Look, I Am Not Your Father’s Market…
June 7, 2016
Image used with permission: iStock/LeventKonuk
Look, I Am Not Your Father’s Market…
OK, so that may be a mash-up of two quotes from the 1980s (more on that later), but it captures the essence of the point. Times change, investment markets change – investors need to ponder and adapt as well.
Over the past decade, interest rates have declined dramatically and the investment landscape has changed. Ten years ago, the Government of Canada 10-Year Bond yielded just less than 4.5%.1 By today’s standards, 4.5% was nirvana. The Canada 10-Year Bond today yields a skinny 1.3%. To be clear, this means that if you give your savings, say $100, to the good Government of Canada, they promise to pay you $1.30 per year for ten years and then give you your $100 back. Oh, if you are a taxable investor and anywhere near the top income tax bracket, you have to repay about half of the $1.30 in taxes annually. In addition, the Bank of Canada has been empowered by the Canadian Government to cause an average of 2% inflation per year, such that the $100 you get back will be worth only about $81.70, measured in today’s purchasing power and assuming the BoC actually does its job. Does that look like a good deal?
Equities are another matter. Ignoring their favourable tax treatment and any potential growth they offer, and just focusing on the income component of equities, ten years ago, Canadian stocks yielded (as dividends) about 2.2%, or less than half of the “safe” 10-Year Bond yield. Today, the dividend yield on Canadian stocks is 3.1%, which is more than double that of the 10-Year Bond. Talk about a complete reversal! This reversal is common across all developed countries. Less economic growth, older demographics, more caution and that’s what you get.
Put another way, you now need to hold the Canada 10-Year Bond for almost 2 ½ years in order to match one year of the average Canadian stock’s dividend yield (before tax – the period after tax is longer). Many other countries fare even worse than Canada by this measure. As shown in the exhibit below, the U.K 10-Year bond needs 3.3 years to match one year of the average U.K stock’s dividend yield. Across Europe, on average, it would take a stunning 26.5 years. In Japan…. oops, the number is infinite, as the 10-year Japanese bond yield is actually negative compared to a healthy 2.0% dividend yield for the average Japanese stock. The U.S. has the “best” time to breakeven income of 1.3 years, but its dividend yield and bond yield have also completely reversed over the past 10 years.
What does this mean? Simply put, bonds no longer offer “safe” income. They may have less volatility, but, if inflation continues, they offer negative real income. Stocks on the other hand, while more volatile in the short-term, provide better income that is taxed at a lower rate and offer the long-term prospect of growth and inflation protection. To paraphrase Jim Grant, the risk-free return from bonds has become return-free risk. The apparent riskiness of equities in the short-term is actually the lower risk asset class over the long term. The usual caveats apply – stocks are not suited for everyone and “all stocks” are suited to only a few. For the rest of us, some combination of stocks, bonds, cash and other investments (such as your house), is the appropriate solution. It comes down to finding the right combination amongst these that works best for you.
Now to those mashed-up quotes in the title. “Luke, I am your father” is from the 1980 movie Star Wars – The Empire Strikes Back… or maybe not. This is supposedly the top movie misquote of all time, according to a poll conducted by LoveFilm in 2009. As part of a conversation, Darth Vader actually tells Luke “No, I am your father.” Close, but no cigar. Other top movie misquotes include “Play it again, Sam” (Casablanca, 1942), “Beam me up, Scotty!” (Star Trek, 1979), “Do you feel lucky, punk?” (Dirty Harry, 1971), and “Frankly Scarlett, I don’t give a damn” (Gone with the Wind, 1939). One close to the heart was “Mirror, mirror, on the wall, who is the fairest of them all?” (Snow White and the Seven Dwarfs, 1937). What… how can that be? I acted in my grade school play and I was the Queen. I’ll leave it to you to google the correct quotes. Some only differ by a word, while others are heavily re-imagined, although they manage to convey the gist of the quote.
The other component of the title mash-up, “This is not your father’s Oldsmobile”, comes from the epically misconceived GM ad campaign that kicked off in 1988. Oldsmobile had been a trusted, American-made car for Americans with American values. Oldsmobile was gaining share in this market segment. The challenge for GM was that the target market was getting older and smaller. Unfortunately, the new message alienated Oldsmobile’s existing customers and reinforced for the younger demographic that Oldsmobile had a stodgy image. Oldsmobile continued to deteriorate, but it took another 16 years before GM finally killed the brand in 2004.
Like I said, investment markets change and investors need to adapt. Luke adapted and survived. Oldsmobile didn’t quite “get it” and things didn’t end well. As for Darth Vader… well, I guess the message is that, unless you want your arm chopped off, be nice to your kids.
1.The data in this article is drawn from “In search of safe income”, by Matthew Barasch of RBC Capital Markets (May 16, 2016).