You’ll find that financial bloggers sit in one of two camps: those who make predictions and those who don’t bother – safe in the knowledge that Mr Market will do what it wants when it wants, and to claim to hold a crystal ball is a little foolish. Sure, some financial bloggers have made some good calls, but they can also fall spectacularly on their face!
Personally, I’ve stayed away from providing timely commentary on market movements, and have looked into the future with even more resistance. However in response to several articles published this month about how the ‘cult of equity’ is dead, I felt like I had to pick up the pen!
Commentators are telling investors that the idea that equities will provide the highest risk-adjusted long term returns has been thwarted by recent economic developments. They say that due to the poor performance of equities over the last 10 years (government bonds have significantly out-performed the stock market in that time), that the fundamental preference and risk-reward ratio is turning southward.
The ‘Cult of Equities’ refers to the idea that Equities should always have a dividend yield lower than government bonds/treasuries. This is because market expectations of growing earnings of the corporations behind the shares (and therefore share price appreciation), means that they should be prepared to accept a lower dividend yield than putting their money away in a safe haven.
Due to the recent surge of investor monies into government bonds, prices have skyrocketed – with the ‘rocks’ of Europe such as Germany and the United Kingdom issuing short term debt carrying less than 1% interest! The effect of these rocketing prices has meant that bonds now yield less than equities… when theory states that this should be the other way round.
Eagle eyed commentators have deduced that this must mean that the market no longer expects long-run capital appreciation from businesses.
However as the best finance books will point out, this would violate a crucial principle of investing – debt should yield less than equities because debt has a capped right to cash flows, whereas equity has the right to all residuals. If debt truly was going to return more than equity – then no businesses would seek debt financing – as the value of the firm would increase under the supposedly lower cost of capital from equity.
It’s all a bit silly really. At the height of every boom, the bottom of every crash, fear runs through the markets and causes people to extrapolate unrealistically and ignore the law of averages and other simple principles.
I am going to keep my head down and continue to feed cash into the market just as normal, like the level-headed investor I would like to be!
Please let us know what your personal plans are during this crisis, and whether you plan to change your strategy as a result of events, or whether you intend to stick with your original investment portfolio?
Some may say that sticking with your original plan shows courage, and others might say it shows stubbornness. Likewise, some might see changing your strategy in the face of negative news as folding to the ‘temporary blips’ of the stock market, which are ultimately inevitable.
