All very interesting you might say, but what about the next 25 years? Forecasting is a difficult business, but the advantage of taking a 25-year view is that one can largely ignore the influence of future cycles.
Let’s face it, no one can forecast where market valuations will be in 25 years’ time, so you have to assume equilibrium has been reached by then.
When we make an investment for the future, our reference points are mainly based on past experience.
This is both natural and probably logical because asset classes rarely provide regular and predictable returns over the cycle.
We are all subject to periods of over-optimism and periods of downright gloom which accentuate the peaks and troughs of asset prices.
So unless your scenario includes the end of the investment cycle as we know it, after a period of bad returns, a period of improved returns is likely to follow over the longer term.
This may sound like blind optimism that what goes down will eventually go back up but there is some justification for such a view.
For example, if we look at the long-term returns from US equities over the last 100 years, the average real return over 25-year periods has rarely been below 4 per cent and rarely above 8 per cent.
In other words, over the long-term, returns from US equities have been remarkably stable in real terms – low returns are eventually followed by higher ones.
Performance of indices over 25yrs
Source: FE Analytics
So what does the future hold? Well, we can say with some certainty that long-term returns from government bonds will be close to zero in real terms.
The UK index-linked gilt that matures in 2037 provides a real return of just below zero.
In other words your return to maturity will match RPI; in fact slightly undershoot it.
To get a higher return in the interim you will need someone to be convinced that your bonds are worth more and buy them from you at a greater negative real yield.
If you are investing in conventional gilts, the numbers are very similar assuming that inflation averages 3.3 per cent – roughly where long-term inflation expectations sit today.
And as your return is fixed, if inflation turns out higher, your real return will be lower.
Forecasting returns in the bond market is the easy part as the terms are by definition fixed or linked to inflation. Equities are more difficult to predict.
The outlook for growth is murky at best. Chief executives across the world have been reluctant to invest heavily in their businesses because they have limited visibility and a lack of confidence in the ability of policy-makers to steer the global economy back to health.
There are many macro and political risks to worry about – too many to mention here.
The fact is it has always been like that. The returns we mentioned earlier span global wars, pandemics, political upheaval and natural disasters.
The world went through a lot but investment returns still came through.
However, we can identify two broad themes which are capable of driving growth from here – innovation and globalisation.
I was reading recently about a new material called graphene which was invented in 2004 at Manchester University.
Its inventors have already received the Nobel Prize and the material is already the subject of over 5,000 patents.
I am no expert but I would be surprised if this is not just one example of thousands of innovations that will help to drive growth during the next few decades across multiple industries.
Globalisation is a theme that has been mentioned countless times before but it remains a powerful force.
For example in China, a nation of aspirational consumers, the number of cars per person is still only around 10 per cent of that in the US.
And possibly more importantly, UK multinationals regularly report that their businesses in Asia and other growth economies continue to become more significant due to their superior growth rates, in stark contrast to what we have seen in Europe.
Thinking slightly more short-term, say over the next five to 10 years, we may be close to a regime change in monetary policy.
Central banks appear to be shifting away from inflation targeting and towards policies which will target nominal growth.
These changes are being sponsored by politicians who are wrestling with the problem of excessive debt.
Austerity is a painful solution which doesn’t always survive the next election.
We have already seen a transfer from creditors to debtors in the form of very low interest rates – negative in some cases – but it does look as though extraordinary monetary techniques such as quantitative easing will be with us for a while yet, at least until we start to see some revival in growth.
With this in the background, it doesn’t appear to be the right time to be investing in fixed income investments which cannot keep up with inflation.
Further, if growth recovers, we should expect the safety premium in gilts and index-linkers to unwind and equities to become the real asset of choice for all investors.
As I write, the Dow Jones has just reached a new high, up over 100 per cent from the 2009 low.
We can’t be far away from institutions deciding that perhaps they are missing out on returns and to start switching back into equities.
The bottom line is that none of us know for sure how markets will play out over the next 25 years, but based on a bit of common sense and historical perspective, now seems the right time to position portfolios with a bias towards equities and away from fixed income.
Drop me a line in 25 years if I am right.
Jeff Keen is co-head of fixed income at JO Hambro Investment Management. The views expressed here are his own.