Back to the future Part 1

With another quiet day in the markets and after my trip down Memory Lane, today I thought I'd start a Back to the Future series. This of course was also a Film series which started back in and was originally set in 1985 and involved the star Michael J Fox travelling back in time to 1955. In addition in the sequel he travelled forward in time to 21st October 2015 which just happens to be tomorrows date. There is an amusing Wiki page dedicated to the series and this link explores the technology that the film makers guessed we might have by now. So we didn't get the Hover board or the auto drying jacket but we did get the video phone and I'm pretty sure that supermarket frozen Pizzas are a good attempt at dehydrated Pizzas!

So what's this got to do with investment I can tell you are thinking? Well I thought I would go back in time and reference some old data and then return to the current day to see what it might be able to tell us about the future. So with that in mind I would suggest you might want to revisit the resources page on the site and look up the Global Year Book 2015 which appears in the useful websites section or click the highlighted link to download a copy.

Following on from the UK Vice post this also has a section starting on page 17 titled Responsible Investing: Does it pay to be bad? This comes to a similar conclusion to me, but it might be interesting for you to read in more detail as activist investing can work too. Amongst other things the document then also goes onto look at returns from global assets classes over 115 years back to 1900. This is then repeated for the various countries around the world reaching the UK on page 57.

This shows that in the long run, the 115 years covered here, although that is clearly too long for most folk except perhaps for babies born to day or in the future with the advances in healthcare etc. Any way this shows that the long term real (after inflation) return on UK equities has been 5.3%. Meanwhile over a more realistic investor lifetime taking the 50 year period from 1965 to 2015 the real returns were 6.2% although I think this figure may be distorted slightly upwards by the lengthy bull markets in that period and a consequent boost from a re-rating of equities over the period. So I think the more normal range of real returns to expect would be more like 4 to 5% in normal circumstances unless you are starting from a particularly depressed valuation level.

The importance of the starting valuation and its effects on future returns is highlighted by the returns which have been earned since the year 2000 when valuations were at extremely high levels. This has led to real returns from UK equities being only 1% over the 14 years to the end of 2014 in what could be described as an on going secular bear market as the FTSE has still failed to convincingly break above the levels it traded at in 2000.

So with all the recent concerns about global growth and consequent market volatility, what might the future hold for returns from here? Well for this I'm going to reference a document which was mentioned in the press yesterday and featured in my twitter stream - the Capita Asset Services Dividend Monitor Q3 2015 which you can download here. This shows 5.9%  growth in underlying dividends from UK companies this year and they expect these to reach £84.8 billion by the end of the year which would be up by 6.8%. This is a decent level of growth and is probably above the long term average of real growth in dividends with inflation running at perhaps 1% or less this year.

They do however flag that they expect to see this growth slow to just 3% nominal in 2016 as the effects of recent cuts from the likes Glencore and Standard Chartered feed through. This would put real growth into the 1 to 2% range which I think is more like the sort of rate that one would expect in the long run. Now in case you think I'm making that up take a look at the following graph from the Capita report:

UK Dividends: Source Capita

Looking at the underlying dividends we can see that since the end of 2007 these have grown from around £61bn to the expected £85bn or so to the end of this year. Thus over the 8 years this represents growth of 39.3% which represents an annual growth rate of 4.23%, despite the fall in dividends in 2009/10 and as such represents a trend including both good and bad periods. UK CPI over the same period including this years expected 0.3% 2015 rate (Source: H M Treasury consensus forecasts October 2015) gives an average CPI of 2.6% per annum or 3.4% for RPI. Thus the real dividend growth using CPI has been 1.63% per annum since 2007 or 0.83% using RPI. Thus on the CPI measure of inflation this puts real growth in recent years in my suggested 1 to 2% range or slightly below using RPI. Taking an average of the two inflation rates would give a 3% rate of inflation and suggest that real dividends had grown by 1.23% per annum.

Summary & Conclusion on Future Return Expectations
So lets look to the future to see what we can see. In the Capita report they suggest that the forecast dividends for next year represent 3% growth in nominal terms and the average forecast for CPI for 2106 is 1.7% to give real growth of 1.3%.
They also suggest that the dividend next year will give a yield of 4.1% which as they say means equities have the best
yields of major asset classes. 

Thinking long term this suggest to me that from these valuation levels we can look forward to real (after inflation) returns from UK Equities in line with or around the long term averages of 5 to 6%. This comes from the yield suggested by Capita of 4.1% for next year. So lets say for the sake of simplicity and to be slightly conservative 4% yield to which you can add assumed real dividend growth of 1 to 2% per annum which should give you total real returns in the region of 5% to 6%.

So there you go I think valuations seem fine on that basis at the moment and investing on these terms should be fine for the long term. However, obviously there are some concerns about dividends from some of the larger sectors like miners and oils and we have seen cuts in recent years from Banks and food retailers, but nevertheless dividends have continued to grow overall over the piece. Thus I wouldn't get unduly worried about more cuts although I accept that cover levels have come down a bit in recent years overall, which could crimp growth or make levels of dividend vulnerable in another downturn, but for now the economy seems to be doing fine and is forecast to grow at a similar rate next year.

As ever I guess time will tell in the short term and the long tern is but a series of short terms, but in the meantime relax, let your dividend roll in and enjoy this video about the things we were supposed to have by now according to the makers of Back to the future!