The overstretched Noughties
Dec 24 2009 By Trevor Law
Stock Market investors have had a frustrating decade, with developed market equities underperforming government bond markets and equities scarcely making money on an absolute basis, even before allowing for inflation.
This pattern was seen in most developed stock markets. That £1 invested on December 31, 1999, when the FTSE 100 reached its all-time high of 6,930, was worth just 75p at the end of November of this year. The return rises to £1.04 if dividends were re-invested.
Meanwhile, investing in Gordon Brown would, perhaps surprisingly from today’s point of view, have been better than investing in the real economy with a return from gilts of 40 per cent.
No doubt some of this gain is thanks to the emergence of the largest gilt-buyer ever: quantitative easing but the real driver for bond growth has been the flood of pension-fund money as trustees have been forced to cover long-term liabilities with low-risk investments. This process has also reduced the activity levels of some of the biggest equity buyers in the market.
If the financial markets do indeed work to the cycle of fear and greed, the last decade can be described in terms of fear, greed and fear again. First fear as the dotcom bubble burst, contributing to plunging of share prices until March 2003. Enron and other corporate scandals highlighted the excesses of the previous decade, followed by lengthy jail sentences for some top executives.
Then cheap and plentiful credit began to lift all boats once more, as the global economy went on to enjoy its strongest GDP growth since the Second World War from 2004 to 2007 and US corporates their longest period of successive quarter-on-quarter profits growth.
The effects on the financial markets of low interest rates from 2001-2005, with product innovation by the financial sector, was astonishing. Financial institutions were able to offer complex packages of high-risk assets, which might have been geared at various levels, to investors who were searching for the higher yield they offered because their bank account or government bond returns were so meagre.
It was not just buyers and creators of financial assets that borrowed excessively in their belief that a brave new world of high debt levels could be sustained. Households reached record levels of borrowing in the US and the UK, fuelling house-price inflation. Meanwhile, in the UK, then-Chancellor Gordon Brown oversaw the emergence of what has become a serious budget-deficit problem as he borrowed to pay for greater public spending.
Stock markets boomed, particularly the emerging markets which were supported by strong underlying GDP and profits growth. By sector, natural resources outperformed on the main markets as tight demand and supply characteristics came to the fore. In the UK, mid-cap stocks outperformed, thanks in part to takeover activity as continental companies looked to grow in the UK.
A new period of fear emerged slowly in 2007, even as stock markets reached their cyclical highs. As the US property cycle began to weaken, fraud was uncovered in the mortgage market.
As defaults rose, particularly in sub-prime mortgages, owners of financial products that contained the debt found that there was no-one to sell
