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Sun 10 Jan 2010 04:00 AM

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Taking stock

Even the most practiced soothsayer will struggle to make any predictions for the next decade, says Matthew Lynn.

Taking stock

Even the most practiced soothsayer will struggle to make any detailed predictions for the next ten years. It's hard enough to know what will happen in the markets in January 2010, never mind December 2019.

The main thing investors need to know about the coming decade can be summed up in one of those pithy Twitter updates. Will it be good or bad for stocks? Everything else is extraneous.

The answer? Good. A shortage of capital from any source other than the stock market; moderate but persistent inflation; and the probability that economic growth will be stronger than many economists expect means that "the 10s" will be a time when equities start to have some rocket fuel in their engine again.

Stock markets usually work in decade-long cycles. The "noughties" were bad for shares. Most of the major markets didn't manage to make any progress at all over the course of the whole ten years. The UK's FTSE-100 index, for example, hit a record of 6,930 in December 1999.A decade on, it is now at about 5,300.

Likewise, Germany's DAX index passed 8,000 in March 2000, but is slightly less than 6,000 now. It doesn't make much difference what benchmark you look at.

A few emerging markets aside, they all had a dismal decade.

Leaving aside the simplistic point that every run of under-performance by any asset class usually comes to an end sometime, there are three solid reasons for thinking that this decade will be a lot better for stocks than the last one.

First, there will be a shortage of capital. One reason why equities performed so miserably during the last decade was that companies, and their chief executives in particular, really didn't need shareholders very much.

Remember, a stock market is just a place where you can raise money for building new factories, shops or warehouses. But in the last decade, if you needed cash, there were lots of people who would give it to you: a bank, the bond market or a private-equity firm. So why bother looking after a lot of irritating shareholders when you didn't really need anything from them?

In the coming decade, that will change. Capital will be in far shorter supply. The only place many companies will be able to raise money will be in the equity markets. The result? Companies will have to make sure their shareholders are being well looked after - and that means steady dividends and a rising share price.

Next, inflation. There are plenty of people out there - most of them gold enthusiasts - predicting hyperinflation. That might happen eventually, if central banks keep printing money like crazy. There is another stage to get through first: moderate, persistent inflation in the five to six percent range.

That's pretty good for equities. The big, multinational companies that dominate the main indexes can usually lift their prices along with the inflation rate.

So long as they can do that, they can keep profits and dividends ticking over nicely, roughly in line with price gains.

In that scenario, equities will be one of the few asset classes that can be depended upon to keep up with inflation. Even better, they should get an additional boost as investors switch their money out of bonds - that get hammered by inflation - to protect themselves against price increases.

Finally, there will be a growth surprise. Given that we have just been through the worst financial crisis of the last half-century, people are pretty gloomy about the global economy right now. And, in fairness, there is plenty to worry about: a damaged banking system, the demise of the dollar, and huge government deficits.

Even so, let's maintain some perspective. Earlier generations overcame famines, plagues and world wars, so a few dodgy banks and some deficits hardly seem that bad.

The chances are that growth in the new decade will give us a pleasant surprise. There are plenty of reasons to be optimistic. As Zurich-based UBS AG said in a recent research note to investors, global population in the next three to four decades will grow by about three billion, mostly in the emerging markets where incomes and consumption are rising rapidly. That will act as a powerful spur to the global economy, even if it will put a huge strain on the environment.

The developed economies have big potential to increase the number of people in the work force if they overhaul their welfare systems. The looming fiscal crunch might well be the trigger for finally making that happen. That, too, would be an economic boost.

And technology, the main driver of innovation and progress, shows no sign of slowing down. If anything, with so many more smart people being born, it should speed up. That's another reason growth should accelerate.

Of course, there will be plenty of choppy economic water ahead. Some more banks may crash, the dollar might implode, and a war or two might be fought. Even so, the stage is set for a great decade for shares. The FTSE, the DAX and the other global benchmarks should end 2019 higher than they started in 2010.

Matthew Lynn is a Bloomberg News columnist. The opinions expressed are his own.

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UK 10 years ago

For discerning investors, stock market is always good, as history has shown. I understand stocks have out-performed all other asset classes. And if one is talking about a time frame of a decade, I must say the outcome would be "too good". The trick is to identify sound companies and remain invested.