The financial media focuses on daily stock movements. In the process, we can forget the big picture emerging from recent and past history. A longitudinal overview can provide useful insights into what might happen next.
As Mark Twain reputedly said – history doesn’t repeat itself but it often rhymes. Here are 4 big picture observations for you to consider.
1. Australia has been the best place to invest in shares since 1900.
According to Credit Suisse Research Institute’s Global Investment Returns Yearbook between 1900 and 2018, Australia has been the best place to invest in sharers whether one measures the annualised returns in US dollars or local currencies. See the chart below. Pity the Austrians, as their stock market came last. We are indeed the lucky country since over this period – we even beat the Yanks!
Source: Elroy Dimson, Paul Marsh and Mike Staunton, Global Investment Returns Yearbook 2019. Zurich: Credit Suisse Research Institute, 2019.
But since the end of the last stock market crash in March 2009, America’s S&P500 index has grown twice as fast as the All Ords index. If history repeats itself, Australia might not only catch up with America but overtake it. That could happen by America correcting further than Australia when stock markets next crash, just as occurred in the 2000 dot com bust. One reason is that highly priced tech stocks comprise less than two percent of Australia’s stock market value, but a quarter of America’s.
2. Australia and Emerging Markets may offer the best prospects in future.
According to GuruFocus.com, Australia and emerging markets have the best long-term prospects, based on their past record of economic growth and dividend yields and assuming their market capitalisation to GDP ratios return to their historic norm. By contrast, the USA looks the big loser on this score. Essentially, America’s market is overstretched, so needs a big crash or a long period of gyrating sideways while earnings keep growing to restore its fair value.
Star Capital Research of Germany also uses a reversion to historic mean approach to forecasting future returns of national stock markets. But it prefers using the Shiller CAPE ratio and Price to book Value Ratio for each market. CAPE stands for cyclically adjusted price/earnings ratio since it divides the share price by the average of earnings over 10 years, adjusted for inflation. Here are its forecasts using these stock market valuation measures. Note that on both measures, Australia is expected to either beat or equal the average return for developed markets. However, emerging markets should be the standout performers.
According to the Credit Suisse Global Investment Returns Yearbook:
- “Looking ahead, expected returns on all asset classes are likely to be low as the authors’ research shows that when real interest rates are low, as they are today, subsequent returns tend to be lower.
- “The authors predict that the margin by which equities are likely to outperform cash in future will be lower than the 119-year historical premium of 4.2% per year. Their long run estimate is 3½%. Even with a lower future equity premium of 3½%, equities are still expected to double relative to cash over a 20-year period.”
3. Over time, shares have been the best performing asset class by far.
A recent RBA research discussion paper shows that over the last 102 years Australian shares had an average annual compound rate of return of 10.2% compared with 6.2% for 10-year government bonds and only 3.9% for cash deposits.
The 4% annual advantage of shares over bonds might not seem a lot, but over time it made a huge difference to returns. If $100 was invested in each asset class in 1917, the share portfolio would now be worth around $2 million, whereas the bond portfolio would be worth just over $46,000. That’s more than a 40 times difference and demonstrates the magic of compounding.
Most worrying is that going forward long-term fixed coupon bonds don’t have the capacity to deliver the stellar returns they have enjoyed in the last three decades. Look at the next chart that shows what an amazing run they have enjoyed in the last three decades beating even the S&P500 share index. That’s because long-term bond yields have been sliding since 1981and have reached historic lows. Should bond yields start climbing bond prices will fall.
Source: The Wall Street Journal, The Daily Shot, 3 July 2019
4. Share owners rarely lose money over a 10-year period.
The next chart by the Reserve Bank shows 10 year equity returns for the overall Australian share index and its major asset classes (finance, resource and other) for each year over the last century. Note that a share portfolio (or equity fund) representative of the stock market index would not have lost money over the previous decade in any years except two: 1974 and 1979.
The lesson here is one should hold shares for the long term. However, many investors find that difficult because they can’t emotionally cope with regular share market crashes or they’re at or near retirement so can’t risk negative or low returns over a 10-year period. Here are two charts, the first showing the real (after inflation) falls in total share market returns since 1900 and the second showing the annual nominal rises and falls in share index since 1875.
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Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.