Investors could hardly be blamed for giving up on equity investment completely. Despite the recent rally it looks as if this decade will wind up being one of the worst for shareholders in a century or more. Barring a sudden doubling of the markets in the next few months (and there’s not much chance of that), virtually all the main global markets will go into 2010 lower than at the start of 2000.
Yet it would be a mistake to write off stockmarkets entirely. Indeed, you could argue that we may well be about to go into one of the best decades yet for equities. Why? Because there are thousands of companies around the world with shattered balance sheets that need a lot of patient nursing back to health. With credit hard to come by, managers won’t have much choice but to get that money from their shareholders. And that means they’ll have to make sure that shareholders are well rewarded.
“About time too,” shareholders could be forgiven for thinking. This has been a rotten decade for anyone holding equities. Up until 2000, it was evident to everyone that shares performed far better than bonds. From 1900 to 1949, the annualised real (inflation-adjusted) return on the World Equity Index was 3.5%, and that was achieved despite two world wars. From 1950 to 2000, it was an impressive 9% a year, according to figures compiled by Elroy Dimson, a professor of investment management at the London Business School.
And yet, since 2000, the MSCI World index has lost a third of its value in real terms, while the major markets all lost between 4%-6% annually. Indeed, two of the four worst bear markets in stockmarket history have occurred in the last ten years – and it would only take another small dip in the markets to make this one the worst bear market ever.
The conventional wisdom that equities outperform bonds over the long-term is now being turned on its head. According to US firm Research Affiliates, if you invested 30 years ago, US Treasury bills would have provided a better return than the S&P 500. And in certain periods – from February 1969 to February 2009, for example – the 40-year return on government bonds beat the S&P 500. Since 40 years is about as long as anyone’s investment horizon can realistically be, it is going to be hard to make a case for buying shares.
No surprise then that some people are writing off equity markets. And yet, taken from a different angle, there is still a good case to be made. In the coming decade, corporate managers will really need their shareholders. They won’t have anyone else to turn to for capital. For much of the last decade, chief executives blathered on endlessly about ‘shareholder value’. Yet, in reality, shareholders were just an irritant. Managers could get all the capital they needed from banks, the bond markets, or private-equity firms. The only sanction shareholders had was supporting a hostile takeover – and since that meant the board collected lavish payouts, it was seldom a scary prospect. This decade, however, CEOs will need their shareholders like never before. The credit crunch has hammered balance sheets. Even if we forget about the hundreds of firms left with unsustainably high debt piles by the private-equity industry, there are many more that need money just to get them through the recession. And beyond that, they will need money to rebuild their competitive strength for the moment when recovery finally arrives.
But the banks are not going to be lending companies tons of money any more. The bond markets will be too busy feeding billion after billion to governments that have run up vast deficits. And the private-equity firms won’t be on permanent stand-by waiting to buy a subsidiary at vastly inflated prices. So the only place they will be able to get money will be from their shareholders. For too much of the past decade, the stockmarket has looked too much like what its left-wing critics accused it of being: a casino where hedge funds gamble with shares as if they were nothing more than chips on a roulette table.
But the credit crunch will force the stockmarket to go back to what it was originally designed to be – a place where businesses could raise the capital they needed to build new mines, start new factories, create chains of shops, or invest in research and development. Businesses that need capital will have to start thinking about how to build a loyal army of shareholders who will give them money when they need it.
In retrospect, it is hardly surprising the last decade was such a poor one for equity markets. They were irrelevant. With abundant capital available for everyone, there was no need to look after shareholders. But now, with capital scarce, firms will have to pay attention to their needs. The best way of doing that? By making sure they earn a decent return on their cash. You’ll probably hear a lot less about ‘shareholder value’ from CEOs in the next decade (which will be a great relief to everyone). Paradoxically, as you hear less about it, you’ll probably see a lot more being created.