Ten years since the market lows

It’s been 10 years since global equity markets hit their lows on the back of the Global Financial Crisis. The MSCI World Index declined by 48% from its peak in October 2007 to its trough on 3 March 2009. Since then, exceptional monetary stimulus through quantitative easing and low interest rates underpinned a significant rebound with the index returning just over 235% over the past 10 years or just under 13% per annum.
This boost to equity market returns emanated from two sources, namely the recovery in economic growth and corporate earnings as well as the positive valuation effect of low interest rates. The market value of equities normally bears close resemblance to the value of future cash flows discounted back to the present using an appropriate interest (discount) rate. Low interest rates boost present values and this has certainly been the case since early 2009.

Where do we go from here? It is probably safe to say that the boost to values from low interest rates is unlikely to be repeated. Central bank policy rates are already relatively low and while they are unlikely to rise significantly given a benign inflation outlook, we do not anticipate that they have much scope to fall unless there is an impending recession which is not our base case (at least in the next two years). Assuming interest rates stay around current levels, then any gains in market valuations will have to be primarily supported by earnings and dividend growth. As a rule of thumb, corporate earnings will correlate to potential nominal gross domestic product growth (real GDP growth plus inflation). This growth plus prevailing dividend yields suggests long-term average returns of around 7% from global equities. This is of course a broad-brush approach and we anticipate many swings and roundabouts around these numbers over the next ten years. The need for vigilance will be as important as ever.