A new Credit Suisse Global Investment Returns Yearbook released last week drives home an oft-stated point that equities have outperformed bonds over the long run.
Over the last 123 years, global equities have provided an annualized real dollar return of 5 per cent versus 1.7 per cent for bonds and 0.4 per cent for bills, the yearbook reveals. Equities have outperformed bonds, bills and inflation in all 35 markets.
The yearbook, which was published by the Credit Suisse Research Institute in collaboration with the London Business School, covers all the main asset categories in 35 countries. This year, it focuses on commodities and inflation and the authors examine whether investing in commodities offers an effective hedge against inflation. Rising commodity prices, particularly energy related, have been a key driver of the steep rise in inflation in 2022 and the authors explore the role that commodities play as an asset class.
Professor Paul Marsh of London Business School, an author of the report, said: “In periods of economic uncertainty, it can be easy to lose perspective of the long-term investment horizon. The yearbook, with its database stretching back 123 years, provides a rich source of information and experience to help readers navigate their investment strategy for the future by learning from the past.”
The yearbook shows that Australia has been the best performing stock market in real dollar terms since 1900, with an annualized real return of 6.43 per cent, very closely followed by the US, at 6.38 per cent.
Prospectively, the authors – Elroy Dimson of Cambridge University, Paul Marsh and Mike Staunton of London Business School – estimate that the equity risk premium will be around 3.5 per cent, a little below the historical figure of 4.6 per cent. With a 3.5 per cent premium, equity investors would expect to double their money relative to short-term government bills in 20 years.
After stock markets and bond markets were mauled last year as interest rates rose, the old “60/40” equity/bond asset allocation model that is a standard feature has come under scrutiny. In the past decade, ultra-low interest rates pumped up equity values and squeezed yields. Even so, the long-term data is a reminder about the wisdom of using listed equities as important portfolio holdings.
Inflation
With inflation becoming a major concern over the past 18 months, the yearbook shows that by the end of 2022, average inflation across the countries was 8 per cent, 19 times higher than at end 2020.
Speaking at the launch event this week, Marsh said that there were signs that inflation had peaked by the end of 2022. However, once inflation goes above 8 per cent, it can take many years to revert to target, he added.
Over the last 123 years, inflation has negatively impacted both bonds and equities. Equities do not provide a hedge against inflation, despite claims to the contrary, he continued.
Marsh highlighted that the stock-bond correlation was mostly negative for over two decades to the end of 2021, making stocks and bonds a hedge for each other, but this was not typical of the longer term and it is not the case anymore.
After four decades of bonds providing equity-like returns, the law of risk and return reasserted itself in 2022, he added. Bonds had their worst year ever in the USA, the UK, Switzerland, and across developed markets.
Return projections for the next generation also reveal that they will be less favorable than for previous generations, Marsh said.
Commodities
The yearbook shows that rising commodity prices, particularly energy related, have been a cause of increasing inflation. The authors question whether investing in commodities offers an effective inflation hedge.
Individual physical/spot commodities have provided low long-run returns since 1900, but an equally-weighted portfolio of the same spot commodities gave a much higher annualized return of 2 per cent, showing the power of diversification, he said.
Marsh also highlighted that although investments in gold have underperformed US bonds and stocks, gold does have a role as an inflation hedge and a cautionary investment. Except for precious metals, investors mostly avoid spot commodities because of storage and insurance costs, livestock being a prime example. Commodity futures are more convenient and cheaper, he added. Contracts are rolled over to avoid delivery. Individual commodity futures have generated higher returns than spot commodities, on average, beating treasury bills by 1 per cent per annum over the long run, he said.
However, futures, like stocks, are susceptible to deep, lengthy drawdowns. The most notable futures drawdowns were in the late 19th century, the 1930s and following the Global Financial Crisis. Historically, commodities have had a low correlation with equities and a negative correlation with bonds, making them effective diversifiers. They are also unique in providing a hedge against inflation, Marsh said.
While commodity futures tend to perform well when inflation is high, their inflation hedging properties mean that they tend to underperform in periods of disinflation.
Axel Lehmann, chairman of the board of directors of Credit Suisse Group and chair of the Credit Suisse Research Institute, said: “With last year’s geopolitical and economic developments leading many market participants into uncharted territory, particularly with the re-emergence of inflation, the historical perspective has been crucial. With expectations seemingly conditioned by the more recent past, many investors have been reminded the hard way in 2022 of a few of the yearbook’s basic long-term learnings, not least the laws of risk and reward.”
The stock markets included in the yearbook represented more than 95 per cent of the global equity market in 1900. Including the 12 new markets introduced in the 2021 and 2022 editions, the 35 yearbook countries now cover 98 per cent of today’s investible universe.
Original article: https://www.wealthbriefing.com/html/article.php?id=197113#.Y_vBsl7MJhE
