The Death of Equities...again

The Death of Equities…again

It has been a tough few years for investors in the stockmarket.  Investor expectations of average annual stock returns of around 10% have been replaced with below average or even negative returns.  For some, their emotional response is to question whether they should remain in the stockmarket, or to possibly reduce their exposure.

A recent article appearing in the UK’s Financial Times that was clearly targeting an emotional response in readers caught our eye.  At first glance it was unremarkable—just one among dozens of recent opinion pieces suggesting that investors were losing interest in shares as markets around the world continued to stagnate.
But the tone of the article was remarkably familiar. We dug out our copy of the “Death of Equities” article appearing in BusinessWeek on 13 August 1979, to have a fresh look.  Similar sentiments?  You be the judge:

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BusinessWeek, 1979:
“This ‘death of equity’ can no longer be seen as something a stock market rally—however strong—will check. It has persisted for more than ten years through market rallies, business cycles, recession, recoveries, and booms.”
Financial Times, 2012:
“Stocks have not been so far out of favor for half a century. Many declare the ‘cult of the equity’ dead.”

BusinessWeek, 1979:
“Individuals who are not gobbling up hard assets are flocking to money market funds to nail down high rates, or into municipal bonds to escape heavy taxes on inflated incomes.”
Financial Times, 2012:
“The pressure to cut equity exposure is being felt across the savings industry. … In the US, inflows to bond funds have exceeded equity inflows every year since 2007, with outright net redemptions from equity funds in each of the past five years.”

BusinessWeek, 1979:
“Few corporations can find buyers for their stocks, forcing them to add debt to a point where balance sheets seem permanently out of whack.”
Financial Times, 2012:
“With equity financing expensive, many companies are opting to raise debt instead, or to retire equity.”

BusinessWeek, 1979:
“We have entered a new financial age. The old rules no longer apply.” —Quotation attributed to Alan B. Coleman, dean of business school, Southern Methodist University
Financial Times, 2012:
“The rules of the game have changed.” —Quotation attributed to Andreas Utermann, Allianz Insurance

BusinessWeek, 1979:
“Today, the old attitude of buying solid stocks as a cornerstone for one’s life savings and retirement has simply disappeared.”
Financial Times, 2012:
“Few people doubt, however, that the old cult of the equity—which steered long-term savers into loading their portfolios with shares—has died.”

If a person invests in the stockmarket, they must understand that there is a risk of experiencing below average returns for periods of time.  However, Warren Buffett perfectly sums up the fate that awaits investors who do not remain patient during these periods:

“Our stay-put behaviour reflects our view that the stock market serves as a relocation centre at which money is moved from the active to the patient”2 .

When the first “Death of Equities” article appeared in 1979, the largest 500 companies in the US (or the S&P 500 Index) had marginally underperformed one-month Treasury bills on a total return basis for the previous 14 years (107.0% vs. 119.6%, respectively).

Three years later, stocks had still underperformed relative to one month Treasury bills. No doubt some investors would have decided ‘enough is enough’ and exited the stockmarket entirely.

It wasn’t obvious at the time, but two weeks later – 13 August 1982 – marked the first day of what would turn out to be one of the longest and strongest bull markets in US history. The S&P 500 was 16% higher by the end of the month and went on to quadruple over the subsequent decade.

The table below shows the growth in the US and Australian stockmarkets for various time periods from August 1982 over the next 30 years:

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So much for the “death of equities”.

This article is not trying to make an argument that stocks are sure to provide investors with appealing returns if they just wait long enough. If stocks are genuinely risky (which is proven to be the case) there is no time period over which we can be assured of receiving a positive result. Nor should we seize on every pundit’s forecast as a reliable contrarian indicator.

The notion that risk and return are related is so simple and so widely acknowledged and accepted that it hardly seems worth arguing about. But these articles (and others of their ilk) offer compelling evidence that applying this principle year-in and year-out is a challenge that few investors can meet, and explains why so many fail to achieve all the returns that markets have to offer.

To make them feel better, some investors decided to just invest in ‘what they know’ and avoid the stockmarket altogether.

Investors need to be wary of making overly simplistic investment decisions in response to emotional reactions. For example, thinking that residential property and the safety of ‘bricks and mortar’ offers a simple and compelling substitute to shares is incorrect.

With our short term memories, some Australians think that purchasing property is a certain wealth accumulation strategy over the long term. We wrote an article in early 2010 stating this isn’t always the case. And recent experience in the main cities of Australia has shown that house prices can indeed go backwards.

Over the long term, research has shown that investors should expect house prices to grow in line with inflation. This evidence is supported below by a recent graph from the US tracking the inflation adjusted price of residential properties going back to 1890:

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Source: GMO

As you can see, US house prices effectively tracked the rate of inflation for most of the second half of the 20th century until they started to rise sharply. This house price bubble which peaked around 2006 was the primary cause of the recent US recession.

Following the GFC, the cost of buying a home has fallen back to roughly where it was (adjusted for inflation) for the 60 years prior to the millennium.

Over shorter periods of time – especially during an individual’s investment lifetime – investors can be lucky and live during a time of rising property
prices, or be unlucky and experience falling prices.

But over time, residential property prices tend to revert to an average that mirrors the inflation rate. This makes rational sense as it is our earning power that dictates how much we can afford to spend.

As a comparison, over the past 100 years shares have on average returned around 6.5% pa more than inflation.3 The compound effect is immense, as shown in the US going back to 1926:

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Whilst $1 invested in line with inflation is now worth $13, $1 invested in the small cap index would be worth $10,020.

This highlights the long term returns of capital markets and reflects our diversified approach including small (and value) stocks in our client portfolios.


1 S&P 500 Index in US dollars. ASX 300 Accumulation Index used as a proxy for Australian stocks.
2 Evidence of Warren Buffett’s “theory into practice” is demonstrated by his company Berkshire Hathaway committing US$24 billion in cash to share purchases in the six months to October 2011 (the largest such commitment in the last 15 years), whilst at the same time investors withdrew US$100 billion from stock funds (due to the Euro debt crisis).
3 Source: Returns Program comparison of the S&P 500 index to the US Consumer Price Index for the period 1 January 1926 to 31 May 2012

Author: Rick Walker

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