European shares look good

Stocktake:EQUITIES will trump bonds and cash over the next five years but returns are likely to be well below historical norms, according to Barclays' annual Equity Gilt Study.

The 18 per cent rally in global equities since early last year means investors will have to settle for real annual gains of just 3 to 4 per cent, Barclays said. Adjusting for inflation, negative returns await bonds and cash.

The authors note the S&P 500’s cyclically adjusted price-earnings ratio (Cape) indicates a very overvalued market. However, they argue Cape’s 10-year average has been “slow to reflect” the “enduring upward shift in earnings” in recent years.

Nevertheless, the cyclical rebound in earnings in the US is “largely complete” whereas an earnings rebound in European earnings is “more plausible”.

Add in less challenging valuations and higher dividends, and European equities should outperform the US by 1-1.5 percentage points annually over the next five years.

Barclays’ low-return thesis echoes Credit Suisse/London Business School’s Global Investment Returns Yearbook, which last month argued the equity risk premium would fall to 3-3.5 per cent over the coming decades.

A measure of fear

LAST week’s Italian election results led to a 34 per cent surge in the Vix, or fear index, the biggest rise in 18 months and the 11th largest one-day jump in the index’s 24-year history. Is this a precursor to more volatility and a see-sawing market? How have markets behaved following past spikes?

Vix expert Bill Luby ( vixandmore.blogspot.com) notes stocks underperformed over the two months following past spikes, but performed well looking out more than two months.

The results vary widely, however, prompting Luby to note that it is possible to drown crossing a stream that is one inch deep “on average”.

For now, investors are optimistic. The Vix gave up two-thirds of its gains over the following days as US stock gains saw indices close in on all-time highs.

Apple investors push for piece of the pie APPLE’S $137 billion cash pile continues to exercise investors.

High-profile hedge fund manager David Einhorn is battling the company in court as he tries to force it to return more of that cash to investors. CEO Tim Cook dismisses the suit as a “silly sideshow” while adding that Apple is in “very, very active” discussions on cash.

Last year, Apple announced it would return $45 billion to shareholders over three years, through dividends and share buy-backs. However, it’s not enough – Apple has already added $40 billion to its cash pile since then.

There have also been rumours of a stock split, hedge fund manager Doug Kass tweeting just that last week.

The stock briefly bounced and Kass, having used the jump to pare his Apple shareholding, subsequently criticised the “baseless” rumour. Ethical questions aside, a stock split is a purely cosmetic move; any investor enthusiasm would dissipate in days, perhaps hours.

The issue of Apple’s cash pile will not go away, given it now accounts for 33 per cent of its market capitalisation.

However, the current situation is not unprecedented, notes Bespoke Investment Group – Apple’s cash pile accounted for more than 50 per cent of its market cap between 2001 and 2003, and hit 37 per cent during the financial crisis.

The dividend factor 

THE Barclays study also contains fascinating data on equities’ long-term performance. In the UK, equities have outperformed cash in 75 of the past 112 years, giving a 67 per cent “beat rate”. That rises to 90 per cent if one extends one’s holding period to 10 years. Investors must reinvest dividend income, however.

Here are the figures: £100 invested in 1899 would be worth £12,782 in nominal terms today, or just £168 after adjusting for inflation, if one did not reinvest dividend income. Those who reinvested, however, would have seen their portfolio soar to £1,837,824 in nominal terms, or £24,184 in real terms.