Stocks for the Long Term? Not for the Last 20 Years...

This is the first financial crisis of the Internet age, and that has made the negative feedback loops particularly vicious and rapid compared to historical precedents, as companies and consumers are just one-click away from adjusting their inventories and portfolios in real-time. However convenient that may seem, in aggregate it damages the resilience of the global economic system by amplifying and propogating the 'animal spirits' of human behaviour that Keynes identified back in the 1930's as "spontaneous urges to action rather than inaction". Fear, panic and uncertainty can be dangerously contagious and self-fulfilling. Standing back from the gruesome current price action in equities, it's worth taking some rational perspective on longer-term valuations and performance. I wrote last November in Will Demographic Decline Raise the Equity Risk Premium? that 'the reverse yield gap has now turned positive in Japan, the UK and Germany, and is at the lowest levels in 60 years across all major markets including the US. Does this just reflect a short-term deflation panic? The ongoing bursting of the bubble in normalized equity valuations since 2000 (when a secular bear market commenced) has been one factor, but our passing the inflection point of the baby boomer investment cycle may become the key underlying influence.'

The chart below indicates the remarkable reversion we have now seen in cumulative bond and equity returns over the last two decades. The benchmark Barclays Capital Aggregate Bond Index has now provided an equal return to the S&P 500 over the past 19 years, including reinvested stock dividends/bond coupons, as shown in the first chart below. Put another way, investors have had no compensating return for the increased volatility risk they incur with an equity portfolio over bonds, and consistently overweighting equities in a balanced portfolio has been a money losing proposition. This has huge implications, not only for individual investors with withered 401k plans, but also insitutional pension schemes, both private and public sector, which are now broadly incapable of meeting retiree benefit liabilities. The ERP has recently hit the highest levels since 1982.

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