Over a century of evidence points to better times ahead.
Despite the recovery that the stock market has staged in the last year, we are living in extraordinary times. Still. And that, in short, is the fundamental message in the latest annual Barclays Equity Gilt study, which has been published continuously since 1956.
Tracking asset returns since 1899, the study has repeatedly confirmed that shares outperform cash, corporate bonds and government gilts -- many, many times over.
With dividends reinvested, £100 invested in equities in 1945 would be worth £119,238 today. £100 in cash would have grown to £6,133, while £100 of gilts would have produced £5,087.
Over the entire period since 1899, the outperformance is even more striking. £100 invested in equities would be worth £1,486,860 -- while £100 gilts would be worth £23,688, just ahead of the £20,026 return from cash.
The lost decade reprised
Last year's Equity Gilt study coined the phrase 'the lost decade'. And it's a measure of the esteem in which the Barclays study is held that the phrase quickly became common parlance.
The reason? The 1998-2008 return from UK equities was just 1.05%.
Over the entire period covered by the 2009 study, only the decade ending in 1974 saw a weaker 10‑year return -- and then only marginally so, with the 1964‑74 period delivering a paltry 1.02%. And that's in nominal terms: inflation adjusted, the real return was negative, at -1.5%.
And despite the steep recovery the markets have experience since March 2009, the lost decade persists. Dropping 1998 from the frame and adding 2009 improves the real return from equities over the past ten years from -1.5% to -1.2%.
Gilts, on the other hand, have yielded a real return of 2.6% over the past ten years, while corporate bonds delivered 2.9%. Even cash in the building society would have produced 1.8% in real terms.
And here's the real shocker. Over a 20 year period, while equities have delivered a -- reassuringly once more positive -- return of 4.6%, gilts returned 5.4%. Cripes. Gilts have outperformed equities. As last year's study noted, this is exceptional -- and you have to go back to 1930s to see anything comparable.
Remember, too, that we're talking overall returns, with dividends reinvested. This isn't solely a phenomenon caused by comparing the dotcom stock market highs of 1999 with the 2009 recessionary slump.
Gilts will suffer
But going forward, continued gilt outperformance looks most unlikely.
Pointing to factors as diverse as increasing macro‑economic volatility, changing demographics, worsening government finances and shifts in global savings trends, the Barclays authors reckon that gilt yields must rise -- and sharply, too. Which, given gilts' fixed interest nature, means that gilt prices must fall.
"Although the outlook for equity returns is not exactly inspiring -- particularly over the next half decade -- it is a good deal better than the prospects for bond markets," notes the study. "Long-term government yields in both the US and UK are set to more than double from current levels over the next decade, moving up to around 10% by 2020. Under such circumstances, total returns from government bonds are likely to be negligible over the next decade."
In other words, while equities will struggle in the short term, the report for 2020, in ten years time, should make for happier reading.
But just how happy?
We're not going to see ten years of euphoric growth, that's for sure. A cyclically-adjusted P/E model, overlaid with demographic projections, suggests to Barclays that a cyclical de-rating is underway, and has been for some time.
While the good news is that around two-thirds of the de-rating has already happened, the bad news is that equity returns will be continue to be somewhat depressed. Nominal equity returns can be expected to be somewhat below the long run historical average of 11% that the UK stock market has delivered -- and well below the 15‑16% returns seen during the halcyon 1982‑2000 period.
However, says Barclays, "assuming a normal trend for profits, equity returns over the next decade should still be positive." So a better decade than the last one, then.
And the odds look pretty good
As usual, the Barclays study contains a table highlighting the number of times that equities outperformed cash and gilts over different periods of time. It's a table of which I'm very fond, and which bears careful study.
| Equity performance | 2 years | 3 years | 4 years | 5 years | 10 years | 18 years |
|---|
| Outperform cash | 72 | 75 | 78 | 79 | 92 | 92 |
| Underperform cash | 37 | 33 | 29 | 27 | 9 | 1 |
| Total number of years | 109 | 108 | 107 | 106 | 101 | 93 |
| Equities outperformed cash | 66% | 69% | 73% | 75% | 91% | 99% |
| Outperform gilts | 75 | 81 | 82 | 82 | 81 | 83 |
| Underperform gilts | 34 | 27 | 25 | 26 | 20 | 10 |
| Total number of years | 109 | 108 | 107 | 106 | 101 | 93 |
| Equities outperformed gilts | 69% | 75% | 77% | 75% | 80% | 89% |
Source: Barclays Capital
The first column shows that over a holding period of two years, equities outperformed cash in 72 out of 109 periods, 66% of the time. Extending the holding period out to 10 years, the probability that equities outperformed rises to 91%. For 18 years -- almost two decades -- the probability rises to 99%.
Of course, there is no guarantee that because we have seen these patterns for the last century or so, they will hold going forward. But it is clear that the past ten years or so have been quite extraordinary, and if history does assert itself, the next ten shouldn't be anything like as bad for equity investors.
And if that's not a 'buy' signal, what is?
More from Malcolm Wheatley:
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