Maggie Thatcher's Bull Market

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You'd be hard put to find an optimistic investor in 1980, so bad was the British economy. Inflation and interest rates were going through the roof, unemployment was rising, and gloom lay all about.

Yet two years later, the FTSE was off on a bull run that would last into the noughties. So what happened to turn the tide? As today's markets alternate between blind panic and irrational relief, it's a highly pertinent question.

Gloom and revulsion
Let's start with the gloom. "For the great bear-market bottoms, you need a society-wide revulsion with equities," according to Russell Napier of CLSA brokerage and investment group, an authority on the subject. We certainly had that in 1980. Inflation in Britain was about to peak at a horrifying 20% and interest rates at 17%. Manufacturing was in the doldrums. What shares could you trust?

It was the same story in America, which had suffered double-digit inflation and double-digit interest rates for years. Reflecting that revulsion, the Dow hit rock bottom at 776.2 in early 1982, almost exactly where it had been 18 years earlier. Meanwhile, the FTSE All-Share index was struggling around the 250 mark.

Shocking numbers
The big figures in the economy probably affected ordinary investors, too. Although they may not know much about the ratio of the deficit to gross domestic product, these figures do hit the headlines and filter into the public consciousness. In the U.S., for example, the deficit was 6%, considered shocking at the time, although today it's in handsome double digits.

But then the headline numbers began to turn. By 1981 inflation had fallen to 12% in Britain and below 5% by January 1983. By then, the bull market was taking hold.

A boost from behind
Equity markets also got a kick in the backside. In America it was Ronald Reagan's tax cuts that provided what economists call an exogenous (external) boost, while in Britain it was a round of privatizations. The latter was a one-off that we won't see again, and it's hard to underestimate its influence.

Maggie's privatization program started from 1981 with the sale of half of Cable and Wireless. Thereafter, many of the jewels in the national crown -- 20% of the economy was in state hands -- were progressively opened up to investors. Because the privatizations were organized in a way that attracted the general public to buy shares in the companies, a whole new class of investors flooded into the stock markets. Cable and Wireless, for example, was oversubscribed by six times.

Delayed results
Macroeconomic policies also play a big role in an equities rally, but they're often invisible. By the time they're having the desired effect, everybody's forgotten exactly what the policy was. When, for instance, the Thatcher government increased taxes in the spring budget of 1981 pretty much as the economy hit rock bottom, the Keynesians said it would prove a disaster. In fact, things began to pick up nicely, because the government's higher tax take allowed it to cut official interest rates and money became a bit freer. 

Also, some research argues that a period of high inflation tends to set the equity markets up for a bull run because it leads to a chronic undervaluation of shares. This is because inexperienced investors capitalize firms' cash flows at nominal, not after-inflation, rates. Certainly, at that time shares on the LSE were priced at a bargain-basement seven to eight times forward earnings, way below the long-run average.

The bulls take hold
And so it began to happen. From 1982 the Dow gained over 40% in 500 days and just kept on going. Within 1,000 days, the gains hit 103%, and so on. By 1994, investors had bagged 214% returns. To summarize, between 1982 and 1999, the compounded real return of the Dow Jones Industrial Average was a whopping 15% a year, way ahead of the increase in earnings of U.S. Inc.

British investors saw a repeat performance. Having languished at 289 in January 1981, the FTSE All-Share index had crawled up to 331 a year later and then to 395 by January 1983. The bull market had begun. A year later again, the index hit 501 and optimism was rife (it's currently around 2,700 -- the FTSE 100 wasn't created until 1984).

Calm before the storm
Another authority on bull market take-offs, Hussman Funds, makes an important -- nay, crucial -- point. Every single bull market in the last 70 years set sail from a calm harbor. That's to say they didn't begin from the kind of fraught period we're seeing now but from a lackluster state. 

Proving the point, throughout most of 1980 the All-Share bumped along in the high 200s with a false rally or two. Then in 1981, it hung mainly around the low 300s with a few ho-hum falls of around 10% before peaking at 335 in August 1981. The scene was set.

So if 1982 is any guide, what we want now is a flat period of six months or so in the equity markets. Next, some genuinely good news about the financial integrity of the banks and the recovery of the sovereign markets would be helpful. Finally, a couple of modest drops in the FTSE would set the scene for a sustained rally. And, oh, yes, an exogenous boost from somewhere.

Or we could just put our money into the emerging markets, the BRICs and the CIVETS that simply weren't options in the 1980s.

More from Selwyn Parker:

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