Nowadays, when the term stagflation is mentioned, everyone thinks back to the 1970s. Anyone who suggests a stagflation scenario as a real scenario for the future is immediately reminded of the many differences between then and now. The vast majority of people in the financial world started working after the 1970s. If they were born then, it is not a period they actively remember.
I myself associate the seventies with strikingly good music, strongly shifting values and norms and of course the breakthrough of colour television. But also many demonstrations, strikes and of course the loss of the Dutch national team (photo) in the 1974 World Cup final against West-Germany. Let’s hope that the World Cup final 2022 will go better for the Netherlands.
One difference between the 1970s and now, according to many, is the big mistakes that were made back then in the monetary and fiscal field. Yet we are also now in a period of monetary madness, an experiment that has surpassed the policy in the 1970s in every respect. Then too, a war made the problems worse.
New world order
Yet even the geopolitical shock of the Ukraine war combined with the sanctions seems greater than the Yom Kippur war of 1973. At that time, the countries supporting Israel were boycotted by Opec for a while, now Western sanctions are bringing about a new world order.
Just as then, there is also a cold war. Now it is mainly in the rivalry between Washington and Beijing. In the 1970s, the credibility of the Americans was seriously undermined by the war in Vietnam. Everyone has seen the images of the Americans who had to leave Saigon in 1975. The Americans’ recent departure from Afghanistan was reminiscent of that. The Americans’ retreat from Vietnam perhaps tempted the Russians to invade Afghanistan.
This was immediately followed by the Carter doctrine: the Americans, not the Russians, were in charge in the Persian Gulf. Not long after, an American intervention to evacuate the American embassy staff from Tehran failed. To regain their reputation, the Americans armed the Afghans with Stingers to get the Russians out of the country. Today, the Americans are again at the forefront of arming Ukraine, again with the latest Stingers.
For China, the Cultural Revolution defined the picture until 1976. Mao Zedong, like Xi Jinping, now had absolute power, power which he had lost after the Great Leap Forward. Only after Mao’s death and the arrest of the Gang of Four did this policy end. Because of that policy, China was internally focused. Now, the zero-Covid policy is ensuring that China is cut off from the outside world. Xi is concerned about polarisation in the world.
The rise of populism is a signal that the middle class is struggling. Xi wants to prevent this in China by creating an olive-shaped middle class, with few rich people, but also with few poor people. Signs of the problems in society in the 1970s were crime and political violence, something that has clearly increased again today.
In the early 1970s, the valuation of the US stock market was at about the same level as it was a few months ago. There was a special segment in the US stock market with companies that had special growth prospects and were therefore highly valued. Back then it was the Nifty Fifty, now it is FANG, Faang or simply Big Tech. The prices of the Nifty Fifty were severely punished in the mid-1970s, which incidentally did not mean that they were able to make a spectacular recovery afterwards. It is mainly the size of the correction that is worrying now as well.
Stability not restored for the time being
The lesson of the 1970s is also that these developments can spread over many years. Do not count on stability returning in the short term. Both macro-economically and geopolitically, we still have a long way to go. In the 1970s, peace in Vietnam was followed by genocide in Cambodia and, in 1979, Vietnam also waged a border war with China. In the 1970s, Americans managed to achieve peace between Israel and the Arabs at Camp David. Thanks to the Soviets, the Middle East remains unsettled to this day. Count on the Russians not to keep quiet after Ukraine, whatever the outcome. In such an environment, it is not easy to get inflation back to around 2 per cent.
The general public resents higher inflation and increased crime. This combination will further polarize politics. The Americans are moving to the right, where in other countries the polarised left may come to power. Only this time the Republicans will not come up with a new Ronald Reagan. In that respect, Trump has the best cards. So we seem to be on the way back.
In that respect, the new vision of the US Supreme Court fits the case of Roe vs Wade. In the 1970s, the death of Mao and later of the Russian party leader Brezhnev caused relaxation. Now both Putin and XI seem to be suffering as well. In the Philippines, a Marcos is back at the helm; his father was already there in the 1970s, just as Justin Trudeau’s father was Prime Minister of Canada in the 1970s.
High inflation fuels social unrest
After a period of high inflation, it is usual for a recession to follow. The combination of high inflation and job losses will cause the Misery Index to rise sharply. There have been six occasions since the Second World War in the United States when inflation was above 5%, while unemployment was below 5%. Each time, this was followed by a recession in the United States. This is at a time when a recession in Europe is likely and China, with zero Covid, will do everything it can to cause one as well. Meanwhile, energy and food prices continue to rise, simply because supply cannot meet demand. Rising food prices cause a lot of social unrest.
Now Sri Lanka is an island far away, but Turkey, too, has raging inflation. In Iran, the government has increased the prices of bread, oil and milk by 100 to 300 per cent. Lebanon has effectively ceased to exist, with 80% of the population living in poverty and hyperinflation. El Salvador will probably go into default early next year, due to its experiment with bitcoin. There are also many crypto-adepts in countries like Vietnam, India and Pakistan.
In Africa, the famines of the 1970s are threatening to return. Besides the effect of the recent locust plagues and droughts on the food supply, many African countries received food from Ukraine and Russia. The famines will cause many people to flee again, probably outnumbering the Ukrainians. The word ‘Biafra’ is inextricably linked to the 1970s, but the same acute need now threatens large parts of Africa.
Warren Buffett
There is one investor who was there in the 1970s and that was Warren Buffett. He now feels like a fish in the water and buys one company after another. He continues to build on his 1970s portfolio, with a lot of room for companies that are active in the field of raw materials, especially oil.
Buffett also demanded that companies have pricing power. He succeeded because the railways he owned had a virtual monopoly west of the Chicago - Houston line. In 1970, Buffett was forty years old, but it is good to know that he made more than 90% of his wealth after he turned 65.
For those from families that were already investing in the 1970s, it might be worth revisiting Grandpa’s portfolio, with Shell as the cornerstone of the portfolio and Australian and Canadian mining companies that were seen as the blue chips - the iron stock - of the portfolio. But also a portfolio that valued real assets more than financial assets. A completely different portfolio from the now obsolete neutral portfolio, but one with less risk and more return.
Han Dieperink is chief investment strategist at Auréus Asset Management. Earlier in his career, he was chief investment officer at Rabobank and Schretlen & Co. His contributions on InvestmentOfficer.lu appear once a week.
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