It’s not just double-dips and deflation that equity investors have to worry about, according to Citigroup’s global equity strategist Robert Buckland. Western stockmarkets face a longer-term headwind: the end of the “cult of equity” that bolstered markets in the late 20th century and its gradual replacement with “the cult of the bond”.
There has been a “profound reassessment of the merits of the two asset classes” by institutional and retail investors, says Buckland. In Britain, pension funds piled into equities from the early 1960s onwards. By the early 1990s they held 76% of assets in stocks versus just 12% in bonds. Now, following a sharp slide in equity weightings over the past ten years, the proportions are roughly equal at 40%, as they were in the early 1960s. It’s a similar story in America.
Inflows into US equity funds rose steadily until 2000, when they peaked. They made a small comeback in subsequent years but have yet to recover from the 2007-2009 market slide. European fund inflows never recovered from the 2000-2003 slide.
So why the shift? One reason is that with deflation now deemed the main threat, bonds are more popular. Pension funds have increasingly gone for the safer option of bonds as populations are ageing. But the key reason is recent performance. “Dreadful returns… are increasingly putting investors off equities,” says Buckland. Global stocks are up just 4% since 1999. And “having two 50% bear markets in a decade is enough” to rattle “the most determined equity cultist”. It doesn’t help that investors were spoiled by the freakishly good returns in the 1980s and 1990s, as Tim Price of PFP Wealth Management points out (see chart above). This helped cement the cult of equities. Meanwhile, global government bonds have returned 103% since 2000.
If we are indeed seeing the end of the equity cult, there is an upside for stock investors. Dividends are the key to long-term returns (see right). As stocks have fallen from favour and bonds have become more popular, dividend yields in most Western markets have eclipsed bond yields. That, as Buttonwood points out in The Economist, means that even if dividends turn out to be stagnant for the next decade, equities still offer a higher income than government bonds. What’s more, if inflation does take off, dividends would increase while “bonds would look horribly overpriced”.