UK economic news over the last week has been bad.
Consumer prices are now increasing at an annual rate of 3.8 per cent, almost double the Bank of England’s 2 per cent target. Inflation is now likely to reach almost 5 per cent by the autumn. At the same time, the labour market is being pulled down by the weaker growth outlook. Claimant count unemployment has increased by an average of 14,000 over each of the last three months, a rate of job loss similar to that of the US when differences in the size of population are accounted for. So, all in all, the Bank of England remains stuck “between a rock and a hard place”. UK economic growth is slowing sharply – but rising inflationary pressures suggest that the authorities may have to remain on the sidelines, at least until late in the year.
Poor economic news has been accompanied by some distinctly wobbly equities markets around the world. Many of these have moved into what is described as “bear market territory” – a fall of more than 20 per cent from their peak. For example, at the end of last week, the S&P 500 was down around 15 per cent on year earlier. As stock markets were also struggling in the previous equities cycle (over 2000-03), the S&P 500 has given a zero return in real (i.e. inflation adjusted) terms over the last 10-year period. And to make things worse, the gain here is measured in US dollars, so in many other currencies the real return from the S&P500 has been negative. Returns from other developed equities markets have also been disappointing.
Equities still attractive
Weak long-term equities performance prompts the question as to whether one should invest significantly in equities. The answer, we believe, is yes. Equities still look quite attractive for long-term investors (five to ten years) – even if the short-term outlook is as fragile as ever.
The reasons for our optimism are two-fold. First, we do not expect equities to give a negative long-term return as valuations are quite low and we see no reason for earnings not to rise in line with economic growth over the next five to ten years.
Second, history shows that the long-term performance of equities is strong following major sell-offs. There have only been five periods since 1970 where the rolling one-year total loss of the S&P 500 has been greater than 10 per cent. And after these periods there have been sustained recoveries.
To look at this another way, the increase in inflation and the risk of recession has already hurt equities’ performance gravely. But it has also set shares up for a well above average long-run return in both nominal and real terms. This, of course, assumes that we do not go back to a period of sustained high inflation. We do not think that this is likely, believing that slower global growth will ease price pressures.
So we continue to think equities are good long-term value – although some short-term upsets are certain.