The industrial revolution of the 19th century introduced mass production and took cheap labour from the countryside into the cities. Between 1800 and 1900, retail prices fell in the UK but the stock market is estimated to have returned more than 6% pa and the economy grew substantially.
If we view the changes of the past 20 years as a new industrial revolution, and there are many parallels, then the post-second world war period of high inflation will be seen as the exception and the low inflation as a return to a ‘very old normal’.
A parallel between the 19th-century industrial revolution and current times is the introduction of mass production and the automation of production through the development of new technology. Technology and the internet bring consumers closer to producers, squeezing retailers and making price comparisons much easier. How many of us have bought a camera or dishwasher without shopping around on the internet?
Technology has allowed production to be automated, meaning there are fewer employees and goods are cheaper to produce. It is now also easier to make things overseas in countries where costs can be lower.
Technological development has also improved our efficiency and, taking fuel as an example, we now use less oil and have improved supply with new methods of extraction such as fracking. The increase in renewable energy reduces the need for fossil fuels at the margin, and shale gas is becoming viable and depressing energy costs.
The Bank of England has been concerned wage inflation has failed to materialise. In the 19th century, labour moving from the countryside to the new cities, Irish immigration and soldiers discharged following the Napoleonic wars all kept wages down.
The free movement of people within the EU means we can no longer look at UK unemployment figures in isolation. Unemployment is high in Europe, particularly within the younger, more mobile age groups, and labour demand in the UK may be met from elsewhere in Europe. A high proportion of part-time workers could also take up any slack by increasing their hours.
The European Central Bank has reduced rates and may well move to full-blown quantitative easing in the coming months. This has depressed the euro, making European imports cheaper in sterling terms.
‘Abenomics’ in Japan, and the resulting fall in the yen, is having a similar effect on Japanese goods.
The rise in the dollar works in the other direction but our main imports priced in dollars are commodities and, as we have seen, these are falling.
As far as the markets are concerned, continued low interest rates mean there is less room for central banks to add stimulus during periods of difficulty. This is likely to make markets more susceptible to wavers in confidence, increasing volatility periodically.
However, in general, I foresee conditions that will be supportive of low bond yields and of Treasury prices, even at the present levels.
Low funding costs are likely to mean corporate bankruptcies remain low, supporting corporate bonds. For equities, innovative companies can benefit from lower costs, providing they are not locked into expensive premises.
While earnings growth cannot rely on price rises with a lower discount rate, the present value of those earnings may be substantially higher. This is supportive for equities but is likely to lead to greater volatility as prices become more sensitive to economic changes.
Overall, I expect inflation to remain low, interest rates to remain low and equities to provide attractive long-term returns.