It was the first of January 1900 and several like-minded financial market specialists had gathered t...
It was the first of January 1900 and several like-minded financial market specialists had gathered together at one of the popular forecasting soirees of Lady Cassandra. A society figure of great charm, she was someone of whom the most common observation was: "Her powers of perception, her insights, her ability to look forward, are all quite incredible."
An interesting word, incredible. Why is it that nobody believes a Cassandra? On this occasion, she turned out to be on cracking form that is, judged with the hindsight of just over a century. Nevertheless, her predictions sounded just too depressing and horrific for anyone to be prepared to take them on board. "Only optimism sells, and none of us can do any business if we tell our clients this," said one whiskered gentleman in the corner of the room. Here is a summary of what she said.
"Very early on in the new century, the cream of the British army will be wiped out by a ragged bunch of insurgents somewhere in the outer reaches of our great Empire, at a place called Spion Kop. This will mark the start of a consistent decline, not only in the military and naval powers of our nation, but in our commercial existence as well. By the end of the century, we will be the lackey of one of our former colonies and much of the country will be an industrial wasteland where manufacturing activity is more of a folk memory than anything else.
"All this will take place in a world laid to waste by two global wars before the first half of the century is finished, and brought to its knees by two bloodthirsty dictators, who will succeed in wiping out millions of their own nationals, let alone killing enemies," she said.
"A bomb will be invented and become available to several world powers that can make the earth totally incapable of supporting human life. In summary, England will be beaten at cricket regularly by almost everyone."
As Lady Cassandra sat down, there were audible gasps of disbelief at the utter hell she had depicted. Besides which, nobody could tolerate the unpatriotic remarks about the English cricket team. In summary, this was clearly an environment in which a shotgun, a can of beans and a bicycle would be the best investment. Nobody should dream of buying shares, should they?
After a while, however, everyone went their own way, decided Cassandra was wrong, and proceeded to invest themselves and their clients up to the hilt for the duration. Good for them.
After 100 years have passed, we now have the outcome. Lady Cassandra was right the 20th century did turn out to be fairly gruesome. And yet it was also a great century to be an investor, with the result that the inheritors of the fortunes of those brave pioneers were able to live very merrily for a while before they bore out the adage rags to rags in three generations..
Anyway, according to Professors Dimson and Marsh of the London Business School, UK equities delivered a real return per year for the century of 5.9%, well ahead of the return on UK gilts of 1.3%. You would have done somewhat better in US equities, which achieved 6.9%, and nobody should ever call Sweden boring again: its equity market was top of the class with 8.2%.
There are probably few surprises that profligate Italy produced 2.7%, the worst equity result of any country measured. Never mind.
The compensation is some very fine operas several notches in quality above Gilbert and Sullivan. My message to those who invest in Swedish equities and spend the dividends on going to the opera at La Scala in Milan? Don't be smug. The next century may be different.
But let's stick to the investment crystal ball. Dimson and Marsh point out that two particular factors helped equities over the past century. The first is that cashflow generation and profitability was better at the end of the century than at the beginning.
The second was that shares became much more expensively rated. Measuring the combined impact of these is difficult, but the implication is that unless there are similar improvements during the 21st century, the real returns will turn out lower. And if there is a deterioration of the same amount, the real returns would come close to being wiped out.
What should we make of this? Well, among other things, the professors observe that the 'economic and political lessons of the 20th century have surely been learned, international trade and investment flows have increased, and the Cold War has ended, leading to a more secure business environment'. The inference has to be that, if this persists, there is every reason for shares to maintain the expensive ratings that they have acquired at least. It is difficult, however, to argue that companies can become ever more profitable, simply because at a certain point capitalism ensures that price competition emerges to limit potential returns.
Almost certainly the transparency of the internet as a medium of transaction is set to ensure that any emerging competition is immediately known to the buyer, so firms are going to find it more difficult to protect themselves by artificial means.
Accordingly, the supernormal returns will go to those who genuinely have a unique selling proposition. This is the attraction of high technology, for instance.
So, maintained ratings and lower profitability sounds a likely combination that might produce real equity returns of 3.54% rather than the near 6% we have enjoyed in the UK. Fortunately, there is a magical additional ingredient that should help to gear these projected figures up further.
The growth of the world economy is accelerating over the long term. It was 1% a year in the 19th century, helped by the industrial revolution. It was 2% in the 20th century, boosted by the car, the
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