This article was originally published in Retail Week on 10th October 2022.
American novelist Pearl Buck once said: “If you want to understand today, you have to search yesterday.”
As we battle through today’s stormy and economically heavy news cycle, history can bring perspective.
Let’s start in 1720. If we thought some of the recent 2021 venture-backed business plans were unduly optimistic, listed businesses then operated in such diverse industries as the trade of human hair and the importation of broomsticks from Germany.
There is not one scenario that completely mimics the current situation. History rhymes rather than repeats
Yet, at its peak, the total capitalisation of the London market was around £500m, roughly 100-times higher than it had been 25 years earlier.
This was the year the infamous South Sea Company peaked at £950 a share in late June before falling to £380 by mid-September. Inflation and a tangle of ruined credit threatened to strangle the economy as up to two-thirds of the money in circulation (paper money and shares) was lost.
Interestingly, government action was cited as the root cause of the 1720 bubble – a parallel that some would see in today’s environment.
Fast-forward two centuries and the idea that traditional, conservative approaches to valuing stocks were no longer valid was the central conclusion of Common Stocks as Long-term Investments, written by American economist Edgar Lawrence Smith in 1924.
US stock prices were propelled by the growing acceptance of new, forward-looking standards of valuation. Price/earnings (P/E) ratios soared from 10.5x in 1926 to 15.8x in 1929. Stock prices rose by 400% in the eight years to 1929, leading the US president at the time to declare a new era of prosperity.
The exemplar of the moment was Radio Corporation of America (RCA) – a bold innovation for the new and glamorous era of broadcasting including a breakthrough technology: television.
The stock shot up from $32 per share in 1926 to $127 in 1927 and in the following two years gained a further $447 in value. The gains occurred despite the company never paying a dividend.
Market history is punctuated with periods characterised by the erratic behaviour of crowds and near-hysterical episodes of optimism or pessimism
To be fair to RCA, earnings improved dramatically such that the P/E ratio was a relatively ‘sensible’ 28x. Between September and mid-November, the market overall fell 50% as pressures compounded.
Comparing it to the most recent batch of IPOs, the 1928 new stock market flotations had tumbled 83%, very similar to today’s newly listed retailers and brands. By 1931, the crash of 1929 had turned into the Great Depression.
In another parallel, sterling was under pressure for most of 1930. In early 1931, John Maynard Keynes referred to “extraordinary nervosity about the pound in the London market”, a concern that led to the abandoning of the gold standard. London stock markets took seven years to reach the 1928 highs again.
The Dow Jones index in America, however, lost 87% of its value between 1929 and 1932 and would not regain its highs for 25 years.
Such was the nervousness, countries such as Germany restricted the use of foreign currency, allowing only “essential” purchases. Those imported products deemed unnecessary were blocked and economic nationalism was born.
The high-water mark of government intervention was 1971, notably by conservative administrations. In the US, Richard Nixon announced a 90-day wage-price freeze, a 10% surcharge on imports and devalued the dollar by removing the currency from the gold standard. Foreign stocks dropped markedly and other economies followed suit.
In the UK, Edward Heath announced a set of similar policies in a desperate attempt to rein in inflation. The Nixon wage controls would later be abandoned, stoking the very inflation they were designed to prevent.
The net effect of these interventions created significant and undesirable market distortions. As a reaction to rising interest rates, stock markets fell 35% and 25% in the US and UK respectively in 1969/70 but these market interventions also resulted in a deeper malaise. After a recovery in the following couple of years, in 1973/74, the Dow Jones dropped by 45%, while British stocks fell by a scary 73%.
Stocks did not prove to be a good hedge against inflation as growth was significantly curtained and nominal earnings could not keep up, exacerbated by the 1970 OPEC oil crisis. Over the decade, the US stock market fell by two-thirds.
It is critical to take advantage of these opportunities when febrile emotions get the better of rationality. Are we at ‘peak fear’? Not yet
All of these examples bear some resemblance to events of the last few years, although there is not one scenario that completely mimics the current situation. History rhymes rather than repeats. What history does show is that compared to current FTSE all-share declines of 12% (or a 29% retreat for the more UK-focused FTSE 250 Index), there appears a long way to go as a traditional consumer-led recession and supply chain distortions drive values lower.
On a more positive note, though we live in a world that is increasingly divided with political and economic pressures that are at their most acute in decades, these do pass. They are not new and, over history, such setbacks consistently provide platforms to invest and create long-term value.
Market history is punctuated with periods characterised by the erratic behaviour of crowds and near-hysterical episodes of either credulous optimism or unanimous pessimism.
It is critical to take advantage of these opportunities when febrile emotions get the better of rationality. Are we at ‘peak fear’? I do not think so yet, but we are getting closer.
Within a margin of safety, act against consensus and find the business managers who genuinely think like owners. Do that, and this can turn into the single best opportunity to build sustainable value in decades.