Gareth Howlett: Worried investors and young children have a lot in common

I think of that harassed parent at the wheel whenever anyone asks me (or whenever I ask myself) how much longer markets are going to trade sideways, or how much longer western economies are going to suffer through the grinding process of bringing debt back under control.

It’s now nearly five years since the first cracks began to appear, and the sense of daily crisis which dogged markets in late 2008 and early 2009 has been replaced not by a return to what we think of as normal conditions, but by a glum trudge with no apparent end in sight.

I’ve written before of my belief that things will indeed get better one day, but I don’t know when that day will come – neither does anyone else – and perhaps more importantly I think that “better” in this case may not necessarily mean “as good as it was before”. It is here that I think that the scope for disappointment is greatest, unless we learn to lower our sights.

A lot of senior people in the investment industry started work in the early 1980s, on the threshold of the greatest bull market in history. Until then, investors did indeed make more money out of shares than any other investment, but the upward slope of the graph was relatively gentle and the oscillations were frequent and often severe.

Between 1900 and 1980, in each calendar decade there were on average four years when equity investors lost money after inflation. In the 1980s and 1990s, the obstacle race gave way to what felt like an effortless escalator to prosperity; markets rose almost without a break until the tech bubble burst at the beginning of the new century, and at a record rate. So the habits and expectations of many of the people looking after investors’ money were formed at a time when conditions were exceptionally favourable for stock markets.

Historians will debate the fine detail of why this happened for years to come, but the broad headlines seem clear enough. The defeat of inflation, increased cross-border trade, the fading influence of militant unionism, the decline and eventual collapse of communism in the Warsaw Pact (and its de facto abandonment in China); these factors taken together created near ideal conditions for the growth of profits and encouraged investors to attach a higher valuation to those profits – the classic double whammy.

If people think risks have been abolished, they will take more risks in order to get rich, and this applies both to the stock market and to the real economy. The problem is, when risk returns, they are unprotected. We are now clearing up the resulting mess.

In older more ruthless times the approach to these matters was correspondingly brutal, and prices – of assets, commodities and labour – fell until the market cleared. So great is the political fear of the consequences that this time virtually all the policy levers have been pulled to prevent such an outcome.

This is entirely understandable (unless you think that mass unemployment and soup kitchens are a price worth paying) but it is likely to mean that the return to normality will take a lot longer.

And when we get there, what will the “new normal” look like? I have a fairly strong hunch that it will be much more like the obstacle race of 1900-1980 than the escalator of 1980-2000. This is not to underestimate the hugely transformative impact of technological change or of the spread of capitalist methods of production to billions of people in the emerging markets.

On actual output levels I am quite optimistic – as indeed is the IMF which has just increased its forecast for global growth to just under 4 per cent this year. But there is no linear link between output and profits, nor between profits and the price which investors are willing to pay for them. In this environment a wary scepticism is the best defence against disappointment.

• Gareth Howlett is fund manager director at Brooks Macdonald