Some of the factors that drove the domestic and global economy back then, appear to have parallels with today. For those who can remember the ’70s and early ’80s, it was a time characterised by an energy crisis fermented by the oil cartel, Opec.
This resulted in the rationing of petrol via "carless days", an inflation and wage spiral accompanied by increasing interest rates. It was a time of interventionist government policy which included the wage and price freeze in the early 1980s as an attempt to head off inflation.
These economic pressures ultimately led to two important structural changes in the New Zealand economy; the floating of the NZ dollar in 1985 and the introduction of the Reserve Bank Act of 1989, which protected the Bank from direct political interference.
As Mark Twain has been reputed to say, "History never repeats itself, but it does often rhyme". Although I am not an economist, I suspect that there are some lessons to be learned from this period.
New Zealand’s inflation rate may have peaked this year at 7.3% pa, and may be on the decline, but the ’70s showed that imported inflation, combined with domestic wage inflation, is very difficult to subdue.
During the 1970s the average inflation rate was just over 12%pa. As a consequence, $100 at the start of the seventies only had the purchasing power of $30 by the end of the decade. Some assets provide a natural hedge against inflation while other investments perform poorly by not managing to keep pace.
During the 1970s the worst performing asset class was fixed interest (i.e. both term deposits and bonds). Funds invested in fixed interest in fact declined in value relative to inflation.
The best performing asset class in that decade was commodities. Commodities are raw materials used to create the products consumers buy. Commodities vary widely and range from grains, gold, beef, to oil and natural gas.
Over the 1970s a broad-based commodities index increased by more than 20% pa. Some shares provide good protection against inflation. Shares in infrastructural companies (such as power companies) tend to do well as they have the capacity to raise their prices with inflation and the value of their physical assets. i.e. dams and power stations, increase as inflation drives up their replacement cost.
Other shares can struggle in a high inflation environment if they find it difficult to pass on their increased costs, and their profit margins come under pressure.
Over that decade property kept pace with inflation but did not grow strongly above inflation. Current Government policy and the drive to increase supply are two further factors that may constrain property growth for the coming period. What learnings can we apply today?:
1. Be more intentional in your investment strategy. Since the start of this year share markets have been strongly negative. For those investors who have complemented their share exposure with exposure to commodities, their situation is looking dramatically better. This is just one example of an intentional forward-looking asset allocation decision based on the evolving investment environment rather than passively relying on the past environment.
2. Don’t bet on a single asset class. Although I have a view on how the future may evolve, I could easily be wrong. That is why I strongly caution against investing in just one asset class. If you own your own business, you might be forced to do this for a period, but when you can diversify away from concentrated investment risk, you should take that step. A "double or quits" approach might be acceptable at the casino, but is not acceptable for your retirement capital.
3. The perception of safety can be an illusion. In an uncertain world it can be tempting to take less risk by avoiding investments where their capital value varies in response to market conditions. The variation in price that some assets experience can feel uncomfortable, but it is the very thing that is likely to help you out run inflation. Volatility is the price that you pay to gain inflation protection. I note that several mortgage funds have recently stepped up their advertising with what look like attractive returns. However, I would question their ability to outperform inflation over the longer term and would point out that with increasing interest rates, we are likely to enter a period of increasing mortgage defaults.
I mentioned the two economic changes, the Reserve Bank Act and our floating exchange rate, that were implemented in response to the experience of the 1970s.
I am hopeful that these two changes will help ensure that the extremes of the ’70s will not fully play out in the coming decade. However, you do need to be prepared for a different environment to the one you have experienced over recent years.
— Peter Ashworth is a principal of New Zealand Funds Management Limited, and is a Dunedin-based financial adviser. The opinions expressed in this column are his own and not necessarily that of his employer. His disclosure statements are available on request and free of charge.
