By JOHN SPIERS 21/12/2005
2005 has turned out to be a remarkably successful year for investors. Unusually, every major market posted positive returns and in most cases these were much higher than predicted. By and large, you were rewarded handsomely for taking on additional risk: the top performing market was Latin American equities while the worst were investment grade bonds. In the chart below we compare the total returns in the year to 30th November 2005 of all the major investment classes with their volatilities.
This is exactly the type of pattern that you should expect to see when comparing returns over long periods of time but it is very unusual to see it displayed over one year. Even the relatively disappointing sectors, such as technology stocks, posted large absolute gains. In this climate it is easy to appear to be an investment genius!
| "Even the relatively disappointing sectors, such as technology stocks, posted large absolute gains." |
Despite the big gains achieved by equities since the dark days of March 2003, valuations generally seem still reasonable because corporate profits and dividends have surged. So, even though many of the indicators that often typify the end of a bull market (high levels of takeover activity, a high appetite for risk etc) are now flashing amber, there does not appear to be a great deal of downside risk unless bond yields start to rise.
As we have said in the past, the key to the markets lies in the inflation outlook. Opinions continue to be sharply divided between those who feel that the modest rise in inflation in the face of oil prices doubling is further evidence of the deflationary pressures at work while others point to the rise in asset prices as the bubble that must surely burst. Eventually, both may be proved right.
2005 may have proved to be a vintage year for investors but in other respects it was deeply depressing. In terms of natural disasters it began with the appalling carnage of the tsunami, then continued with the earthquake in India & Pakistan and the havoc caused by the hurricanes. Agreement by world leaders on proposals to control global warming made negligible progress but it is clear to most people that we are already depleting the world’s resources at an alarming rate.
The gap between rich and poor continued to widen and the euphoria created by the Live 8 concerts seem a distant memory now. African agriculture will continue to face heavily subsidised competition from Europe and the USA. Estimates of the Chinese economy were increased by 25%, making it the fourth largest in the world already and well on course to be number one within two decades. This will have major ramifications for the rest of the world.
| "Yesterday Rentokil became the first large company to close its final salary scheme to existing employees." |
Back at home, the government has shamelessly backed away from tackling the long term pensions crisis. Meanwhile, the deficits on final salary schemes have continued to widen despite booming stockmarkets, much of it caused by Gordon Brown’s reckless and retrospective removal of dividend tax credits in 1997. Yesterday Rentokil became the first large company to close its final salary scheme to existing employees and others are bound to follow suit. So, 2006 may turn out to be another good year for the markets but the storm clouds are gathering. Merry Xmas.