Sunday, 28 February 2010
economist deze week
IT IS all too easy, given today’s 24-hour news cycle, to become obsessed with short-term movements in financial markets. But investors must learn to focus on the long term.
The final return of an equity investor is highly dependent on when he starts to put money in. In real (inflation-adjusted) terms, British equity prices reached peaks in 1906, 1936, 1968 and 1999, according to the Barclays Capital Equity-Gilt study. The regularity of the intervals between these summits is remarkable and will undoubtedly encourage believers in “long wave” theories (Wall Street’s peaks, in real terms, occurred in 1928, 1968 and 1999). The patterns suggest that each generation discovers a passion for equity investment that is followed by disappointment.
Strikingly, the recent year-end trough in this inflation-adjusted index, in 2008, was only fractionally higher than the peak in 1968. Investors had made no capital gains in real terms over 40 years although, of course, they had enjoyed the benefits of a dividend income throughout this period. But this long drought was far from unique. At the British economy’s nadir of 1974, the era of the three-day week, equities traded for just 30% of their real value at the end of the 19th century.
When markets are booming, however, commentators tend to look back at the performance of stocks and extrapolate an even rosier future. In 1929 John Raskob, a director of General Motors, wrote an article in the Ladies’ Home Journal entitled “Everybody Ought to Be Rich”. Mr Raskob calculated that an investment of just $15 a month would, with dividends reinvested, grow into $80,000 after 20 years.
In the mid-1990s Jeremy Siegel of the Wharton School produced “Stocks for the Long Run”, an impressive work of scholarship showing that American equities had outperformed other asset classes over all 20-year periods. This insight was extrapolated by James Glassman and Kevin Hassett into a book called “Dow 36,000”, based on the idea that equities should trade at much higher valuations given that they were no more risky than bonds for long-term investors.
In the event, the “noughties” decade produced average real returns (including income) of -2.2% a year from American equities and -1.2% a year from British shares. Over the 20 years to the end of 2009 American equities barely beat government bonds, and British shares lagged gilts.
Of course, it was the belief in ever-rising share prices that pushed stockmarket valuations to absurd levels and thus ensured subsequent underperformance. A similar process happened in Japan in the 1980s. Share prices in Tokyo are still trading at only a quarter of their 1989 peak levels.
The obvious parallel is with house prices. Analysts were convinced that American house prices might suffer regional busts but would not fall at the national level. The idea of housing as a one-way bet fuelled the boom in subprime lending and pushed prices up to a peak from which they could only fall. Robert Shiller of Yale University has pointed out that, in real terms, an index of American house prices rose from 100 in 1890 to 110 by the end of the 20th century. By the end of 2006, at the top of the housing boom, the index had reached 199.
Are these preferences for asset classes driven by some underlying factor, rather as John Maynard Keynes argued that practical men were often slaves to the writings of some “defunct economist”? Tim Bond of Barclays Capital argues that demography may be to blame. The key “saving age” is the cohort of 35-54 year-olds. As they prepare for retirement, they pile into the asset class du jour. Mr Bond shows that since the second world war there has been a close correlation between American equity valuations and the proportion of 35-54 year-olds in the population. That the “noughties” proved to be a dismal decade for equities was hardly surprising. The number of retirees (who run down their portfolios) was rising relative to the number of savers.
The bad news is that the demographic maths imply that equity valuations will continue to fall until the middle of this decade. The news is even worse for government bonds. A similar model suggests that yields in both America and Britain are heading for 10% by 2020.
So demography drives investment fashion, and fashion determines valuations. In turn the long-term return is crucially dependent on the starting valuation. American equities now offer a dividend yield of just 2%, less than half the long-term average. Investors should remember that salutary statistic whenever they are tempted to get too bullish.