Friday, 8 March 2013

Equity markets – what a wonderful 10 years... really?

Yes....really! Despite what has been one of the most volatile and frenetic 10 year periods for equity market investing, a £100 investment in the FTSE 100 made on March 7th 2003, would now be worth £259. This equates to a 159% total return, or a 10% annualised return. Not a bad outcome given the near collapse of the global financial system, and the constant threat of eurozone disintegration.

However, as Homer Simpson so wisely pronounced, “Facts? You can prove anything with facts!”. As a result we should caveat that this particular ‘fact’ could prove a little misleading. Ten years ago nearly to the day, not only was a certain MP driving around in his car a little too fast, but equity markets were hitting multi-year lows following the bursting of the dot-com bubble. The exact catalysts for turnarounds are always challenging to pin down, but the 2003 rally was labelled the ‘Baghdad Bounce’, following the capture of the city by allied forces.

In this environment of high unemployment, high debt and low growth, it is a brave call to predict 10% annualised returns over the next 10 years. However, were equities really quite so outstandingly cheap 10 years ago in comparison to today’s levels?

First, let’s take a look at yields. In March 2003 the FTSE 100 dividend yield was roughly 3.9%, today it sits at around 3.7% – hardly a significant premium. If we also look at Price to Book (P/B) ratios ie what we are paying for the company’s net value (assets minus liabilities), in March 2003 we were paying 2.4x, today we are paying 1.8x. On a P/B basis, therefore, equities are actually cheaper now then 10 years ago.

These measures are, of course, not the only means to assess the attractiveness of equities. Investors could also compare the returns on offer from the stock market with other asset classes. In that regard, it is well worth considering that the yield on the 10-year UK government bond in March 2003 was 4.1%, where today it is 1.9%. What's more, inflation 10 years ago was running at 3.1%, representing a positive real bond return of 1% per year. Today, inflation is still running at above 3%, equating to a negative real return of approximately 1% year-on-year from government bonds.

With some major risks still casting a cloud over the economic outlook, equities will surely experience more bumps along the way. However, despite the multitude of disruptions over the last 10 years, the equity market has still been an outstanding investment. And equity valuations look just as attractive today as they did 10 years ago – if not more so relative to the alternatives.

Ben Gutteridge
Divisional Director Research

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