Chapter 1 – The lost decade
Equity investors have been on a wild and ultimately disappointing ride over the past decade. Equities have been the worst-performing asset class since 1997, sharply underperforming all other asset classes. We examine the causes of this relative weakness, and find that the utility of simple valuation measures has been thoroughly vindicated by the dreadful recent returns from equities. We show how future long-term returns from equities – the equity risk premium – can be forecast. We also describe the factors that cause equity valuations to fluctuate over time. Finally, we compare the outlook for stock and bond returns over the next 10 years.
Chapter 2 – Deflated markets
The financial turbulence of 2008 has led to a fascination with the Depression era. Concerns over deflation have replaced the inflation scare which prevailed in the first half of 2008. This raises the question over which state presents the greater evil, deflation or high inflation? In this article, we compare the performance of a range of assets and equity sectors across different inflation regimes since the 1920s. We differentiate between phases of good and bad deflation to gain further insight and find that, in fact, credit conditions may be a more important factor to consider in determining trends in asset performance. Perhaps the focus on deflation or stagflation has been a diversion in comparison to the importance of credit regimes.
Chapter 3 – Viral economics
Both the occurrence and the economic impact of the credit crunch caught policy-makers, regulators, bankers, analysts and investors largely unprepared. We examine why this might be so, given the empirical evidence that credit cycles are inherently predictable and of considerable importance to the path of economic growth. Our conclusions highlight the endemic instability of a pure free market system.
Chapter 4 – Back to beta with ETFs
In 1975 Charles Ellis highlighted the shortfall of active managers in his often referenced article “The Loser’s Game” published in the Financial Analysts Journal, July/August 1975. He reported that over the prior decade 85% of all institutional investors who tried to beat the stock market underperformed the S&P 500 index. In 1976, the first indexed fund was launched in the US. Since then ETFs have become popular and widely used investment vehicles. This article discusses the many advantages offered by ETFs and examines how they can be used in a variety of portfolio strategies.
Chapters 5 and 6
We publish last year’s US and UK asset Returns, placing them within a historical context. Equities had a terrible year globally. The FTSE All-share real total returns were the weakest since the 1970s. The US equity returns were the weakest since the Great Depression. Government bonds were the main beneficiary of the financial turbulence of 2008. In both the UK and the US, government bonds were the best-performing asset of the year. They also produced the best average annual returns over 20 years. Bonds rarely outperform equities over such a long holding period.
