Stocks: a better bet than bonds

When trouble looms, investors should “think of the riskiest assets out there and buy them by the bucketload”, says The Guardian. This is one of the main conclusions to be drawn from the latest Global Investment Returns Yearbook by the London Business School and ABN Amro, which has assessed the performance of 16 world markets since 1900. Last year’s strong rebound from March lows amid jitters over the Iraq war gave rise to an annual gain of 21% for the overall UK market. But Brazilian equities rose by 86%. But don’t be “too dazzled” by this kind of statistic. Over the long run, “quality companies” paying a dividend are still the best bet, provided the dividends are reinvested.

The report notes that an investment of £1 in the UK market in 1900 would have grown into £13,253 by now if dividends had been reinvested (representing a total return of 9.6% a year), whereas if the dividends had been spent, the initial stake would be worth just £112, reflecting annual capital gains of 4.6% a year. It’s a similar story in the US. And the higher the dividend yield, the higher the overall gain; witness the “staggering” return available from investing by yield since the market peaked in 2000, says Deborah Hargreaves in the FT. A punt on the 20% of UK stocks with the highest yields would have produced a 51% return over the past four years compared with a 64% loss for the lowest-yielding 20%. “What better endorsement of value-style investing during challenging periods?”

The report also shows that buying when yields are generally high produces better real returns over the next one, four and ten years than buying when yields are low in most global markets, including the UK, says Philip Coggan, also in the FT. This seems to support the view, which gained currency last March as many European market yields eclipsed government bond yields, that yields are a useful market-timing tool. But probing the relationship between annual real returns and dividend yields shows that a forecast model that assumed future returns would be the same as past ones has outperformed the yield approach in all markets except the UK since 1900, where the yield model has only worked better since 1975. So don’t bet the farm on it.

One thing’s for sure though, says Jeremy Warner in The Independent: today, stocks are a better bet than government bonds. According to Credit Suisse First Boston’s Annual Equity Gilt Study, annual real rates of return on gilts are running at 60% above their long-term trend. Stocks are only slightly above theirs.And for gilts to go much higher from current levels requires another fall in inflationary expectations - “hardly the way to bet” as profligate government spending around the world will eventually be paid for by printing more money. That will prompt higher inflation and rising interest rates. “Steer clear.”