Shares beat inflation over 20 years

WITH SIGNIFICANT risks continuing to swirl around financial markets, many people are understandably reluctant to invest. But we should remember that markets always face uncertainty - risk is a fact of life when you are investing.
If we go back 20 years, things were much worse in 1990 than they are now, and markets have done fine since. This year might seem rough, but 1990 wasn't that flash either. I started work in the financial sector in 1990, and I thought I would celebrate my 20th anniversary by looking at how markets have performed since I first put on a tie.
The year 1990 was no picnic for investors, or workers. The unemployment rate was 8.9 per cent, commercial property prices were collapsing, GDP was shrinking and we were in recession.
Inflation was 7.9 per cent and the floating mortgage rate stood at 14.9 per cent. Our sharemarket had halved in value over the previous three years.
Then, just when you thought it couldn't get much worse, in August 1990, Saddam Hussein invaded Kuwait, sending our sharemarket down another 30 per cent.
Soon after, Bank of New Zealand (BNZ) needed recapitalising by the government. Then we went through what the UK is facing now - massive budget cuts to fix a very sick-looking set of public accounts. Our economy, already suffering, rolled over. GDP shrunk by 2 per cent and unemployment went to 11 per cent.
 In the midst of all this terrible news, the New Zealand sharemarket quietly found a bottom in early February 1991 - from memory it was on, or soon after, the day the Americans crossed the border into Kuwait.
People who had the fortitude to invest in shares during this maelstrom of bad news over 1990 have had a good run over the past 20 years.
New Zealand shares are up 320 per cent, house prices by 380 per cent and Australian shares have gained an impressive 565 per cent.
Despite it all, not a bad 20 years
In fact, all assets did well. Fixed income, represented in the adjacent table by six-month deposits, returned 6.8 per cent a year before tax and 4.8 per cent a year after tax, still well clear of inflation which rose 2.2 per cent a year.
Turning to today, what is the chance that returns over the next 20 years will look similar to those over the past 20 years?
Today, like in 1990, investors have plenty they can worry about. Sovereign risk, debt, budget deficits, inflation, deflation, war, weak house prices, rising interest rates, volatile share markets, oil slicks and so on.
It is impossible to predict how all of this will affect markets and future returns, but perhaps when considering the next 20 years, the Malagasy way of looking at the future may offer guidance.
In the English language, we describe the future as being ahead and the past behind us.
In Madagascar they do the opposite. In Malagasy, the future is said to be behind you and the past in front of you - the reasoning being that you can't see the future, therefore it is behind you, but you can see the past, so it is in front of you.
Thanks to Jen Hay, associate professor of linguistics at Canterbury University who outlined this interesting gem on National Radio last week.
The Malagasy reasoning makes good sense to me, especially when it comes to looking at today's markets.
 There is a decent chance that we could experience a Malagasy-type future over the next two decades where returns from markets could be similar to the returns we have seen over the past 20 years. History may well repeat itself.
So, we could be looking at 8 per cent a year or so from shares and property, and perhaps 6 per cent from fixed income. Some readers will recoil at this.
After all, who would invest in shares and property with the expectation of earning a measly 8 per cent return?
I certainly hope to earn more than 8 per cent a year from my share investments. But I know that the market is going to struggle to give me any more than that.
Any extra return will come from picking good quality stocks, and having the patience and fortitude to pick them up cheaply during those inevitable bouts of market weakness, when good companies, like babies, often get thrown out with the bathwater.
If market returns are subdued, an active rather than passive approach to investing in shares will become more important.
Over coming years, an investor who takes an approach of building a portfolio of carefully selected high-quality companies with solid dividends stands a good chance of beating an investor who buys an index fund.
Investors in housing will also need to adopt a value approach. The Reserve Bank is forecasting house prices will be flat in nominal terms over coming years and fall in real terms, after taking account of inflation.
This forecast is obviously based on the fact that prices are still very high relative to household incomes - around five times when they have historically traded around three times.
Perhaps the true reason why so many people are reluctant to invest at present is not so much concern about risk, but more an unwillingness to accept that returns will be lower than they expect, require or want.
But gone are the days of 10 per cent risk-free returns. In 1990 you could earn more than this from a term deposit - there was no need to even bother with shares.
Today, buying a low-risk bond or deposit at a yield of 5 or 6 per cent is clearly not going to net you a 10 per cent return.
We investors simply have to accept this new reality. When it comes to investment returns, 7.5 per cent is the new 10 per cent.
Many investors are still scrambling around chasing rainbows trying to find "alternative" investments. It seems that some people will do anything to avoid buying shares.
But shares still offer reasonable value. Dividend yields are in many cases higher than deposit rates, and are available from good-quality companies that should be able to grow this yield over time.
A considered and careful approach is important. Investors who buy gradually, seek to use periods of market weakness to their advantage to accumulate good-quality companies, take a long-term view and, most of all, have realistic return expectations, can continue to invest in shares with a reasonable degree of confidence. For sure, coming years will see the usual mix of volatility, risk and scary events, but by 2030, 2010 may end up looking a lot like 1990 does today. The future could well be behind us.
Cameron Watson is director, private wealth research at Craigs Investment Partners, based in Tauranga. His disclosure statement is available free of charge under his profile on www.craigsip.com. This column is general in nature and should not be regarded as specific investment advice.