Sideways is the natural direction

IF YOU ask people how much share prices have gone up on average every year for the 100 plus years since 1900, they always get it wrong. The optimists say 10%. The pessimists say 3%. But the real answer, looking only at capital appreciation and adjusting for inflation, is 0.2%.

That is not a misprint. It is indeed just one-fifth of one% per year. No one challenges this figure, which derives from work done by London business schools academics, published and updated every year - but it needs a bit of explanation.

The long-run growth of shares is normally claimed to be around 5.5% in real terms by fund managers - but that includes the effect of re-investing all dividend income. It also includes a long period in the first half of the last century - basically from 1910 to 1940 - when shares went nowhere.

Three things changed the world from the 1960s onwards. First we had serious inflation, which got us used to apparently high interest rates, dividends and rates of return - though in real terms these were nothing out of the ordinary.

Second, the growth of pension funds meant there were vast pools of money chasing a limited number of shares - guaranteed to force prices higher. Third, we managed to get through the period without protracted wars or long-run depressions.

Upward trend

THE point of this homily is to underline how spoiled we have become in the past 30 years, whether we have been investing in shares or houses, fine wine or art. There have been booms and there have been busts, but taking the period as a whole the trend has been firmly up.

This has concealed an important message. The growth rates we have enjoyed, even taking account of the bad times, are much better than anything experienced by our parents, grandparents or their predecessors, the eminent Victorians.

This is worth remembering as we hear the siren warning of a coming bust in house prices or the way the rising price of oil is going to turn us all into paupers.

There is an alternative to boom and bust - and it rejoices in the unglamorous name of 'sideways'. Sideways is what our ancestors were brought up on. Sideways is what happened to the price of the homes my parents owned for most of their lives, which is why they could not understand my keenness in the late Sixties to get on the housing ladder.

Sideways was the natural law of markets - shares, houses, art, wine - for most of the time. You never hear this from investment professionals or estate agents - for one simple reason.

When prices are changing only a little, there is much less pressure to buy or sell - so their commissions dry up and they make much less money. Hence they tell us prices are certain to go up, to make sure everyone who can buy does so.

Then, when that fails to work any more because the population is spent out and prices have got to unsustainable heights, they predict a crash - hoping to bounce as many of us as possible into selling before it happens, so they can earn maximise their commissions on the way down too.

Orderly retreat

THERE is, however, a respectable body of opinion - academics, industrialists, Government officials - who think we could be entering a period similar to Britain after the 1870s, when for 30 years prices were stable or fell slightly - a period which was horrible for agriculture but in which a lot of other sectors did reasonably well.

There is certainly a lot of adjusting to be done in the world as balance of payments deficits are brought down and people and governments learn better to live within their means. But we ran up these imbalances in an orderly way, so it should be possible to organise an orderly retreat from them. Nevertheless, these are worrying times, with reports of gathering clouds on housing and an outright storm in oil.

But it helps to have a sense of perspective. Oil prices are at their peak in money terms, but they would need to hit $100 a barrel, not $50, to deliver the kind of shock the Western world experienced in 1973, or again in 1980. Without a major terrorist attack, they won't get there.

What is more likely is that the rising price will add to industrial costs and increase unemployment, particularly in the United States, which will be a drag on the world economy - but a self-correcting one in that its first effects will be to cut the demand for oil and help to pull prices back down to less painful levels.

10-year adjustment

HOUSE prices have crashed before - in 1974, in 1982 and most recently in 1992. But most people can ride out the storm unless something else happens - such as getting ill, divorced or losing their job - because then they become forced sellers and have to take what price they can get.

It is no coincidence that the worst crashes coincide with recessions. But it does not have to be that way, and provided the overall economy stays stable, it should not be. Boom and bust is not the natural order of things. Sideways is - and that is the way the market will go until incomes have caught up and house prices have adjusted back to the levels that people can afford, even if it takes 10 years.

The same applies to shares. Companies cannot make money in a competitive, inflation-free world and if profits are not growing there is no reason to buy equities.

So the most convincing direction for the stock markets for the next five to 10 years is also sideways - and this poses quite a challenge. What are we going to talk about if house prices are off the agenda?

After all this hype we will have to learn to cope with a world where things financial revert to being seriously boring. Some may find that hard, but it is surely not disastrous by any measure.