Need for an historical perspective

This is my latest Perspective column for Fund Strategy magazine.

Just because the future never simply repeats the past it does not follow that history is unimportant. On the contrary, looking at historical trends can help glean insights into the present.

The standard disclaimer that “past performance is not a guide to future performance” should simply be read as a warning against naive extrapolations from history. Just because a particular asset has performed well in the recent past, it does not necessarily follow that it will continue to do so. The main reason people sometimes believe otherwise is that they get caught in the euphoria of rising markets.

However, the opposite error is much more pernicious and less widely recognised. It is what could be called “presentism”: defined by the Oxford English Dictionary as “a bias towards the present or present-day attitudes”.

Presentism manifests itself in many ways in the discussion of finance and economics. Perhaps the most damaging is the discussion of the current crisis.

The vast bulk of the debate focuses on the consequences of the bursting of the financial bubble while ignoring structural economic factors. No one following such a blinkered perspective can get a proper grasp of recent developments.

As a corrective to the presentist trap I am always pleased to receive reports such as the recent one on the Longest Pictures from Bank of America Merrill Lynch. The publication is a statistical guide to the financial markets since 1800.

Admittedly the usefulness of some of the indicators is not immediately obvious. For instance, I now know that the widest spread of US Treasuries over dividend yields was 1,023 basis points in 1981. This may be of use to someone, somewhere but I cannot see its immediate significance.

However, many of the indicators help to illustrate the extreme character of the world economy’s predicament. America and western Europe seem to be suffering particularly badly. Take the state of the bond markets last month as an example:

• US 10-year Treasury yields were at a 220-year low of 1.45%.
• US short-term rates were at their lowest rate since the 1940s.
• UK yields were at their lowest level since January 1951.
• German yields were at their lowest rate in the past 200 years.
• French yields were at a 260-year low.
• Dutch yields were at their lowest rate in 500 years.

Since low yields mean high prices (since one is the inverse of the other) these figures would seem to indicate strong demand for bonds. No doubt quantitative easing and credit easing – where central banks buy large quantities of bonds – are an important part of the story.

The figures confirm that the authorities are cheapening credit on a massive scale in a desperate attempt to shore up economic activity. It is likely too that this monetary boost is behind the strong performance of equities since their low in March 2009.

Global markets have almost doubled over that period yet, at least in the West, it is hard to see much of an economic recovery. The surge in stock prices seems to be largely the result of an artificial stimulus.

There must also be a strong risk that at some point consumer price inflation will take off. Admittedly some – particularly free market – economists have warned about this for years and it has failed to materialise. But the temptation for the authorities to try to inflate away their debts must be growing by the day.

Such a course of action would have important implications for the financial markets – with savers and holders of “safe” assets such as government bonds being hit hard – and for the bulk of the population. It is easy to see real wages being eroded even more than they are by substantial price rises.

But the pictures from the Merrill Lynch report extend beyond asset prices. They also give an inkling of how the financial markets, along with the world more generally, are changing in other ways.

For instance, there is the relative decline of American power. In 1945, foreigners only owned 1% of US Treasur­ies whereas the figure has risen to 44% today. America has only maintained its economic momentum by getting in hock to the rest of the world.

An alternative indicator of American decline is the shift in location of the world’s tallest buildings. American skyscrapers held the record for almost the whole of the twentieth century with a succession of giants including the Empire State Building, the World Trade Center and the Sears Tower. In 1996 the baton passed to the Petronas Towers in Kuala Lumpur, then to Taipei 101 in Taiwan in 2004 before shifting to the Burj Khalifa in the United Arab ­Emi­rates in 2010.

Not that America has suffered the greatest relative decline. If 1900 is used as the base, America’s share of global GDP was slightly up in 2011, whereas Britain’s was dramatically down. The biggest gainers were emerging Asia, Latin America and Japan.

The Merrill figures also show the relative decline of manufacturing and rise of finance. Back in 1899 industrials accounted for 67% of American equities while finance was 7%. The corresponding figures for this year are only 10% for industrials and 14% for financials.

Global financials have experienced huge swings in cap­italisation. At the peak of the technology bubble in 2000 they fell to 16% of the world total and subsequently rose to a peak of 26% in 2007.

Overall, the report seems to confirm that the difficult times for the western economies have hardly begun while there is a long-term shift to the East.

^{* For those interested in such long-term figures, there are other studies to look at. The annual Credit Suisse Global Investment Returns Yearbook is freely available on the internet while a synopsis of the Barclays Equity Gilt Study is available to non-clients.}