Die Hard, with a vengeance
(continued)
Tim Price, Director of Investment PFP
Wealth Management
“Equity myth”? Isn’t that somewhat harsh? Not really.
Consider the following chart, which we have demonstrated before. It shows the
annualised 20-year returns from the UK stock market over three centuries: the
18th, 19th and 20th.
Three aspects of the chart are worthy of emphasis. Firstly,
it looks much like the standard ‘bell curve’ - which is what you would expect,
but only over the very long term, a term realistically much longer than the
typical investor’s timeline. Results cluster around an average return.
Secondly, and more alarmingly, those average returns are
dramatically lower than equity market propagandists would have you believe. The
median real annual return from UK stocks, over a period of three centuries,
broken down into smaller, 20 year durations, is approximately zero. Not only is
“stocks for the long run” a ridiculous thesis, but the long-run return has had,
if history is any guide - and it is our only guide - a tendency to be
vanishingly small. Perhaps the riskiness of the stock market is understated in
popular conception?
The third observation is, to us, the most striking.
It certainly answers the question posed in the title: why do
so many financial advisers favour stocks? Answer: because the chances are, those
advisers all worked at least some stage during the last twenty years - the one
period on the entire chart during which the annual 20-year real return from the
stock market was meaningfully large, at between 8% and 10%.
To put it another way, the 1980-1999 experience was, in the
context of the past three centuries, unique. To put it another way, the
1980-1999 equity market return was a 1 in 15 phenomenon. It was most certainly
not the norm. But the fund management industry, with its perennial obsession
with equities over any other form of asset, certainly behaves as if it was the
norm. As the regulator insists, past performance is not necessarily any
guarantee as to future returns. Equity market apologists today must fervently
wish that to be the case.
(Source:
Global Financial Data, Datastream.)
Of course, the problem with statistics is that if you torture
them for long enough, you can get them to confess to anything.
Since we’re not in the business of promoting funds [either
equity funds or those of any other kind] we can speak with some degree of
objectivity about the current make-up of the investment landscape. Whatever else
it can be said to be, it is extraordinarily polarised. Stocks continue to bounce
around in a largely trendless way, but the recovery/dead-cat bounce off the lows
of March 2009 is undeniable. Government bonds, on the other hand, notably those
within G7 markets, are predicting nothing less than deflation. There is no other
way to interpret two-year US Treasury notes yielding 0.5%.
US 10 year
yields, last 10 years
Here is the
chart of 10 year US Treasury bond yields over the past decade. (Source:
Bloomberg LLP.)
The trend is undeniable. From a yield of almost 7% at the
start of the decade, US yields have trended relentlessly lower, approaching 2%
during the panic phase of the crisis in 2008, and sitting at around 2.75% today,
and still trending downward. Other major government bond markets have delivered
similar performance. But the historical precedent of one of those markets is the
most instructive: that of Japan.
Japan was ahead of the West by almost 20 years. The seeds of
its own property market and banking collapse were sown in the 1980s, and by the
late 1990s the country was already floundering in deflation. Note also that the
process of quantitative easing, the second iteration of which now threatens in
the other industrialised economies, has achieved little by way of meaningful
positive impact in Japan. At the risk of labouring the message about equities,
Japan’s Nikkei 225 Index is currently 75% below its bubble era high, reached
some 21 years ago.
To sum up, then: The banking and financial services industry
routinely overstates the performance and, indeed, relevance of exclusively
long-only equity investing. This would be understandable if it were a message
coming solely from stockbrokers, but is more galling to be being transmitted
from institutions that should be asset class agnostic.
The investment media, by and large, assist in this
equity-centric propaganda. This is not to be simplistically critical of the idea
of owning common stocks per se, but it is meant to be critical of an
entirely equity-centric portfolio at a time when the likelihood of a full-blown
deflation has not been higher since the 1930s - in western markets at
any rate. This argument also underlines the admittedly longer term equity case
for investment in the fundamentally more attractive emerging economies.
Japanese 10
year government bond yields,
1990 to present day
(Source:
Bloomberg LLP.)
To add kerosene to the tinder box, governments have not stood
entirely idly by. Heavily influenced by the neo-Keynesian addicts to stimulus
irrespective of sovereign solvency, Western administrations, led in no small
part by the US Federal Reserve, have thrown everything at their disposal by way
of taxpayers funds to try and ensure (vainly, thus far) that economic recovery
will soon return - in much the same way that our ancient ancestors used to make
human sacrifices to placate the gods of the harvest. While it has brought
recovery no closer, it has managed to utterly distort the pricing signals of the
financial markets and guarantee a foggy mixture of moral hazard and general
economic confusion. Perhaps, as in the case of a forest fire, it might be better
to let the conflagration burn itself out and allow the forest to prepare for
cyclical re-growth.
James Rickards nicely identified the problem of “moral hazard
creep”, writing in a recent Financial Times: “Policy, whether it be printing
money, guarantees or deficit spending, can prop up asset values for a while.
This may even be useful in a liquidity crisis. But a solvency crisis is another
thing. The longer policy distorts markets by ignoring fundamentals, the longer
those reliant on market signals will sit on their hands [investors: this means
you]. The Fed’s recent decision to continue asset purchases shows there is no
exit once this path is chosen. As we approach the second anniversary of the
Fannie and Freddie bailouts, are we better off? Values cannot recover until they
first hit bottom. In short, our economies would be growing more robustly today
if we had taken our medicine in 2009.”
No use crying over spilt milk, though. From the perspective
of today’s investor, the answer must surely be: diversify across multiple asset
classes as appropriate, and keep some powder dry.
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The above data and research was compiled from sources
believed to be reliable. However, neither MBMG International Ltd nor its
officers can accept any liability for any errors or omissions in the above
article nor bear any responsibility for any losses achieved as a result of any
actions taken or not taken as a consequence of reading the above article. For
more information please contact Graham Macdonald on graham@mbmg-international.com
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