20 May

Why you have to invest differently!

Like many Australians, we enjoyed our first weekend of relative freedom, enjoying a trip to the shops, a coffee at our local coffee shop, and a trip to the park with our children.

The streets and the shops were incredibly busy, a good sign that things continue to head in the right direction, though we think it will be years before we return to normal, with millions of Australians likely to remain reliant on the government for economic ‘life support’ for the foreseeable future.

Economic data suggests we have a hard slog ahead of us, with last week’s unemployment figures in Australia suggesting the unemployment rate would have headed toward 10% were it not for the huge reduction of Australians in the labour force.

The problem is clearly global in nature, with the St. Louis Federal Reserve GDP Nowcast model (essentially a forecast for the current quarter’s economic output) forecasting a 48% decline in US economic activity.

Stock markets are still by and large ignoring the economic reality, though we think the next few weeks may well see downside risks re-emerge.

In this week’s market update we look at how kind financial markets have been over the last several decades, why history won’t repeat, and why now is the time to invest differently.

How kind financial markets have been

Despite the volatility that we’ve seen in stock markets and commodities throughout 2020, it’s worth taking a step back, and reviewing just how kind financial markets have been to investors over the last few decades.

The chart below from JP Morgan helps illustrate this, showing the range of rolling returns over multiple time periods (1 year through to 20 years) to the end of 2018, for stocks, for bonds, and for a 50/50 portfolio.

For example, the chart is telling us that over a 1-year period, the best return for stocks has been 47%, whilst the worst has been -39%.


Range of stock, bond and blended total returns
Annual total returns, 1950-2018

Range of stock, bond and blended total returns. Annual total returns, 1950-2018

Source: Barclays, Bloomberg, FactSet, Federal Reserve, Robert Shiller, Strategas/Ibbotson, J.P Morgan Asset Management, Returns shown are based on calendar year returns from 1950 to 2018. Stocks represents the S&P 500 Shiller Composite and Bonds represent Strategas/Ibbotson for period from 1950 to 2010 and Bloomberg Barclays Aggregate thereafter.

Note how over 20-year periods, even the worst returns for stocks, bonds and a 50/50 portfolio are 6%, 1%, and 5% respectively, with the best returns coming in at 17%, 12%, and 14%.

These are extraordinary figures, with the returns themselves dwarfing the growth in the economy itself over this time period. This incredibly powerful tailwind has also helped millions of investors build wealth, but those returns belongs to the past, not the future.

History will not repeat

Whilst most finance professionals who sell investment products made up of traditional assets like stocks and bonds will use these historical returns as the basis for their forecasted return assumptions (with all the relevant legal disclaimers), the next ten to twenty years are unlikely to be anywhere near as rewarding as the past few decades.

This can perhaps best be seen through the graph below, which shows annualized real returns for equities and bonds for Baby Boomer, Generation X and Millennial investors.

Pay particular attention to the columns on the far right of the chart as you look at it, which are the expected future real returns (i.e. factoring in inflation) for equities and bonds.

Annualised real returns on equities and bonds (%)

As the chart says at the bottom, a standard portfolio with 60% of its money in equities and 40% invested in bonds will be lucky to earn 2% per annum going forward.

In our view even that may prove optimistic, for the next decade at least, as inflation may soar in the years to come, whilst equities are already priced to perfection, with returns in the next decade possibly negative in real terms.

We could be wrong about that of course, though we’d note that legendary investors like Stanley Druckenmiller recently went on record to state that the ‘risk-reward in stocks is the worst he’s seen’, with hopes that we’ll see a V shaped recovery from the coronavirus induced recession a fantasy in his view.

For those unfamiliar, Druckenmiller is a long-time hedge fund and family office manager, with an estimated net worth of $5.8 billion, after having generated “returns of about 30% a year over three decades”, according to this Bloomberg article.

It’s up to individual investors to decide whether or not they want to heed warnings from the likes of Druckenmiller, but with a track record like the one he has, we for one are definitely paying attention.

You have to invest differently

Astute investors are well aware of the trends that we’ve discussed in this article. They know that returns from cash, bonds, equities and real estate are likely to be low to negative for the foreseeable future, with inflation an ever-present threat.

They know that to protect and grow wealth in the years ahead, you have to invest differently, with these trends encouraging those astute investors to diversify into hard tangible assets.

The closure of the Argyle Diamond mine means that of all the hard-tangible assets investors could look at, it is pink diamonds that are uniquely set to outperform in the years ahead.

The laws of supply and demand will inevitably kick in, helping to push prices higher, as indeed they have over the majority of the last 15 years, with pink diamond prices rising by over 400% over this time period.

As always, we hope you’ve enjoyed this week’s edition of “In the Loupe” and look forward to any questions or comments you may have.


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