Equity Gilt Study
The Equity Gilt Study has been published continuously since 1956, providing data, analysis and commentary on long-term asset returns in the UK and US. This publication contains a uniquely long and consistent database: the UK data go back to 1899, while the US data – provided by the Centre for Research in Security Prices at the University of Chicago – begin in 1925. We also use the Equity Gilt Study as an opportunity to analyze medium to long- term market trends.
Chapter 1 considers whether the eurozone is moving toward Japan-style deflation. Our assessment is that the verdict is still out, but the risks are higher than market pricing or policymakers suggest. ECB policy is starting to look too tight and bank lending has yet to improve. True, the asset price shock, demographic dynamics and exchange-rate trend are less acute than they were in Japan, but tight fiscal policy, ongoing internal devaluations and global disinflationary pressures are adding to the eurozone’s deflation risks.
Chapter 2 introduces a new valuation metric for stock indices that accounts for differences in sectoral composition across countries. A country whose equity market contains a high proportion of companies in sectors that attract low multiples may appear more inexpensive than it would be if it were analyzed on a sector-by-sector basis. Applying the sector- and cyclically-adjusted PE ratio (SCAPE) renders US equity valuations more attractive relative to other countries, which tend to have a larger share of companies in the financial sector and a smaller share of technology firms.
Chapter 3 looks at the economic implications of demographic change. In China and much of the economically advanced world, population growth is decelerating and dependency ratios are rising. These dynamics are set to stress fiscal sustainability in advanced and emerging markets and could complicate the debt dynamics of southern Europe and rebalancing in China. They could also tilt the terms of trade in favour of labour income relative to profits in the US. But we do not expect these dynamics to create strong deflationary tendencies.
Chapter 4 considers the cost of evolving bank regulation which has mandated capital structure changes to boost industry safety. It argues that regulations aimed at shifting the balance between sources of wholesale funding should not increase the average cost of funding for banks. However, reforms that raise capital requirements as a percentage of the balance sheet could constrain the ability of large banks to interact efficiently with clients, creating a cost that would be passed on to various stakeholders. We suggest that these costs be weighed against the safety and soundness benefits.
Chapter 5 focuses on the future of US housing finance, which continues to be explicitly or implicitly guaranteed by the US government. We estimate that $400-450bn of private capital will be needed to transfer the credit risk of all government-guaranteed mortgages to the private sector. Thus, a complete government retreat will need to be orderly and, in our view, spread over at least 10-15 years.
Chapter 6 examines the investment implications for economies shifting into reflation or deflation, with an emphasis on Japan and Europe.
We sincerely hope that you find the data and the essays interesting and enlightening, as well as useful inputs to your investment decisions.
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