During the two aforementioned periods, inflation rose from 1.2% to 23.7% and from 0.0% to 11.0% respectively. You still got paid back, but in dollars that were worth an awful lot less.
What distorts current thinking further is that inflation during the last couple of decades has been unusually stable. Go back further and a different picture emerges: for only one third of the time since 1774 has 10-year annualised inflation in the US been between 0% and 3%.
So, the chances are that this period of stable inflation will at some point end, though it’s hard to predict when and in which direction it will head.
It is certainly possible given how leveraged the world economy is that we get one last deflationary shock, in which case long bonds may have one last hurrah, but I wouldn’t count on it. Inflation would have to fall substantially to make up for the prevailing negative real yields in the UK.
To put it simply, important risk is the risk of permanent loss of capital, the sort that is currently embedded in the real yields of UK gilts. And yet bonds are generally viewed as low risk because they are low volatility. When inflation starts rising, as it is likely to do at some point, you will see your real capital erode, but only gradually. Consider this low risk at your peril.
But fear not; help is at hand. During the two bond bear markets mentioned earlier, equities in the US did just fine, returning in real terms 7.0% and 4.4% per annum respectively compared with long-term average of 6.4%.
Furthermore, during the three bond bull markets, they did even better, returning 8.4%, 7.2% and 8.7% respectively. Another way of putting this is that if you look over a long enough time frame, it turns out that equities are less risky than bonds!
True, there were some pretty nasty equity bear markets over the last 150 or so years but they didn’t, unlike their bond equivalents, tend to last very long.
The fact is that equities have generally exhibited a remarkable ability to recover, principally because companies, unlike bonds, have been able to adapt to prevailing conditions.
Furthermore, dividend distributions have been a lot more stable than you’d think by looking at market movements.
The only one of the seven US equity bear markets since 1970 in which aggregate dividends fell was the most recent one, and that was concentrated in one sector: financials.
That equities can be less risky than is generally perceived and bonds more so are findings that will I think prove highly pertinent over the next couple of decades.
