The New Year is often rung in with a kiss, a hug and by singing a rendition of the Auld Lang Syne. The Auld Lang Syne song is an age-old tradition that was thought to have been composed by Scottish poet and lyricist Robert Burns in 1788. The literal translation of the song means “long, long ago” or “days gone by”.
It is a nice song that conjures up thoughts of the past and hopes for the future. As we look to the financial markets, many investors in equities probably want to forget the past thirteen years and look towards the future. In contrast, investors in fixed income probably have fond memories of the past thirteen years and have a tear in their eye when they think about the current yields on fixed income.
The past 13 years have been rocky at best for the equity markets. It was one of the few historical periods during the past one hundred years where the stock market resulted in a very low or negative return over a greater than 10 year time period. If a person invested in the Dow 30 on 31 December, 1999, and sold out around 30 November, 2012, their price appreciation would have only been 13.29 per cent. If dividends are included, the total return over the period was 53.99 per cent which looks great at first glance. However, calculated on an annual basis the return was 3.4 per cent which doesn’t sound quite as exciting. Although in contrast with the NASDAQ Composite over the same time period, it still appears outstanding. Over the same period the price change of the NASDAQ Composite was -26.03 per cent. If including dividends the return was slightly less negative with a total return of -18.64 per cent or an annualised return of -1.58 per cent. Given inflation rates over the past thirteen years, an equity investor would have underperformed compared to the fixed income market.
The equity market performance is a stark contrast to the fixed income market performance. Over the past thirteen years, fixed income has shined. A US Treasury bond purchased on 31 December, 1999 with 13 years to maturity would have yielded about 6.44 per cent annually. If this US Treasury bond was a zero coupon bond, the total return for the period would have been 125 per cent. That would be at least double what the Dow 30 did which was one of the better performing equity indexes.
The reality is that most people do not invest large sums at the top of the market and have an asset allocation that is more balanced towards fixed income. So, it is safe to say that most investors, unless extremely conservative or overly aggressive, ended up with average returns between 3-5 per cent over this time period.
Hopes for the future
When looking towards the future, things seem a little bleak. Globally we still have issues in the Middle East, a debt crisis in Europe and potentially slowing economy in the emerging markets. All of which could have a negative effect on expected returns going forward for the equity market. The one saving grace is that because equities have underperformed since 1999, the price multiple you would pay now given earnings is much less, in fact almost half. P/E ratios in the late nineties were in excess of 20 for the Dow 30 and had reached a height of above 25 at the end of 1999. The same index has P/E ratios currently at around 13.
For the fixed income market, the future is just plain grim. Recently, a given search produced thirteen year zero coupon bonds which had an annual yield of 2.2 per cent. An investor would be looking at a guaranteed held-to-maturity return of almost a third of what they would have received at the end of 1999.
From a high level, this tells us that equity prices are relatively cheap compared to what they used to be and fixed income is expensive. It will be interesting to see what the future brings over the next thirteen years, but I would assume a stronger return for equities and a lagging return for fixed income over an equal time period. As a caveat, I would expect a lot of volatility on a year-to-year basis in both asset classes along the way just as in the past.