The past decade has been an astonishing period in financial markets generally. Global equities have risen in value by almost 300% over this period, led as usual by the US market, while global bond markets have returned more than 30% over this time frame (and well over 100% over the past two decades). The reasons for this asset price inflation are manifold, among them the introduction of Quantitative Easing by global governments, low asset valuations post the Global Financial Crisis in 2008, the growth of China as a global economic force, the rapid expansion of technology on multiple fronts etc. However, it is an easy argument to make that asset values are very stretched at this point and that there is little evidence of true value to be seen anywhere.
Looking beyond what is happening in broader financial markets, there is evidence of pervasive excess everywhere you look. Some random examples:
- Cryptocurrencies, as yet unregulated and unapproved, have exploded in terms of the number of currencies now available and the funds committed, mainly from smaller investors.
- Tesla has achieved a valuation of one trillion dollars. This equates to a multiple of 21 times revenues and an astronomical profit multiple.
- Money flows into financial markets so far in 2021 have beaten previous records by a street
As the world haltingly emerges from Covid, there is cautious optimism that the early signs of a rapid global economic recovery will lead to a period of sustained growth for economies around the world. The performance of equity markets throughout 2021 has certainly been significantly buoyed by this view. However there is a growing sense that the phase in financial markets illustrated in the chart above is coming to an end and that we are entering a whole new phase with market returns unlikely to come anywhere near those of recent years. In addition, the pattern of returns could well be a lot more uneven over the coming few years compared to what investors have become used to. As we come to the end of 2021 and much of the ‘good news’ – insofar as corporate and economic performance and outlook is concerned – seen to be in the market and reflected in valuations, the big question is are we facing into one or more events which could tip the markets in the other direction. And the risk of course is that a downward shift in markets could be substantial due to a number of factors including (i) high valuations (ii) substantial ‘new money’ in markets more prone to panic (iii) high levels of passive investment which could accentuate negative spirals.
History has taught us that the trigger event for a market event can never be foreseen as such (if it were markets would already have moved). That said, there are plenty of potential flashpoints out there from which such a trigger event could be generated. These include the following:
- A significant worsening of the Covid situation globally
- Signs that real inflation has taken hold
- A marked rise in US-China tensions
- War breaking out between Russia and the Ukraine.
The first of these possible events appears to have kicked off already over recent days and it remains to be seen what the ultimate impact on markets will be. However, all things considered it does seem that we can expect a volatile year in 2022.
But what about the longer term? For investors committing money to investment markets today what level of returns can they expect over the next decade? It would certainly take a foolhardy degree of optimism to expect that returns will match those achieved over the past ten years. We at Harvest have been attempting for some time to rein in client expectations in relation to future growth expectations. Our current view is reflected in the table below.
Expected Annualised Return over next Decade
It may well turn out of course that discriminating investors will do a lot better than the returns indicated above. For example, equity investors pursuing a sectoral approach could find themselves reaping significant rewards over the medium to long term. Some examples:
- Areas such as Cybersecurity, Robotics and Big Data/Cloud Computing are all expected to grow a lot faster than economies in general.
- As life expectations lengthen and populations age, Healthcare will be an inevitable beneficiary and should continue to deliver for investors.
- Expanding middle classes worldwide will demand a wider array of food products leading to upward pressure on food prices and widening margins for food companies.
Finally, two very important observations to make in relation to the projections in the above table. Firstly the central assumption is that while inflation will rise it will not get out of control. If it does all bets are off. Secondly, should a major correction occur in investment markets, funds invested after such an event could well face a much improved return outlook compared with those shown in the table above.
Author: Terry Devitt, Head of Investments at Harvest Financial Services. To find out more go to www.harvestfinancial.ie