By Richard Buxton, head of UK equities, Schroders
Over a decade ago I warned that equities were likely to go sideways for 10-15 years. Not because I anticipated all the headwinds to growth we now face, but because from a starting price-to-earnings (PE) ratio above 20x, the stockmarket was always going to struggle. Moreover, the pattern of long-term returns from UK equities is made up of extended periods of strong gains and multi-year phases of going nowhere.
By 1999 we had enjoyed a near 20-year period of double-digit per annum returns. No wonder equity funds were best-selling and pension funds allocated over 80% to equities. There was no talk then of ‘the death of equity’ or ‘the lost decade’. Fast forward to 2012 and the prevailing mood is gloomy. Outflows from equity funds are unrelenting and money continues to pour into bonds. For 12 years, equity investment has delivered lots of volatility and precious little return, which has led a scarred generation of investors to search for ‘safe havens’. A difficult backdrop The economic outlook is tough. Bank deleveraging in the UK and Europe is ongoing. Governments and individuals continue to retrench, ensuring that economic activity is low. China has yet to avert fears of a ‘hard landing’ or show whether it can manage the transition to growth less dependent on infrastructure investment. Meanwhile, the never-ending attempts in Europe to reconcile austerity and fiscal rectitude grind on. Investors mistrust politicians and politicians mistrust markets – both have summit fatigue. But this is exactly why the stockmarket now sells on a PE of just 11x. Everyone knows and focuses on the bad news – and it’s why equities are good value in absolute and in relative terms. Companies have strong balance sheets, good cashflows and rising dividends with many companies’ shares yielding more than their corporate debt. The ‘lost decade’ – the ‘new normal’ There is lots of talk of the ‘lost decade’, the ‘new normal’ where banks and governments are going to continue to delever for some years to come. Back in 1999 investors could see no clouds; the outlook now is unremittingly gloomy. Importantly, in 2012 we struggled to reconcile official GDP data, which has had the economy stuck in recession for much of the past year, with what companies tell us. Companies are telling us that “it is not getting much better but it is not getting any worse”. Inflation is coming down, albeit slowly and erratically, which should support some real income growth over time. Even though the public sector continues to shed staff, the private sector is creating sufficient jobs that net employment growth is positive. Equally, even though it is very difficult to get credit from banks, net new business formation (new businesses formed minus the businesses that are going bankrupt) is running at double-digit year-overyear rates of growth. It’s really important for the UK economy that new businesses are being created because most people are employed by small businesses, not large ones. Three big concerns… Investors have three immediate concerns. Can the US avert falling over the ‘fiscal cliff’? Will China achieve a ‘soft landing’? Can Europe make meaningful progress in addressing its sovereign and banking crisis? Over the course of 2013 I believe fears will reduce on all three fronts. The US is likely to agree a fiscal policy which turns the ‘cliff’ into a gentle slope. Given that US banks are creating credit again and that an improving housing market is underpinning consumer confidence, a positive agreement will reassure US corporates. Having held back on spending ahead of the Presidential election and the ‘fiscal cliff’ negotiations, a satisfactory outcome should see a resurgence in investment and orders. Stronger activity in the US could lead global growth in 2013. Equally, now the policy vacuum in China prior to the leadership transition is over, better economic data and modest policy stimulus should ease fears of a ‘hard landing’. Against a background of improving activity in the US and China, even Europe may fail to dominate investor sentiment. Much progress has been made this year in the multi-year evolution towards fiscal union and the appropriate mix of austerity, reforms and fiscal transfers. Expect there to be further progress in 2013.
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