“the end is nigh” for stock market valuations. Or is it?

We’re All Doomed – are we not?

The papers seem to be full of pundits predicting that “the end is nigh” for stock market valuations at their current level. And if, or when this happens, no doubt there will be a few people proclaiming that they saw it all coming. But the so called melt down that pundits are talking about if it did happen, and it is still an ‘if’ whilst this would hurt, you have to remember that history tells us that this is probably a rare event, in fact a very rare event. The question I would ask anybody is does it actually matter? If you are investing money into the financial markets it should be medium to long term funds anyway. Of course we would all love to be able to ‘get into the markets’ just after a crash, and maybe get out just before one. In reality this isn’t going to happen. That’s because nobody really knows, honestly, even the Mail and the Express.

 

The Contribution of Dividends to a Portfolio

While dividend payments from a portfolio are attractive for those who may need a regular income, the reinvestment of dividends turns equity income investing into a good long term growth strategy also. The compounding effect tends to kick in a lot quicker than most investors think. And this compounding is boosted even more if the dividend payments are fairly large by historical standards, which is the case today.

I once saw an article from a firm which showed a graph of the FTSE All Share Index. The firm was using the graph to ‘ridicule’ the performance over a 5 year period. This was because the graph merely showed the performance not to have moved over the 5 years. This was very misleading, because it did not take into account the dividend re-investment. Over the last 25 years around 60% of the total return from the FTSE All Share Index has come from reinvested dividends. This is an additional 544 percentage points of returned gained thanks to the compounding effect of dividend reinvestment.

As you can see from the graphs below, actually the FTSE 100 has lost money over the last 14 year period. So after all the roller coaster of recovery, austerity and reconstruction, we still haven’t reached our peak of the last day of 1999. You might find this slightly depressing.

Actually it shouldn’t be depressing. If you look at the second graph illustrated below, you will see a good steady trend and in fact if you had included the dividends, then instead of losing 4.8% over 14 years you would have made a relatively healthy 56.6%. The fact is that in most cases your dividends and their reinvestment are more important than the vagaries of individual stock movements. Dividends may sound dull but just look how much they contribute each year.

There is a belief among many investors that high dividend paying companies tend to be lower earnings growth companies, while low or non-dividend payers have better growth prospects. But historical evidence tends to suggest that expected future growth can be faster when current dividend pay-out ratios are high, and slower when pay-out ratios are low. This possibly explains why the share price performance of higher dividend paying shares is also very good. Some of the best well-known brands and companies fall into this category such as,   Proctor & Gamble, Unilever, Johnson & Johnson, Prudential, BP, and Nestle to name but a few.

Chart 1 – FTSE 100

Source – Bloomberg

Chart 2 – FTSE Total Return

Source – Bloomberg

Stick to thinking of the longer term and you will be fine.

 

The Future for Interest Rates

Many of my clients will have tired with me over the last 3 years telling them what they didn’t want to hear, which was that interest rates are ‘going nowhere’. But it has proved to be the case, and I still thought earlier in the Summer that people were getting a little carried away once again with the “will they”, “they’ve got to surely?” notion, that an interest rate rise was on the cards.

You have to look at the job that the Bank of England has to do. Is it to look after old age pensioners surviving on interest on their deposit account? No, it is to make sure inflation stays under control as well as a few other of the government financial targets. Well figures out recently showed that inflation figures could fall below 1% in the next 6 months, and this is well ahead of central government’s target. It was not too long ago that we were looking at inflation at nearly 5%. So there is no pressure on the BoE to raise interest rates. And as I have often said in the past, this is not something that just UK is witnessing. If you look around at the developed world, the Eurozone, Japan, China, the US, they all have interest rates very similar to our own. Add to this, that unemployment is not exactly out of control, commodity prices, and in particular oil has fallen nearly 30% from its post-crisis peak. And with all the Supermarkets appearing to be fighting to give their goods away, the costs of food has also fallen over the last 12 months or so.

I would say at this stage that this links back to my first comment, because if you are getting 1% (If you’re lucky) in the bank, then what is the alternative? There isn’t one realistically. You have to take a little bit of risk if you want to achieve your objectives. And the longer that those objectives are away into the future the better chance you have by investing into the financial markets.

 

And finally

An amusing story that I heard last week. An acquaintance told how he has discovered a low-cost method of reducing his house insurance costs. He’s put two Iranian flags in his front garden, one at each corner and the black flag of ISIS in the centre. The local police, MI5, MI6, Special Branch and all the other intelligence services are now watching his house round the clock. He says he’s never felt safer!

Kind regards

Don

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