Archive for May, 2016
Day after day, day after day,
We stuck, nor breath nor motion;
As idle as a painted ship
Upon a painted ocean.
Thus Coleridge, in his celebrated “Rime of the British Stock Market”.
In 2014 the FTSE 100 index returned +0.7%, a year later -1.3% and over the course of 2016 to date it has delivered -0.8%. One can point to several reasons for this lacklustre performance, notably the commodity markets, the pound and their effect on reported earnings. These are admittedly forecast to pick up this year (though even forward-looking valuations do not look especially cheap on an absolute basis). In any event, to say that it has been a frustrating period for equity investors is to make something of an understatement.
Of course two and a half years barely amounts to a medium term horizon. Like all investors, we know that equities are a long term asset class. They will outperform other types of asset, especially if we remember to reinvest our dividends whenever possible, but will deliver bouts of short term volatility. Hang on in there and those long run returns will begin to come through.
There are, however, some issues with this analysis. Short term bouts of equity market losses have been a recurrent feature of life in the twenty-first century. It started out with the end of the dot-com bubble (three consecutive years of negative returns to the Footsie over 2000-2002). Then there was a peak-to-trough loss of 45%, again on a total returns basis, from October 2007 to March 2009 amid the credit crunch and the Great Recession. The recovery from that low point was soon derailed by the carnage of the sovereign debt crisis in 2011 (total return for the year: -2.2%). There was some brief strength in 2013, and now we are where we are.
Another way of looking at this is to say that from the 31st of December 1999 to the end of March this year, the FTSE 100 index had returned an annualized +2.8%. Uncannily enough, this is exactly the annualized change in value of the Retail Price Index over the same period. Which is to say that over the century to date, the key UK market benchmark has returned exactly zero in real terms.
Is it really the correct response to this fact to dismiss it as a short term effect, and put our faith in long run real returns of 5% – as calculated by the Barclays Equity Gilt Study team – from 1899-2015? (As an aside at this point it is worth noting that Barclays used to cite the arithmetic rather than the geometric mean for forecasting on the grounds that, for various statistical reasons, it provides “the better unbiased estimate”. The arithmetic mean real return to equity is closer to 7% than 5%. While the methodological explanation remains in the 2016 study, however, that 7% “unbiased estimate” is nowhere to be found any more.)
1899-2015. The Long Run. There is something compelling, something authoritative, about this. Nonetheless, a 16-year period of zero real returns is not to be scoffed at either. And that 116-year databank is marked by it too: the real return to UK equity from 1899-1999 was 5.7%. The new century has already wiped almost 1% off the entire long run average.
Look at the 16 years heading into 1999 and the story is very different: stocks averaged a return of +12.6%. Ex out that stellar period from the series and the real return to the asset class (from 1899 to 1983) diminishes to 4.4%. Over the first half of the twentieth century it averaged only a little more than 3%.
In defence of the equity market the FTSE 100 is not at the high-growth end of the spectrum. Since 1999 the mid-cap FTSE 250 has put on over 9% annualized, and so has delivered a real return of +6.2%, which is about what the historic data conditions us to think of as our due.
And yet the 250 is only a fifth the size of the 100 in terms of market capitalization, so it is much less genuinely representative of UK equity as an asset class. Other asset markets do not have to resort to this kind of selectiveness: the IPD UK All [Commercial] Property index shows an annualized total return of +8% for December 1999 to March 2016, the Nationwide index of house prices managed +6.2% (and that ignores rental yield), the gilt market delivered +5.9% and sterling non-government bonds +6.3%. UK investors could have put their pounds to work in any other major asset class – with the single exception of cash – and made a creditable real return. Equity has been, quite simply, appalling.
Past performance is not a guide to future returns . . . and even the Ancient Mariner makes it home in the end. Should the FTSE 100 perk up and hit 7,000 at some point over the next few months things would be feeling very different. But there are sound reasons when looking at expected returns for regarding the 1980s and 90s as the truly anomalous period: the Cold War is not going to end again, nor the internet be invented a second time. Looking further forward one might also note the impact of (developed) world demographics on aggregate demand, and observe that Japan’s stock market has returned an annualized +0.2% over the past 30 years.
The aim of this piece, however, is to raise questions, not to pontificate about any supposed cult of equity. Perhaps, like the Mariner, we should conclude simply by recommending the embrace of diversification.
This week saw headlines appear about the possibility of another debt crisis in Greece. A multi-billion loan repayment to the ECB is due this summer; the European Commission and the IMF – the other two members of the “troika” governing the bailout arrangement – are divided on the scale of deficit reduction required to allow funds to be released; and in the meantime the country has just gone out on a general strike today in protest at any further “austerity”.
It feels, rather sadly, just like old times.
Yet things have changed in Greece since the pandemonium over her original bailout and debt restructuring. The governing leftist coalition, Syriza, has learned through bitter experience that it really does have no option but to comply with its creditors’ requests. And while books will doubtless continue to be written on the fiscal consolidation undergone by western countries since the Great Recession it is undeniable that Greece has been getting on with the job: the budget deficit there, as a proportion of GDP, has been falling from its 2009 peak of -15.2% at almost twice the pace at which it had grown during the course of Greece’s eurozone membership up to that point. This has had the effect of containing the national debt to GDP ratio, which while eye-wateringly high (177% for 2015) has fallen since 2014 despite the suffering brought about as a result of the Greek government’s hubris a year ago. Indeed, take out the effect of the debt restructuring in 2012 and last year’s fall in this ratio was the first since 2007.
There were also tentative signs of recuperation on the broader economic front too. The European Commission’s spring economic forecast was published on Tuesday and the expected contraction in Greek GDP this year was revised down from -0.7% to -0.3%. (Growth of +2.7% is projected for 2017.) The slow turnaround in employment might have halted for now, stuck between 24%-25% over the nine months to January, but with growth beginning to return again this should continue to tick down – and remains below the peak of 28% reached three years ago.
In the meantime, bond markets in Greece and elsewhere on the eurozone periphery are not showing any sign of panic. Ten year Greek government paper is trading down towards its lows for the year to date (just over 8% at present), well short of the over 11% reached during February’s market-wide funk. Italian and Spanish bonds have been priced around the 1.5% mark in recent weeks, just like ten year gilts.
It is worth reflecting that five short years ago – when many respected commentators were confidently predicting the demise of the euro – this was unthinkable. Greece might have been in the headlines again but there is absolutely no contagion in evidence today. Today, markets are not even bothering to try taking on Mr Draghi and his “bazooka”.
It is also worth reflecting that economic growth in the eurozone as a whole is projected at +1.6% this year and +1.7% next – a breakneck pace compared to the average rate of +0.9% over the last 15 years. And talking of headlines, it drew some attention last week when data emerged to show that the zone’s GDP had finally surpassed its pre-Great Recession peak in real terms. Numbers out last month showed its deficit falling as a percentage of GDP for the sixth consecutive year in 2015 to -2.1%, and confirmed that total debt to GDP peaked a year earlier. The unemployment rate might already have dropped back below 10% this month for the first time since April 2011.
There are political risks ahead for Europe but to say that the eurozone as a whole has moved on from the debt crisis is beginning to look like an understatement. It is to be hoped that Greece manages to continue her recuperation. If she does so the “European debt crisis” will soon be history.