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Despite the present slump, are shares actually good value in the long term?
Yes, says Graham Oldham, chief-executive of the Share Centre
There's no doubting that share prices are volatile, but are they really good value in the long-term?
There are three arguments I'd like to put forward to support my "yes" answer. The first is financial, the second is about the balance between hope and despair (or fear and greed, if you're that way disposed) and the third is a reflection on what shares really represent - human enterprise.
There can be no doubt that share prices are much better value now than they were 18 months ago. On 3 September 2007 the FTSE All Share Index stood at 3,273: at the close on 3 March 2009 it was 1,782. On 3 September 2007 its price earnings ratio (PER) was 12.5 and the yield was 2.9%; on 3 March the PER was 7.4 and its average yield was 5.8%. That means if earnings are maintained, it will take five fewer years than 18 months ago for them to equal the share price, and if dividends are maintained you will get an extra £2.90 per year per £100 invested. Of course, this includes a couple of big "ifs". But pick your investments wisely and you will find the value's there.
A comparison is often made between gilt yields (government stocks) and equity yields. When you bear in mind that dividends on equities can increase (as well as be cut), but interest on gilts is set when they're issued, you can see why gilts look poor value at present.
Then there's hope and despair, which equities always experience in abundance. Why? It's because people's trading is always based on anticipation of the future, something that's always highly subjective and frequently emotional. At present just about everything is going wrong, and there seems to be no light at the end of the tunnel. It's nearly six months since the first major bank bail-out and they're still in a mess.
But, encouraged by the huge levels of government stimulus, those elusive green shoots of recovery will start to appear later this year. Hope will return, and when it does all of a sudden there will be a rush of investors looking to re-enter the stockmarket before it's too late. Of course there will still be setbacks: but the depths of despair we're now experiencing will be well behind us.
Finally, shares represent human enterprise. We all seek to build a better life, to improve standards of living - and modern civilisation has proved over and over again how we can harness our knowledge and improve technology to that end. That doesn't stop because there's a recession: people are still hard at work planning and putting in place businesses which create wealth through the power of human enterprise. Shares are a proxy for that process like no other.
Economics does go in cycles, and periods of excess are inevitably followed by periods of enforced restraint. There has been a prolonged period of extravagant excess, which has resulted in asset prices - particularly property - being elevated to unsustainable levels by a huge bubble of credit. We are now seeing a harsh process of asset price correction which has destroyed that illusion of wealth.
No, says David Kauders, a partner at Kauders Portfolio Management
There is a widely used long term statistical argument that says shares always go up. I believe this no longer holds true. In the great post-war inflation, governments were able to encourage banks to lend more, creating more credit which drove asset prices upwards. As a result, the price of assets which ultimately depended on the supply of credit rose in tandem with the long rise in inflation, thus creating the greatest bull market ever known. If prices did slip back, they always recovered to new higher levels as new money flowed into the market.
The current banking crisis has changed this experience. This predicament is about lack of lending, rising bad debts and an inability to continue paying ourselves more than we earn. Governments are printing money in the twin hopes of expanding the economy and creating inflation, but the financial system seems unable to transform that cash into increased lending for businesses and consumers. And who will now volunteer to borrow more, unnecessarily? Instead, families are likely to draw on their savings, which means that investments will be sold for cash rather than saved for the future. Inflation is not a danger because of the weight of existing debt, and therefore the driving force that led to ever-higher share prices is over.
Conditions have fundamentally changed from those that led to the comfortable conclusion that share prices rise in the long run. Every bull market, in which prices rise, is followed by a bear market, in which prices fall. Investors should never lose sight of the fundamental point that markets are cyclical.
In the last great bear market in the UK, from 1972 to 1975, the driving concern was rising inflation. Then, the index in London (the FT 30, since superseded by the FTSE 100) fell by three-quarters from peak to trough. Going back as far as Wall Street in 1929 to 1932, when the market was driven by deflation, the peak to trough loss for the Dow Jones was nine-tenths. More recently, the Japanese stock market has lost more than 80% since its high point of 19 years ago.
At a stockmarket peak, price to earnings ratios are high (typically 20 to 50) and dividend yields low (typically 2% or 3%). In a market trough the opposite happens. Price to earnings ratios are in low single figures and dividend yields in double figures. During a bull market share prices rise faster than dividends, whereas in the bear market the exact reverse occurs.
Sentiment at a stock market peak has most people believing in the power of the market to deliver rising capital values. There are plenty of buyers and few sellers. Conversely, at a stock market bottom, opinion turns against investment, leaving sellers with insufficient buyers to counterbalance them.
Since we are now locked into a major bear market, it follows that there is little point in investing in shares. Investors should guard their cash for true market bottom conditions which, I believe, is still some years away. Not only are equities precarious, but schemes that try to play the short-term trends are very high-risk.
There will be a historic buying opportunity ahead in stock markets, but only for those who succeed in guarding their capital base from the damage caused by this bear market.
But don't imagine it will stop there. Recovery will follow just as sure as day follows night and, though many will remain permanently scarred by the experience, human enterprise will triumph again - and that means shares.
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