By Alan Steel
13 April 2012

For publication in The Scotsman

Wouldn't it be handy if investors had easy access to a time machine? Not one that looked back. No, one that could look years into the future.

What a bonus that would have been 30 years ago. Anybody remember how we all felt then about economic prospects? Times were tough. UK interest rates were in the high teens so mortgage rates were crippling. We had just survived a recession, the Stockmarket hadn't gone anywhere since 1965 and unemployment hit a record with
3 million jobless.

Despite 3 years of a Conservative Government top rate tax was 60%, 75% if you also had significant investment income. Unfairly a wife's unearned income was taxed as her husband's.

It wasn't a good time to be a high earner, with a big mortgage (despite tax relief), or an investor saving for retirement. It looked fine if you were retired, earning interest from banks or building societies - if you ignored tax and inflation.

But mainly, things didn't look good. But now, looking back, you couldn't have been more wrong. It was a time of opportunity. The miseries, at the time, didn't see it, but interest rates could only have gone one way - down. Stockmarkets had been so poor since 1965, even the law of averages suggested they could only get better.

As it happens, anybody taking the time to study history would have seen what was going to happen next. Because, when you study history, you can see trends and cycles.

Most folks like to think progress is linear, but in fact it's cyclical. Pity somebody didn't tell Gordon Brown. Recognise where you are in long or short cycles and, as my Dad used to say, "You're quids in".

1982 was a pivotal year. A new long term bull market started in Equities, much to the surprise of economic doom sayers. A new bull market in Gilts began too. If interest rates were likely to fall, locking into 17% returns wasn't a bad idea, especially as you could sell the asset some years later at vast tax free profit.

Roughly half way between then and now, number crunchers, including mathematicians and actuaries, seeing what had happened over the previous 15 years, and assuming this was likely to last forever, built their models.

They had this idea of the efficiency of markets and for equity investment came up with "what could be simpler than just following a Stockmarket Index?" After all, if an index keeps going up, why bother trying to do too much work spotting individual winners?

So, in the UK, Index Trackers were born, and sadly still dominate Equity exposure in most Final Salary Pension Schemes. 15 years later and these schemes are in trouble. Anybody notice the link?

For 4 or 5 years Indexing worked but then something happened - a secular change. You didn't need a time machine to spot it. All you needed was to study history. Do that and you'll notice these long term cycle changes - referred to as secular.

Should you Index track when in a Secular Bear Market? You tell me. Between December 1999 and March 2003 the FT 100 Index fell 52%. From the Summer of 2007 to March 2009 it fell 48%. Why track an Index that can fall 50% in less than
2 years?

So, still without a time machine, what does history tell us that's likely to happen over the next 5 to 10 years? Well sadly, it suggests the UK Stockmarket Index will still resemble a financial yoyo. That's not good for our nerves. As to Gilts, we're likely to see a secular change - a 20 to 30 year period where interest rates move upwards. That's bad news for Gilt holders today.

So, unless investors change their ways, especially Trustees of Final Salary Pension Schemes and their Advisers, it looks like there's more misery going to be piled on. But it's good news for those who follow the best active managers, and fortunately there's a good few of them.

Written by Alan Steel on 13 April 2012
For future publication in The Scotsman