The fact that the FTSE 100 index should have taken more than 15 years to regain its previous “high” is a bit of stunner – but maybe not so much of a stunner as the current nominal returns on European government bonds.
The idea that there might be no capital growth in share prices for half a generation runs counter to the whole rationale for share investment. When you pay into a pension there is a tacit assumption that there will be some growth in the capital, as well as the build-up in value from retained dividends. Suppose someone buying a house now were told that the money value of that house would be exactly the same in 15 years’ time, and would have been a lot lower in the meantime. They would conclude that buying a house was a bit of a mug’s game – which is the attitude of many people towards equity investment.
But then the idea that investing in UK government securities was a profoundly risky strategy – as it was for anyone who bought gilts from the 1950s through to the early 1980s – would also jar. At present, 10-year gilt yields are 1.7 per cent, having briefly dipped to below 1.4 per cent at the end of January. With an inflation target of 2 per cent and a long history of overshooting that target, that sounds like a licence to lose money.
So what can we sensibly say about investment in different assets? Let me put three propositions.
The first is that having 15 years of flat share prices is unusual, but not unprecedented. Markets at the turn of the millennium were over-priced. It was, after all, the height of the dotcom boom, and in terms of the impact on our daily lives, the expectations of that boom have surely been fulfilled. But the experience of Apple aside, the financial returns have been disappointing. It is a classic story, repeated many times: the railways transformed the face of the earth, but with a few exceptions they did not make much money for the people who invested in them. So the starting point is an exceptional one, a time when investors got a bit carried away. Now we are still in normal times, and there is every reason to expect that over the next 15 years performance will be much better.
The second proposition is that UK shares have rather underperformed over the past 15 years, particularly vis-à-vis the US and Germany since 2011. You can see that in the top graph. One reason for that is sterling. It has strengthened significantly against the euro so you would expect the FTSE 100 index to underperform against the German Dax. Shareholders would have got their return from the currency appreciation rather than a rise in the sterling-denominated share prices. Underperformance against Wall Street is harder to explain. A bit of it has to do with the heavier weighting of oil and resources companies in the index, and the higher US weighting of technology companies. In addition our banks have been slower to recover than US ones. But it may be that US markets have run more ahead of themselves. The UK residential property market has, by contrast, outperformed the US one. Maybe this period of relative underperformance is drawing to a close, though whether this will be because US markets come down or ours go up is impossible to call.
The third is that capital appreciation has on average been the lesser part of the return on shares: dividends have been larger. The bottom graph, which comes from the new Barclays Equity Gilt Study, shows how if dividends are reinvested, UK equities have massively outperformed both gilts and cash over the past 115 years. (The study has been running, under various owners, for 60 years.) In real terms – ie allowing for inflation – equities yield an average 5 per cent a year over this period, gilts 1.3 per cent and cash (or near cash such as Treasury bills) 0.8 per cent.
This comparison does assume that all income is reinvested in full – in other words the holder would not have to pay tax on either dividends or income – which is difficult for ordinary investors unless they have funds in some form of tax-efficient pot, such as an Isa or a Sipp. (Even then there is some tax drag on dividends.)
But the message is pretty clear: on a very long view, shares have been a better investment than gilts. Not many investors are able to take a 100-year view. Indeed, about the only ones who can are the managers of Oxbridge college endowments, where the joke runs: “Well, we have good centuries and bad centuries.” But I suppose family offices and sovereign wealth funds, where the aim of both is to preserve wealth in a spirit of intergenerational equity, should also be able to take a very long-term view.
The trouble, of course, is that the value of anything is a snapshot taken at one moment in time, and perceptions of value swing massively. Take Ireland: it can now, in theory at least, borrow at below 1 per cent for 10 years. Five years ago it could not borrow from the markets at all and had to go for a bailout from the eurozone. I happen to think that these very low bond yields are mad, but then I thought that two-and-a-half years ago when they were around the same level. The shift from a bull market in bonds to a bear market has been a long and bumpy transition.
Still, intuitively the present level of share prices is not ridiculous. We may have a few more years of rising markets, interrupted by the odd sharp dip. We may have a couple of bad years. But there is not the febrile atmosphere, the arrogance, you might say, of the dotcom boom. Investors are cautious now, and that itself is a reason to be modestly confident.
Finally, if you want a rule-of-thumb as to how much you can safely take out of an equity portfolio without running down the real value of the capital, it is somewhere below 5 per cent: say about 3.5 per cent. That, on a 100-year view, leaves a bit of headroom for dingy decades, such as we have just had.Reuse content