Equity returns over the next decade
William Buckhurst - 04.1.10
‘The lost decade’ – this sounds a bit dramatic and conjures up images of a chapter found in thebiography of an ageing rock star’s recollection of the 1960’s. But the 2000’s truly have been adecade to forget for stock market investors. Someone investing $1 in the US stock market (theworld’s largest market by capitalisation and indicative of other major markets) in December 1999would be left with just over 75 cents ten years later. Even when that person takes into account allthe dividends received and reinvested they would still be left with only 89 cents. One would hopethat an active investment manager would provide a better return than this but nonetheless it isdamning verdict of a ten-year period where equities as a whole failed to provide positive returns.
In contrast, if that person had invested $1 into US Treasury bonds – normally one of the least risky assetclasses available to investors and generally thought to be rather dull – they would now be sitting on$1.54, a profit of just over 50%. Risk has not paid off over the last 10 years.
We often talk about equities being the best asset class to own over the long-term and 10 years is a longtime by most people’s reckoning; so it is very unusual for equities to fall in value in real terms (i.e. adjustedfor the cost of living) over a decade. According to the Barclays Equity Gilt Study, in calendar decadeterms only the 1930’s have been worse for investors (US equities fell by 12.1% in real terms). Morerecently there have been some 10-year periods that don’t fit so conveniently into actual decade terms –the periods ending in 1974 (-6.0%), 1976 (-0.3%), 1977 (-0.2%), 1978 (-3.5%), 1979 (-2.3%), 1981 (-2.4%) and 1982 (-1.2%) – where investors had not made money in real terms.
What is encouraging is that, without exception, in the ten years immediately following each of theseperiods, investors in US equities made double digit returns (the average real return with incomereinvested was 14%).
The poor showing by equities over the last decade has led to people talking about the demise of theequity ‘cult’. Yet the last time equities received such bad press was in 1979 when the influential USjournal, Business Week, published a cover story entitled “The Death of Equities” only months beforeequities went into two decades of positive growth. Indeed, the recent weak performance from equities isnot due to some intrinsic problem with the asset class, rather it is attributable to the extreme overvaluationof equities at the start of the decade: US equities were, by some forecasts, on a price to earnings ratio ofalmost 45x in 1999 compared to a long term average of just over 16x - they now trade slightly belowaverage. While equity valuations fell sharply during the 2000-03 bear market they never really rose againduring the 2003-08 rally so that equities actually underperformed corporate profits during that period.Following a sharp fall in 2008 and partial recovery in 2009 we are left with equities entering the nextdecade at attractively valued levels.
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