The Golden Twenties?
Our industry feels impelled to make forecasts at the end of each year. The perceived need to demonstrate one’s expert status by forecasting specific values for equity indices, interest rates, or exchange rates misleads even humble souls into performing the annual ritual of crystal-ball gazing.
Even though they generally turn out to be more or less incorrect at the end of the year, the practice is repeated each year. A year ago, for example, almost no one expected a large increase in equity prices, a significant decrease in government bond yields, or – in spite of the government chaos – a strong British pound.
We at Flossbach von Storch therefore refrain from making short-term forecasts of specific values. Not because we are afraid of embarrassing ourselves, but because we feel they are of no use to anyone. We do, of course, think about the future and include these thoughts in our strategic investment world view when defining the long-term risk-return outlook for individual asset classes and segments.
We therefore take the opportunity at the beginning of a new decade to present a long-term outlook that, contrary to popular opinion, is generally easier, more accurate and therefore more sensible than short-term forecasts. This can be seen by the annual forecasts issued by investment strategists. They average around seven per cent almost every year and although this means they are far from accurate, they are nevertheless relatively good from a long-term point of view.
A comparison of the last two decades
For equity investors, “long-term” should mean an investment period of at least 10 years, although not every decade rewards such patience as handsomely as the previous one. The German equity index (DAX), for example, has risen – not linearly, but on average – 8.3 per cent p.a. since the end of 2009, the global MSCI World equity index recorded an annual return of 9.5 per cent and the US S&P 500 index even achieved a total annual return of 12.9 per cent (in all cases including dividends, see Table 1 on the following page). The starting level, however, was also very low, as the preceding decade of zero years was the worst in stock-exchange history. The DAX and S&P 500 lost around 1.5 per cent p.a. from the end of 1999 to the end of 2009, while the MSCI World recorded a small annual loss of 0.2 per cent. This is not surprising, as the first decade started with a collapse of the tech bubble and ended in 2009, shortly after the financial crisis. Performance for the current century is still below-average even if the two decades are combined, with the DAX and MSCI World recording modest gains of 3.3 and 4.5 per cent p.a., respectively, while the S&P 500 achieved a total annual return of 5.4 per cent, which is at least close to the typical range of equity returns.
The past 10 years have therefore been very rewarding for equity investors. Performance was, however, also very dependent on the region in question. The small-scale DAX index, consisting of just 30 equities, recorded the poorest performance, falling far below other stock markets due to inadequate diversification, too few growth companies, too many cyclical industrial companies, and poorly performing energy providers and banks. The much broader Stoxx Europe 600 index also failed to really shine, achieving an annual 8.1 per cent gain similar to the DAX, mainly due to a high weighting of bank shares. The decade was considerably better for US equities, with the S&P 500 recording an annual performance that was almost twice as large, at 15.7 per cent, and a total gain that was three times as large due to compound interest over the 10 years. This was mainly due to the high weighting of technology shares, such as Apple, Amazon, Alphabet, Facebook and Microsoft, and fast growing payment service providers such as Visa and Mastercard, along with the US tax reform and, last but not least, the strong US dollar, which also increased the performance of the MSCI World index for euro-based investors.
Although the price of gold failed to achieve such gains, the strength of the US dollar also helped here, changing a modest 10-year increase of 38 per cent to a 77 per cent increase in euros, which corresponds to an annual return of 5.9 per cent. Ten-year German Bunds recorded a significantly lower performance, with an overall return of 34 per cent, or three per cent per annum. The return on demand bank deposits, on the other hand, was almost zero. Leaving EUR 10,000 in an account for 10 years would have generated EUR 324
in interest by the end of the decade.
What can we expect in the Twenties?
Returns in the upcoming Twenties will be more modest overall than the previous decade. They are already even pre-programmed for safe government bonds. In addition to zero interest for 10 years, investors who bought the new “Silvesteranleihe” (New Year’s bond) issued by the Federal Republic of Germany at the beginning of 2020 will also suffer a guaranteed price loss of 2.5 per cent. The picture is not much better for high-quality corporate bonds. For example, a bond from software company SAP that is due in March 2030 provides a yield to maturity of just 0.4 per cent. Even a rating two levels lower, below the investment-grade threshold, does not provide a much greater return. A ThyssenKrupp bond with five years left to maturity provides a yield of just two per cent. As a result, nothing can be achieved in the upcoming decade using a buy-and-hold strategy. The same applies to loyal bank account and savings account investors. Those hoping to earn a significant positive return on demand deposits will likely be disappointed. Even hopes for a zero per cent decade are optimistic for large investment amounts, which are currently being “penalised” with an interest rate of around minus 0.5 per cent.
Exact expectations cannot be determined for the price of gold. As mentioned, we hold gold as an insurance against potential shocks in the financial system and the unforeseeable effects of the long-term zero interest-rate policy followed by the European Central Bank (ECB). We hope in this regard that the return on gold is not much higher than the annual rate of inflation. The potential return on equities, on the other hand, can be better estimated, although not with the precision of bonds. The previous two decades illustrate
that the starting level plays a major role for expected returns. The first decade started at the peak of the high-tech euphoria with extremely high equity valuations. The second decade had far better performance prospects at the beginning of 2010. Investors had modest expectations shortly after the financial crisis, prices were low and valuations were relatively low.