The Bear’s Lair: The death of long-term investment

Last year, the British government redeemed the Consolidated Annuities perpetual bonds (Consols), which had been in existence for 263 years, albeit with two reductions in rates in 1757 and 1888. This was only an extreme example of the effect funny money policies worldwide have had on investment, reducing “time horizons” to no more than a few weeks, as investors look for ephemeral trading profits. Yet truly long-term investment is a cornerstone of capitalism, and both our individual lives and the economy as a whole suffer from its absence.

In the nineteenth century of John Galsworthy’s Forsyte Saga (the first part of which is set in 1886) it was a different matter. Some of the Forsytes invested in house property, some in long-established businesses, some in warehouses or retail properties, some in bonds, while Uncle Timothy, the most conservative investor of them all, put his trust in Consols.

The Forsytes had several advantages over us as investors. Britain was on the Gold Standard, so they could be sure that money would retain its purchasing power over the decades. The securities in which they invested were not necessarily safe – stretching for additional yield through investing in South American bonds notoriously came to grief on several occasions. However, they mostly stayed in existence for several decades; there were few short-term bonds and very little reinvestment risk.

The investment world of the Forsytes disappeared owing to two factors. First, after 1914 there was no longer certainty on the value of the currency; investors could no longer be sure that $1 now would be worth $1 in ten years’ time. This is even more the case today, when central banks do not even aim for price stability, but instead blither about a “target” inflation rate of 2%, which doubles prices every 35 years.

Second, equities began to play a larger role in the investment universe. At first, these seemed an unalloyed blessing; they paid dividend yields that were more or less equivalent to the yields on bonds and offered the possibility of capital gains as businesses grew. In the first half of the twentieth century, equities were a minority investment, providing returns almost as steady as bonds, but with rather more risk (as their unfortunate investors found out after 1929.)

That changed with the advent of Keynesian “fiat money” policy in the 1950s and 1960s. That caused a mass shift by individual investors into equities, which were thought to provide better protection against inflation than bonds. The change was symbolized by the ultimate blue chip, AT&T, which had maintained a proud record of maintaining its $9 per annum dividend through the Great Depression; it split its shares and increased the dividend in 1959.

Once this began to happen, investors began to invest for capital gains rather than dividends, even though “dividend aristocrats” attracted conservative investors by increasing their dividend year after year. It is notable that the oldest of these dividend aristocrats today, Procter and Gamble, has increased its dividend in every year since 1954; there are then maybe a dozen whose record stretches back to the 1950s, but none whose track record is longer than that.

The “cult of the equity” reversed somewhat during the inflationary low-growth years of the 1970s. I remember in 1982 a friend told me of the substantial equity mutual fund investment she had been given at her birth in 1958, which was now worth less in cash terms than the value of the gift, even though dividends had been faithfully reinvested for 24 years and the whole thing, being in a trust, had been compounding tax-free. In real terms the fund was worth less than a quarter of the amount originally invested – a lousiness of performance that depended somewhat on high fees and underperformance by the fund’s managers, but not much.

Of course, after 34 years of a bull market that has outpaced inflation, equity investment is a mantra preached by legions of well-compensated advisors. It is however likely that, starting from this point, investors who commit to equities will suffer returns similar to those of my friend in the 1958-82 period. The hapless Millennials, who have incurred mountains of student debt and have struggled to get low-paid jobs in today’s lousy economy, will thus find their retirements even more impoverished than they had feared. It is enough to make one fear that Keynes’ “euthanasia of the rentier” will occur over the next 25 years, with everybody relying on their modest wages for day-to-day living and throwing themselves on the mercy of the state for retirement.

With returns fluctuating wildly, and 25-year periods in which their performance destroys savings, equities are not a good investment for the long term. That’s not surprising; I once calculated that the average lifespan of Fortune 500 companies was less than 40 years, so you wouldn’t expect a reliable retirement investment toi arise from the common stock of any one of them. Buying a mutual fund or an index-tracking ETF helps, but not as much as investors currently expect.

In an era of fiat currency, bonds are even worse. In the Gold Standard period, Uncle Timothy could buy Consols and be sure of the real value of his income, year after year, except for the effect of the 1888 refinancing that reduced Consols’ yield from 3% to 2.5%. But once Britain went off the Gold Standard in 1914, there was no such assurance. After 1945 it was even worse; my great-aunt retired in 1947 with a substantial holding of 3½% War Loan and by her death in 1972 its value had descended to below 40% of par in cash terms and below 10% of par in real money, while the real value of the income from it had also declined by three quarters. Needless to say, U.S. bondholders’ experience since 1981 has been very different, but can anyone doubt that buyers of 30+ year dollar bonds today will have an experience very much like that of my great-aunt?

From 1752 until 1914, British investors had a safe haven that guaranteed them an income that lost no purchasing power, with a capital value that fluctuated only moderately (and foreign investors had the same benefits if they were living in a gold-standard country that did not go to war with Britain – if it did, their investments would not be expropriated, but the income would be impossible to collect while the war lasted.) Those investors suffered if they had to sell at certain periods, notably 1797-98; on their other hand, they made out like gangbusters after 1815, as Consols’ price moved back towards par and severe deflation increased the value of their income. Overall, however, investors had a readily available choice that gave them what they needed for over 160 years, not a bad track record.

There is no such investment available today. Today’s 25-year-old may well see his lifespan extended by better medicine, in which case he will have to work 50 or more years until retirement. On that view say a 50-year view, bonds are not safe because of the inflation risk (and the rising default risk on bonds of Western governments except Germany.) Even inflation-indexed bonds, apart from price declines through increases in real interest rates, will suffer erosion of capital, because the price indexes are fiddled (they may only be fiddled by 1% or so, but that will lose an investor 40% of principal over 50 years, a poor return for thrift given that such bonds pay almost no interest.)

As for equities, as I have discussed, they may be about to enter a 25-year period of negative real returns, even if you buy an indexed fund. Admittedly, the 25-year-old with a 50-year time horizon should not worry about this; the lousy performance until 2041, if he invests evenly each year, should give him some years of buying very cheap that will yield spectacular returns in 2041-66.

Even so, there should be a nagging doubt: can we be absolutely sure that corporate equities of publicly listed companies will provide a decent return over the next 50 years. If we were sitting in William McKinley’s America, we might think we could, but we saw in the 1929-41 period that economic policy can be based on such spectacularly bad principles that corporate equity value can be destroyed.

What is more, there is the problem of leverage. As equity holders, we are entitled only to the residual value in the company after its debt has been paid. However, in this world of share buybacks, a lengthy period of inept economic policy and over-leverage could easily bankrupt a high percentage of America’s public companies, without wholly ruining the economy itself. Combined with a government debt default caused by excessive entitlements costs, this could result in the total destruction of our youthful investor’s portfolio.

Real estate offers prospects that are little better. Housing in major metropolitan areas is absurdly priced, while smaller cities can be subjected over a 50-year period to a decay, depopulation and default similar to those in Detroit or to a lesser extent Cleveland. Retail properties used to offer a steady income, but in the era of Amazon that is no longer so sure. Farmland is again grossly overpriced currently. With asset values in general inflated beyond belief, there is no sector of real estate in which today’s young Forsyte can feel secure.

With no secure 50-year investments, the rentier is in severe danger of being wiped out. That will destroy capitalism as we know it, which cannot possibly exist without capital. Other barmy economic arrangements, such as socialism, syndicalism, feudalism and the cooperative movement, have been proved over and over again to be grossly inferior. It is therefore essential that, as quickly as possible, we reorder our economy in the interests of the rentier, with a variety of attractive and solid 50-year investments.,

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)