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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
It’s that time of year when strategists and fund managers are bullied by their marketing colleagues into making on-the-record public forecasts about The Year Ahead. Good luck to them!
Absent any incentive to make our own predictions about future equity returns, we thought it a good time to throw a bit of light on the past. First up, here’s a chart that splits equity returns into dividends, earnings, valuations, and currency:
Sure, US stocks are a bit richer than they were five or ten years ago, But sitting behind the performance of US stocks has been some really stonking earnings growth, which is in spite of dollar strength diminishing the value of the ~40 per cent of revenue that comes from overseas.
Drilling down a level to sectors, the story is similar. This time we’ve thrown the data onto a bubble chart and left returns in local currency. The size of each bubble is the share of the MSCI All Country World Index accounted for by the region-sector cohort — so, for example, the bubble in the right-hand corner is US Technology, which accounts for 18.8 per cent of global equities. It has had annualised growth in forward earnings to the tune of 11.6 per cent over the past decade, and returns of 20.1 per cent per annum.
US Tech really is a gigantic bubble. That’s not our opinion, it’s an aesthetic observation; a chart like this can confirm almost any biases you bring to it.
American exceptionalists can point to the transformative power of earnings growth to justify astounding historical equity returns. Fundamental analysts and investors can point to the goodness of fit between earnings growth and returns to justify their existence. Bears can point to the size of Tech on the chart, its elevation above a line of best fit, and the impact that gravity reasserting itself would have on global — and especially US — equity market returns.
But what does the chart really say? Generally, over long periods, an investor did better buying baskets of stocks that delivered higher levels of persistent earnings growth than by buying baskets of stocks that delivered lower persistent earnings growth. To see how fragile this seemingly self-evident statement is, flick the chart filter from ten years to five years and watch the correlation melt before your eyes.
Further reading:
— Most stocks are bad for your wealth (FTAV)
Read the full article here