2003 barclays equity gilt study says equities look extremely cheap compared to bonds
All investors, with the exception of maturing pension funds, should overweight equities and avoid bonds, the 2003 Barclays Equity Gilt study has concluded.
Equities look extremely cheap by whatever historical barometer is chosen, the report said, noting markets are discounting a very improbable future of exceptionally slow growth and borderline deflation.
Report authors, Barclays Capital head of global rates strategy Tim Bond and rates strategy director Mark Capleton, confirm 2002 saw equities trail fixed-income securities on investment performance for a third year running.
The annual real total return in 2002 was -24.5%, the fourth worst year since 1900.
The figure compares to returns in 2001 of -13.8% and is the worst since 1974's drop of 58.1%, largely caused by the Opec crisis.
Equity dividend growth on a five-year view fell by 2.7% on average, according to Barclays. However, that obscures the fact that in 2002, dividend income grew for the first time since 1998.
The study, started in 1956 and the oldest continuously published City research document, noted the 2002 real return on gilts was 6.7%. For corporate bonds, the figure was 6.6% and for index-linked gilts, 5.1%.
Equities, the authors noted, have underperformed gilts over a full 10-year period, with an average annual return of 3.9% against 7.2% for gilts. corporate bonds were the top performer over the past decade, with an average annualised return of 8.6%.
Another statistic highlighted by Bond and Capleton is that the 10-year equity risk premium versus gilts narrowed to 0.6% from 2.4%. The equity risk premium is now at its lowest level since the end of the Great Depression.
After blaming failed corporate governance as the main factor behind the continued bear market, the study turned to how investors should be careful about avoiding the markets.
'Having eaten gruel for three years, the market does not appear to have the stomach to tuck into the rich pickings that now seem to be on offer,' the authors added.
This is despite growth models showing expected long-term returns from equities at 8.9%, 4.6% more than expected long-term gilt yields.
The report analyses what likely threats to corporate earnings might affect this 'healthy prospective risk premium'.
Some leakage, it said, can be expected from survivorship bias, whereby already-held companies go into decline or go bust, while new companies come into existence and record strong growth. Other leakage, the report added, might be caused by dilution, from the likelihood the corporate sector may need new equity capital in the long term. The rosy picture might also be threatened by the need to repair holes in pension funds.
However, Bond and Capelton said, earnings leakages described tend to be modest.
They added: 'The better news is that not only is the stock market cheap relative to bonds, it is cheaply rated on the basis of what are depressed earnings.'
The study also assesses who might take over the role of providing equity capital if UK institutional investors withdraw because of low risk appetite.
It points out corporate UK is now strongly cashflow positive. For private, non-financial companies, disposable income has almost recovered to its 1999 high, at around £26bn, while capital investment remains subdued.
The paucity of capex opportunities might lead stronger companies to retire equity, the report said. With short and long-term interest rates so low and the cost of equity capital so high on a dividend or earnings yield basis, the temptation to do this must now be great, they concluded.
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