arguably falling short in the provision of real, capital funding.

Past could yet be prologue.