“How do investors position themselves in a low return environment?” seems to be the title of every investor conference, product pitch, or advertising brochure. It now seems to be received wisdom that we are in a world of secular stagnation.
It’s interesting, because the reality of the three years to the end of December 2015 has been that major equity markets: the S&P 500, Topix, Dax, and the MSCI World have delivered annualised total nominal returns of over 10%.
In broader regional equity markets, real total returns have been well above the average annualised returns delivered since 1966 (according to the 2016 Credit Suisse Global Investment Returns Yearbook, the bible for long term investors).
There have been pockets of weakness, like Canada and other markets that have been caught up in the spectacular oil decline of the last two years. One could also argue that the starting point for European markets is flattering, coming as it does ‘post-Draghi’. However, even with a five year time horizon to the end of 2015, the MSCI World has delivered real returns of 6% per annum in Dollar terms.
As for government bonds, most have delivered total returns over the last three years far higher than the yields they were priced to deliver at the start of the period.
And, if you had been prepared to lend to Japan for thirty years at a rate of 1.4% six months ago, you’d now be 30% richer.
So when we talk about a low return world, we either mean cash rates, or we are talking about the world we are about to enter.
The argument that we are entering a low return world is reasonable in some respects. When bond yields fall, the chances of them delivering the same returns again fall with them (though negative rates have challenged how confident we can be about even this).
But it also reflects something about how human beings view history. For most of us, the present always seems chaotic and full of angst. At all stages of history there have been fears that the world is getting worse.
On the other hand the past looks orderly. Young investors are often heard to say: ‘it was easy to make money back then, all you had to do was x.’ Few believe that the 1990s or early 2000s could feel just as uncertain and scary as today.
The always excellent Morgan Housel has written this year about why it sounds smarter to be pessimistic, whereas optimism is seen as naïve. The irritating know-it-all at a lecture or conference tends to interrupt by picking holes in an argument, not providing evidence in support. Famous satirists rarely become so by being positive.
The costs of pessimism
However, there are dangers to being overconfident in your pessimism, and not only because of the returns you may have missed out on by listening to those who talked of a low return world three, or even five years ago:
In the film “It’s a Mad, Mad, Mad, Mad World” greed prompts a group of strangers to put themselves and others in danger to find riches buried under ‘the big W’. Today we are at risk of another “W”: being whipsawed by market volatility.
There is nothing wrong with being bearish or believing we are about to enter a low return world, however if we allow short term price action to dictate how strongly we hold these views, the risks are great. For example, if we had been tempted to sell everything at the two lows of the ‘W’ of the last twelve months, just because it is ‘obvious’ that we are in a low return world, it could have been very costly.
I don’t want to forecast the path of returns, and I find it hard to disagree with the very reasonable arguments in favour of both secular stagnation and diminishing investment returns. However it is vital that you don’t allow short term price action to dictate your long term view.
It is also worth remembering what people were saying in the late 1990s:
Just as it is obvious today that we are in a low return world, it was obvious then that returns were set to be stellar. Maybe in twenty years’ time, young investors will look back at the twenty-tens and wish they were around when investing was so easy.