Picture your future portfolio

ANYONE interested in how their investment portfolio might look in a decade or two should read The Longest Pictures, Merrill Lynch’s 102-page analysis of financial markets since 1800.

Europe appears the obvious long-term buy, says the guide. It accounted for 35 per cent of global stock-market capitalisation in 1998, before falling to 22 per cent in May, its lowest since 1989. Relative to German bonds, European equities are at their cheapest in 90 years. Dividend yields, which hit an all-time low of 1.7 per cent in the tech bubble, are now at 4.4 per cent, above their long-term average of 3.9 per cent.

A word of caution: Japan is also a secular contrarian buy “but has been for the past decade”. The world’s largest equity market in 1988, its 44 per cent share of global market value is now 8 per cent, just above 2003’s all-time low.

Good news for bulls and bears

MERRILL’S US stats offer comfort to bulls and bears. A $1 investment in US large-cap stocks in 1824 would be worth $3,642,000 today with dividends reinvested. Returns over the next five to seven years look “fairly promising”, with the SP 500’s trailing price-earnings ratio almost identical to its average since 1900.

However, stock declines are common, the index experiencing negative real returns in one out of every two years since 1871. The current secular bear market began in 2000 and stocks took 20-30 years to hit new highs in real terms after prior secular tops in 1907, 1929 and 1968. “Every equity breakout from a long-run trading range has coincided with a secular inflection point in the bond market,” the report says, so expect returns to be contained until a “good” rise in interest rates is seen.

Dutch bond yields lowest in centuries

THE REPORT notes Dutch government bond yields are at their lowest level since 1517. French yields are at a 260-year low, while Germany’s are at their lowest level in two centuries.

Global equities now yield 3 per cent, below their long-term average of 3.7 per cent but well above 2000’s all-time low of 1.29 per cent. In March, telecom stocks’ percentage of global market cap hit its lowest level ever, and remains below 5 per cent. Energy’s share has declined since bubbling over in 2008 but, at 11 per cent, it remains well above its 17-year average of 8 per cent. Technology’s 13 per cent share is in line with historical averages “but the trend is certainly up”.

Investor optimism stubbornly low

“STRATEGISTS are now more bearish on equities than they were at any point during the collapse of the tech bubble or the recent financial crisis,” says Savita Subramanian of BofA Merrill Lynch, with recommended equity allocations now averaging 49.3 per cent – the first reading below 50 since 1997. Her note, entitled “Wall Street proclaims the death of equities”, says strategists typically recommend weightings in the region of 60-65 per cent. Over the past 27 years, median 12-month returns of more than 30 per cent have followed when the indicator has been this low, Subramanian adds.

Retail investors, too, are wary. Investor optimism has been below historical averages for the past 14 weeks, according to the American Association of Individual Investors’ weekly sentiment survey.

‘Value in equities even if euro fails’

SWISS investor Marc Faber is keen on European equities, saying last week that “stellar companies” have been “dragged down” in France, Italy, Portugal and Spain, where markets are at or below March 2009 lows. “I see value in equities, regardless of whether the euro zone stays or is abandoned.”

While Europe remains a hot issue in global markets, many see China as a likely cause of market dislocation. Last week, worried authorities cut interest rates for the second time in a month. Another famous bear, short seller Jim Chanos, thinks it’s too late. “I’m being conservative.”