Strategists see lower returns as economy mirrors 1970s

Time to dig out those bell-bottoms and eight-track tapes. Wall Street may be headed for a second season of "That '70s Show."

Not that today’s millennial investors know what those items are of course.

A pair of high-profile financial commentators went on record this week saying investors may need to study the playbook for the 1970s if they want to make money in the 2020s.

Mohamed El-Erian, president of Queens’ College at Cambridge and chief economic adviser at Allianz, warned of a '70s-style “stagflation” in a Bloomberg interview this week, blaming the Federal Reserve’s view in 2021 that inflation would at some point fade. He noted that Fed Chair Jerome Powell has since retired the “transitory” thesis and that Powell now says he will tighten monetary policy until he sees “clear and convincing” evidence that inflation is in retreat.

“The Fed is finally catching up to developments on the ground,” El-Erian said, adding that stagflation is the “worst thing for central banks, especially for the Fed, because it puts its two objectives in conflict with each other.” Those two Fed objectives are low unemployment and stable prices.

Meanwhile, financial historian Niall Ferguson told a crowd at a Pictet Asset Management gathering this week that the recent pattern of geopolitical and economic events clearly resembles that of the 1970s and will likely lead to similarly poor stock and bond returns. Ferguson cited the current Ukraine war and Russian oil embargo as reminiscent of the Arab-Israeli conflict of 1973, which led to a spike in gas prices.

For those too young to remember, the Dow Jones Industrial Average, which was just above 800 at the start of the 1970s, had only advanced to about 839 by the end of the decade, an overall gain of 5% over this 10-year period. Furthermore, when adjusted for inflation, stock market investors were down about 49% over the course of the decade.

Like El-Erian, Ferguson warned that the current Federal Reserve was far too late in raising rates to stamp out inflation. And he is skeptical that Powell has the fortitude to hike in the face of a slowing economy as his predecessor Paul Volcker did some 40 years ago.

Even worse, says Ferguson, is the fact that most fund managers on Wall Street today barely know the name Volcker.

“Very few people in the market today are old enough to have been active in the 1970s," Ferguson said. "Wall Street is full of and run by people whose careers began after 1982. Careers which were shaped by one of the great bond market rallies of history. Careers that have been shaped by a period of great disinflation. And unless those people have studied history, those people are struggling to make sense of where we are now. Because we are now in a period that is more like the late '60s, early '70s than it is like anything that we have experienced in our adult lives.”

As to the investments that worked during the Ford and Carter administrations, well, it helped if it glittered like a disco ball. Gold was the best-performing asset in the 1970s, spiking more than 22%. Other commodities, such as energy and raw materials, also outperformed, rising 15%.

Will an investing strategy based on the '70s work again?

Maybe. But not all fund managers are rushing to dig out their "Frampton Comes Alive" albums.

“Gold has not held up near as well as people think as a hedge against inflation since 1980,” said Josh Strange, president of advisory firm Good Life NOVA. “Energy stocks have done well, but if we start to see things resolve in the Ukraine conflict or supply come online in the U.S., those prices could come down and hurt those stocks.”   

Andrew Graham, founder of Jackson Square Capital, says higher oil prices won’t cripple the U.S. economy as they did during the 1970s because oil consumption as a share of GDP was three times higher then. He said the U.S. and other developed countries are far less dependent on oil now, with more diversified economies.

“Oil was just a much larger share of wallet then as compared to now,” Graham said. “That said, global energy demand continues to rise, and most economists see large deficits in 2020.” He recommends staying with energy as a sector overweight and loves Shell (SHEL) as the top player in liquid natural gas, especially when Europe is in dire need of it.

Stephen Colavito Jr., chief investment officer at Perigon Wealth Management, agrees with El-Erian and Ferguson that investors may want to invest in tangible assets as they did back when Aerosmith sold out arenas (the first time).

“Real assets like energy, metals and real estate — REITS — should always be a part of a diversified portfolio because they hedge against inflation and have lower correlations to equities,” Colavito said. “Many investors moved away from that way of thinking because of indexing. With the Fed raising rates and providing less liquidity to the Treasury market, we will see markets that trade more on real price discovery and less on intervention.”

Alex Shahidi, managing partner and co-chief investment officer at independent RIA Evoke Advisors, also sees shades of the 70s in the current environment, saying the recent spike in inflation and the risk that it may last a while reinforce the need for investors to hold better-balanced portfolios that include inflation hedges.

“A risk parity framework always includes assets such as commodities, gold and inflation-linked bonds precisely because unexpected shifts in the economic environment commonly occur,” Shahidi said.

He added that investors should keep in mind that both stocks and bonds underperformed cash during the entire decade of the 1970s, so “a shift in strategy from equity and bond-centric portfolios seems prudent” at this time.

Finally, Ferguson noted that even if we do see a return to '70s returns in the stock market and the Fed can’t “Whip Inflation Now,” things may not be so bad.

“The 1970s was fun. Way more fun than now. There was an astonishing amount of sex,” said Ferguson. “There was actually a very rigorous study that was based on multidecade surveys which proved conclusively that there has never been a generation that has had more sex than the generation that was born in the 1950s.”

If only there were an ETF for that.