Investment Insights

So, it’s all over. The end of equities.

  • Apr 10, 2020
  • Mark Clubb

No more stock buy backs to fuel the market. No more retail buyers and no more institutional buyers. No buyers ever again. Well just hold on a minute....

I think there is something missing in these assumptions. Because of demographics in the Developed World, there is a massive pension problem. Every day, more “baby boomers” are retiring or looking to retire. Baby Boomers, the generation born between 1946 and 1964, are retiring at a rate in the 10,000's a day.

The virus will have accelerated this. The problem is with interest rates at zero and investment grade/sovereign bonds yielding so little, these gargantuan institutional and personal pension funds or pots of money will be driven into equities in the hunt for short, medium and long term income. US Treasury 10 year bonds currently give an income yield of 0.6%. That's what you are locked into for 10 fricking years and inflation is say 2.5%. You know what, I cannot live on that. OK. I will take some risk (more on that later). The equivalent UK bonds are 0.3%. The German is -0.45%.

The current estimated mean for the S&P dividend yield is 4.3%, FTSE All Share is 4.46% and Dax is 3.35%.

Clearly dividend payments are a function of company profits/balance sheets and obligations which is a function of economic activity/health. But not all companies are going to be loss making. Some will prosper. Take Microsoft, one of my favourite companies. It is the largest position in all my portfolios and has been for 10 years. “Microsoft was built for the Covid-19 crisis”. It has recently announced a 775% rise in its cloud services business Azure. The same will be true for Amazon, another portfolio company I have a large position in. The transition to cloud computing is expected to be worth $623 billion by 2023.

Microsoft pays a dividend currently giving an income yield of 1.28% and has a history of growing that dividend every year. 5 year growth rate of 10.9%. It has $136.5 billion of cash.

I think we are going the see a massive separation within the market. The “haves" and the "have nots” or the “divs” and the “div nots". The "have/div nots" will be zombie companies, propped up and controlled directly or indirectly by Governments/States. Utilities, transport and infrastructure including the banking systems will all be State controlled. It's the only way for States to get back anything from the massive debt currently being rained down into the economy. It will be like this for a good decade. Public infrastructure spend will keep the construction industry alive for example, but on inflation linked contracts with defined profit margins. Good for employment numbers also. The banks in Europe already are effectively controlled. Witness the UK's behaviour towards dividends and banks and insurance companies. The same will be true in Europe. These “have nots” or “zombies” will not pay "real" dividends for some time/years. If they do they will be linked to Government Bonds. They are effectively nationalised. You cannot have Equity Risk Premium when the equity is not truly in the hands of the shareholders.

The “haves” will be the companies outside those controls. The free market operators. I think we will return to a “Nifty Fifty” type market. In the US during the 1960s and 1970s there were 50 companies regarded as solid buy and hold stocks or “blue chip”. These stocks propelled the bull market of the 1960/early 70s. Between 1960 and 1973 the S&P went up more than 200% but US GDP only went up by 77%. Interestingly the average p/e in 1960 was 17.2 times and finished in 1973 on 18 times. Today the S&P is on a multiple of 18.3 times. Something of a coincidence.

My point is that Pension Funds will hunt for income. They have to. Even if the market (S&P) dividend payout were to halve to 2.15% and it probably will ultra short term, equities still offer 3.5 times more in income than bonds. Strong well financed, dividend paying company equities will ultimately be in demand. These Pension Funds have no choice. They have liabilities that must be matched. They need to make those monthly pension payments. As in all markets, it is about buyers and sellers.

Investors and savers have totally forgotten the fundamental core reason to invest in equities or shares. The very reason over the last 400 years we have seen the monumental growth in the "Cult of the Equity". The clue is in the word "share". A "share" of the assets, the debt and the cash, the earnings or profits (and losses) and importantly the returns of some of that through cash distributions called dividends. Because of the risk (its a company out on the economic ocean) this cash return needs to be above something "risk free" like a "must pay" Government bond. Hence we have an "Equity Risk Premium" (ERP). That is the total return including dividends over and above that of a "risk free" asset such as a 10 year Government bond. With these bonds currently yielding no more than 0.6% and the historic average ERP of 3.5% it stands to reason, investors should expect an average per annum return from equities of say 5% per annum for the next 10 years versus at best and locked in for 10 years theoretically of 0.6% from Government bonds.

Although this is a very crude measure of market relationships I think it is most relevant. It can go up (see below) and I think that will happen during the next 10 years. You could see ERP go to 7/8% in the clamber for income. It has done several times (all be them different economic times) in the past. Then you would be expecting 8/9% pa on average from equities over 10 years.

Below is historic ERP


I and we at TEAM have our "Nifty Fifty for 2020/30". I and we are always happy to discuss any of this, including the individual companies in more detail directly with you. Also happy to talk through ERP theory and technicals.

TEAM Asset Management is a trading name of Theta Enhanced Asset Management Limited which is regulated by the Jersey Financial Services Commission.