The NICE decade for equities

Mervyn King, the Governor of the Bank of England, recently warned of “the end of the NICE decade.” NICE is an acronym for Non-Inflationary Credit Expansion, but it was also pretty nice for consumers and governments.

In the last twenty years, the “Phillips curve,” the trade-off between unemployment and inflation, ceased to be a constraint. In the OECD, unemployment has fallen from nearly 8% in 1994 to 5.5% now, despite a temporary pick-up in 2001-3, while core inflation, over 10% in 1988 and still over 4% in 1994, fell to under 2%.

Consumers enjoyed a virtuous circle of falling interest rates and lending margins, greater availability of credit, rising house prices, an expanding economy and rising salaries. Governments enjoyed the benefit of low bond yields, increasing market appetite for debt, rising tax revenues, escalating expenditure and the illusion of economic competence.

That has all changed. Lenders have stopped lending, forcing consumers to stop borrowing and therefore to spend less. The threat of ballooning budget deficits is forcing governments to restrain public spending. Property prices are falling, living standards are under pressure and economic growth is slowing. The virtuous economic cycle has gone into reverse, compounded by the spiralling cost of commodities.

Equity investors, however, missed out on the party. In mid 1998, profits were growing rapidly, Asia and emerging markets were booming, the technology sector was starting to take off and every mega-cap merger was greeted with soaring share prices. Though markets continued upwards until the millennium, that proved to be only the first leg of a ten year roller-coaster. Over those ten years, the 3.5% annualised return of the UK All Share index and the 2.5% return of the S&P scarcely kept up with inflation. The annualised return on the MSCI World index has been 4.7% in Dollars, but only 2.8% in Sterling and 0.9% in Euros.

Bond investors have done rather better, with UK gilts and US Treasuries returning over 5% annualised. So much for the notion of equities for the long term and for the long-term evidence of excess equity returns averaging 4%. The actual figure has been -1.7% in the UK, -2.8% in the US and -1.8% globally.

Warren Buffett once commented that "the mistake that investors repeatedly make is that they are habitually guided by the rear-view mirror and, for the most part, by the vistas immediately behind them." This should serve as a warning not to extrapolate the past 10 years into the next. The economic outlook now is as gloomy as it was rosy in 1998, but equity markets have been progressively de-rated to the lowest multiple for over 20 years.

This leads us to make one very confident prediction: over the next 10 years, equity returns will handsomely beat both inflation and the returns from government bonds. The nice decade for the economy may be over, but the nice decade for equity investors is about to start.

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