Fool's Eye View

[ November 16, 2000 ]

The Long View

By Rob Davies (TMFEssex)

Carburton Street, London. OK, so two weeks out of the office hardly counts as a long time. But the last few weeks have been busy in terms of news and financial data, and I have only been dimly aware of much of it because I was heavily involved in domestic affairs. Yes, there has been a very close race in the US Presidential election, yes there has been a kind of mini-budget and there has been a stack of company results. But has that really changed anything?

The short answer is no. Given the closeness of the US election it is clear that there is no great divide between the two candidates on policy and there is no reason to expect much difference in economic policy whoever is elected. Moreover, the almost even split in both houses will prevent any extreme legislation being passed. Finally, there is still the steady hand of Alan Greenspan on the monetary tiller, and arguably he has more control over the economy than whoever lives in the White House. The US is the largest economy in the world by a long way and its continued prosperity is vital to all of us. The events of the last week or so should do nothing to make it worse.

In the UK the pre-budget briefing was really a non-event. Some modest handouts to politically sensitive groups were to be expected after recent events. Nevertheless, the size of the pension increase is a testament to the importance of the pensioners vote. This year's £5 increase to the country's 10.5m pensioners can be swallowed, but it makes one wonder whether the same generosity will be sufficient in 2010 when there will be a million more pensioners. Just look at the cost of this relatively modest package.

Year                    2000/01    20001/02   20002/03   2003/04
£m
Pensioners' Package      435        1,830      2,540       2,595

This group of active voters needs to be kept sweet by politicians of all colours, but without bankrupting the country. The trick of linking the Minimum Income Guarantee to earnings, but only making ad hoc increases in the state pension (possibly every five years?) shows quite clearly that the state is withdrawing universal benefits and moving towards means tested benefits. That only reinforces the imperative of individuals to save for their own retirement. So no change there then.

However, I thought the really good news from Prudence Brown was the reduction in the National Debt. By the end of this fiscal year the public sector net debt will be only £314b or, to put it into context, about ten times the debt of British Telecom (LSE: BT.A). Put another way it is only 32% of GDP, and that is very low in comparison to other countries.

Now, if the government doesn't need to borrow so much, and it is the biggest borrower, it means interest rates should come down and that is great news for business. What is good for business is good for the stock market and hence for investors. So despite Prudence Brown's irritating habit of making things more complicated than they need to be, this pre-budget briefing is good news for equity investors, but bad news for depositors.

Look at this table of the interest rates available to UK bond investors.

Life of bond in years      Yield (%)

2                          5.6
5                          5.4
10                         5.1
15                         4.9
20                         4.6
30                         4.5

While short-term interest rates are 6%, they are not guaranteed for anything longer than overnight. It is only possible to lock in 5.6% for two years and a measly 4.5% for thirty years. If and when short-term interest rates are cut, investors will snap up bonds offering even these low rates pushing them higher, and yields lower, in the process. The lower these rates go the more attractive equities become for long-term investors. Even the 2.1% dividend yield on the FT All Share starts to look good. With bond yields less than 5%, and likely to go lower, it is clear that we only a need a few percentage points of capital growth from shares, on top of the dividend, to get a better return from equities than from bonds. This simple exercise demonstrates the logic of buying equities for the long term.

Long term investing is typically seen as something that employees do to prepare for the retirement. But these days retirement itself can be long time. The reason I was away for the last few weeks was to be with my terminally ill father, who eventually died last week at the age of 84. He had a good life so I cannot be too sad. But it is interesting to reflect that he was retired for 22 years and the decision he took in 1978 to commute his pension and put it into equities, even horrible managed funds, has left my mother well placed for the future. That move worried him enormously at the time, but it was absolutely the right thing to do.

Even though no one is quite sure what the absolute levels of return from the market are going to be, it seems clear to me that the best place for long-term savings is still the stock market. But not everyone shares our view and many people have too much money tied up in overnight deposit accounts where the returns could fall overnight on the whim of the Bank of England. Of course it is important to keep some cash for emergencies, but not too much.

It would be interesting to know just how much people think they need to keep for such occasions, so we have included a little poll to get some idea of what people keep by for a rainy day.

So why not tell us how much cash, in terms of months of expenditure, you keep as a reserve rather than investing in the stock market?

A)1 Month
B)3 Months
C)6 Months
D)12 Months
E)24 Months


Tell us here.

And we welcome your thoughts on the Fool's Eye View discussion board.