Shares don't always pay; just mostly
The $64,000 question is whether we are entering a period of much lower or even negative growth
Saturday 16 January 1999
As a taster to its fascinating annual Equity-Gilt study, which is to be published in its full form next month, CSFB tell us that pounds 100 invested in UK equities 80 years ago (in other words immediately after the end of the First World War) would finally have topped the pounds 1m mark in value by the end of last year. By comparison, gilts would have grown to a mere pounds 13,315 and cash to just pounds 7,038.
Unfortunately, that doesn't mean that equities are always the best investment in the short term. Last year, they were positively thrashed by gilts, which delivered a 25 per cent return. Equities earned a more modest 13.7 per cent, or not significantly more than cash, which yielded nearly 8 per cent. So plainly it doesn't always pay to be invested in shares. All the same, it is certainly true that on a long view, equities have always outperformed. Perhaps a more useful exercise, then, would be to try and define what the long term is. According to Shushil Wadhawani of Tudor Investment Corporation, the average annual real rate of return from US equities over the last 200 years has been 7 per cent. This average holds good for almost any 70-year period you care to name. At 8 per cent, CSFB comes up with a surprisingly similar number for the real annual rate of return on UK equities since 1918. Unless you are investing for your new- born baby's late retirement, however, very few of us are going to be taking that kind of perspective. Only the big pension funds would normally invest in financial assets on any more than a 25-year view, the usual length of a mortgage endowment policy.
Of course, for periods of shorter than 70 years, there is a quite considerable variance. The $64,000 question is whether after 20 years of well above trend return from equities, we are entering a period of much lower or even negative growth. Unfortunately there is no easy answer to this question since history can never be a reliable guide to how long any trend might be sustained. But common sense tells us that even if the stock market is not about to collapse, the double digit growth of recent years must be about to come to an end.
One of the reasons we have had such a long period of equity inflation is that investors have been prepared to accept lower "equity risk premiums". This is just a poshed up way of saying that investors tolerate higher valuations for shares because they believe companies to be a less risky form of investment against the alternatives than they were. There are plenty of good reasons for thinking this. Governments, at least in the West, are generally better at macro-economic management, and corporate management is on the whole much more sophisticated. However, this continuing shrinkage in the premium is also in part just an echo from the prolonged bout of relatively high inflation we have just been through. Companies are a better hedge against rising prices than bonds, whose value can be completely destroyed by inflation.
If we are indeed entering a new phase of low inflation and low growth, then these trends may go into reverse. Last year's outperformance by gilts suggest that they already are. Marks and Spencer has its own special difficulties right now, but for the doyen of British retailing to announce a near halving of profits is indicative of just how tough the corporate environment is becoming.
None of this necessarily means there is going to be a crash. But it is hard to disagree with CSFB's central conclusion that we are heading for a period when returns will be much closer to the norm than they have been, or even below it.
I DON'T think I was wrong to be so sanguine about the Brazilian crisis when I wrote about it earlier this week. As is so often the case when politicians finally bow to the inevitable, the immediate reaction in markets to President Cardoso's decision to abandon his defence of the currency was one of relief.
We should be careful not to underestimate the import of what's just happened, of course. The dollar peg was the cornerstone of President Cardoso's strategy for dragging Brazil out of decades of hyper inflation and economic chaos. That policy now lies in tatters, and with it both his own and the IMF's credibility. Furthermore, it is quite easy to imagine a doomsday scenario stretching from these events to a big slow down in the US economy, a crash on Wall Street and a severe worldwide recession.
But a bit like Britain when it came out of the ERM, the economic consequences of allowing the exchange rate to float may be largely to the good. Providing there is no widescale default and President Cardoso can continue to push through his fiscal reforms, then there is still a good chance of disaster being averted.
THE MIRROR GROUP share price has suffered a terrible beating since the company terminated merger talks with Axel Springer of Germany last summer. David Montgomery, Mirror's chief executive, must be wishing he had taken the 240p a share which may then have been on offer. But he wanted more from the next door neighbour and former colleague, Gus Fischer, who now runs the German publishing goliath. It was not to be.
Still, in recent weeks, the share price has been regaining some of the lost ground, stimulated in part by a revival of on-off merger talks with Trinity, Britain's largest regional newspaper group. Right now the talks are said to be off again, much to the dismay of Mirror Group's biggest shareholder, Phillips & Drew, which believes both companies need to get bigger to thrive in today's highly competitive market place. Unfortunately, the two sides can agree neither on a division of top jobs nor on terms. According to the Trinity spin, it is all Mr Montgomery's fault. He refused to accept that the top job in the combined group should go to Trinity's Philip Graf. According to the Mirror Group spin, Trinity was pushing for too large a share of the pie, and in any case lacked the stomach for the sort of cost-cutting needed to justify the merger. At a reported annual saving of just pounds 10m, this would scarcely seem to justify any merger, let alone one of this size, but presumably there would be other long- term synergies and benefits to be had from combining the two groups' regional newspaper interests.
The trouble is that Mirror Group is still chiefly known for its national newspaper titles and Mr Graf seems not a bit interested in either owning or running these. One possible solution would be to sell or spin them off, either as a prelude to, or as part of the merger. Axel might still be prepared to buy these titles and the City is alive with talk of a venture capital bid for all or part of the group. One thing is for sure. Mr Montgomery has to find some way of realising shareholder value. His earnings keep rising, but nobody wants to listen to his story. The company is said to be considering a name change, so perhaps Mr Montgomery should take up Michael Bloomberg's suggestion and opt for E.mirror. Maybe then those blighters in the City would finally sit up and take notice.
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