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Likely Market Returns From Here

By November 27, 2017February 18th, 2022featured articles

Despite all the noise that the markets generate on a daily basis, on a medium to long-term view there are just a few variables that drive returns for investors.

The first is the initial cash dividend yield on offer. The second is earnings growth, as dividends are paid from earnings. The rate at which earnings grow largely drives the pace at which dividends grow.

Earnings and dividend growth, in turn, drive share price growth (or capital gains). The combination of the dividend income you receive plus the capital growth represents the total return an investor receives over the medium to long-term less any costs incurred along the way. There is, however, another variable, which we will discuss towards the end of this featured article.

Let’s take a look at the relevant statistics on the MSCI All-World Index from 1995 to 2017 inclusive. The MSCI All-World Index includes developed, developing and emerging equity markets, and the key US equity market accounts for circa 55% of the MSCI All-World Index.

The chart above highlights the growth in the MSCI All-World ‘price’ and ‘dividend’ indices from the start of 1995 to 2017 year-to-date. What is immediately clear is that over this timeline the growth in global equity markets has more or less tracked the growth in global dividends.

The chart also highlights the bubble period for global equities – driven by the tech craze in the developed markets in the main from 1997 to early 2000 – when global equity prices galloped ahead of the growth in underlying dividends (and earnings). This bubble was corrected in the 2000 to early 2003 global bear market. In the Global Credit Crisis, even dividends declined, a fairly rare occurrence (and certainly of that magnitude). Today, both global dividend income and global share prices are at new peaks. What’s also obvious is how volatile share prices are, in general, compared to the dividend income stream.

As the table highlights, the initial dividend yield available from global equities at the start of 1995 was 2.28%. Dividends paid by companies in the global index grew at 5.47% compound per annum over the 1995 to 2017 period, while global share prices grew at a slightly less 5.25% compound per annum. Hence, had you invested in, say, a global equity exchange-traded fund (ETF), you would have received this initial dividend yield of 2.28% plus the annual capital growth of 5.25% for a total annual return of 7.53%, less any costs in the fund.

Today, the initial dividend yield on the MSCI All-World Index is 2.39%, and above the starting 1995 level. So, on a medium to long-term view, returns to investors in global equities can be expected to be in the order of 2.39% plus the growth in the dividend income stream – which should be reflected in capital growth (share price growth) as it has been in the past.

In terms of the rate of earnings and dividend growth going forward, what growth might we expect from global equities? To take account of a global economy with more debt — which is acting as a drag on growth, in the developed world at least, we might assume a lower 3-4% growth in annual earnings and dividends going forward. Baring a deep recession that could lower dividends significantly, this holds out the prospect of total returns to investors in a global equity fund of 5.4-6.4% annually (or 5-6%). This level of potential returns, of course, is significantly below the long-term average returns that global equities have delivered of circa 9-10% annually over the past 100 years.

But, despite the likely lower returns from global equities going forward, the returns from global long-dated bonds are known (as they offer a simple fixed income until maturity) and will be extremely low,  given that yields to maturity currently are at record lows. So, unless deflationary forces regain the upper hand, it’s hard to argue that equities aren’t still the place to be. As the table highlights, when global equities offered a starting dividend yield of 2.28% in 1995, global 10-year bond yields averaged 7.86%. That was a significant headwind for equities at the time, yet global equities still provided reasonable (inflation plus) subsequent returns. Today, global 10-year bond yields offer an average yield to maturity of just 1.63%, and there’ll be no growth in this yield once you’ve bought the bond.

This analysis provides a guide as to what global equity market returns might be over the next 5-10 years. What happens over shorter timelines is a bit of a lottery. Recessions are normal and often reduce earnings and sometimes dividends temporarily so that what happens on a 1-5 year view is often just guesswork.

Another unknown is long-term interest rates. What would happen to equities if global long-dated bond yields headed up to a more normal 3-4% range from their current record lows? Rising interest rates can spook stock markets as they compete for investors’ monies. It’s an unknown, but our own guess is that markets would decline initially, but recover thereafter as even long-term interest rates at the 3-4% level are unlikely to deliver the same returns as stock markets. Again, however, we can only stand over such analysis on a 5-10 year view, and we do have to assume no return to deflationary conditions.

Finally, the US equity market, which accounts for at least 55% of the MSCI All-World Index, is more highly valued than other markets at present. For example, the MSCI All-World (x-US) Index today offers a higher initial dividend yield of 2.94%, some 20% ahead of the MSCI All-World Index. And as the MSCI All-World (x-US) Index includes the likely faster growing developing and emerging economies, it is not unreasonable to assume a slightly higher rate of dividend growth from these markets of, say, 4-5% per annum. On a 5-10 year view, then, this analysis suggests that the MSCI All-World (x-US) Index can deliver returns of circa 7-8% per annum. We have recently been highlighting to our website subscribers some funds that provide exposure to markets outside the US.

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