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Equity rally greater than some of its parts

Andrew Milligan  |  30 Jan 2013Text size  Decrease  Increase  |  

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Andrew Milligan is the Edinburgh-based head of global strategy with Standard Life Investments.


One of the most enduring of Aesop's Fables is the account of The Tortoise and the Hare. In this tale, a sprightly if somewhat complacent hare is pitted against a slow-moving tortoise in a foot race of unequals.

Yet despite the hare's obvious speed advantage, the tortoise comes out on top - serving to highlight the virtues of consistency and perseverance. Of course, this lesson is nothing new for investors in equity markets - some of the most revered stock investors employ a relatively prosaic approach - but that does not stop a celebratory mood breaking out whenever a key index hits a monthly/yearly/decade high.

Indeed, we have seen much rejoicing in recent weeks as the S&P 500 hit a five-year high and the FTSE soared to its highest level for four-and-a-half years. Of course, breaking through psychological barriers will always carry an emotive response, but is the recent price-level-induced euphoria missing the point?

The attractive long-term returns generated by equity markets have historically been the result of a combination of capital appreciation and dividend income. To get a better indication of the real impact of recent market trends on equity portfolios, it is much more sensible to consider total return indices.

This measure not only captures a more accurate reflection of the long-term drivers of equity returns, but may also prove an invaluable tool as we look to track changing corporate behaviour.

So, what do total return indices tell us about the current state of equity markets? Well, for the attentive investor, it has been clear that the combination of dividend yields and capital growth has proven a very powerful source of returns during 2012.

In the US, the S&P 500 index posted a healthy 16 per cent total return, up from just 2 per cent in 2011. This meant that, despite a year of macro ups and downs, the US equity market outperformed all alternatives on a total return basis including corporate bonds, government bonds, and cash.

In the UK, the FTSE 100 index also derived an attractive total return during 2012, with the market up around 12 per cent. This more than reversed the decline in 2011 and was well ahead of the corresponding return from conventional gilts, though below the returns from corporate bonds.

Since the low in equity prices in March 2009, however, the cumulative total return from equities has been more than 100 per cent, while the accompanying returns from government and corporate bonds have been 33 per cent and 60 per cent, respectively.

In Europe, total return indices have not yet reached the extremes seen elsewhere, with the Eurostoxx 50 and DAX indices about 25 per cent and 5 per cent below their record highs, respectively. However, the story at a country level has proven quite remarkable over the last 12 months.

In Germany, equity markets generated a total return of 29 per cent in 2012, while French equities rose approximately 20 per cent. These returns have been ably assisted by a dividend yield of over 4 per cent. In fact, dividends yields now account for approximately 40 per cent of Eurostoxx 50 returns since inception.