"Melt-up" was a popular phrase among year-end commentators looking at 2018 stockmarket prospects.
This should not be surprising: meltdown is often the equally emotional response to irrational enthusiasm for stockmarket investment, which may well happen this year or next on the back of the second-longest bull market in US history.
As commentator John Authers wrote in the Financial Times: “Unless the economic data cruelly misleads us, the world economy has reached a point where it can grow in a strong and co-ordinated way. The data admits little other interpretation (even if US job growth is slowing as full employment nears). The world has not looked so well poised for growth in at least a decade.
“And the desperate monetary policy measures that central bankers used to stave off a second great depression look as though they might allow the world economy to take off again without having to endure a crash or a bout of hyperinflation first.”
Avoiding unnecessary risks
Knowing that asset prices are high, and are going higher yet in a ‘melt-up’, is one thing. But avoiding the meltdown is key for investors concerned with the long-term growth of their savings. If a market slump turns 100 into 50, that 50 has to double in value to get back to its starting level, which may prove a whole lot harder.
There have been significant melt-ups and meltdowns over the past 20 years, and January’s column examined the performance of 10 ‘dividend hero’ investment trusts over this period. All avoided the traps, producing not only a dividend income nearly comparable with the capital invested, but also trebling or quadrupling that initial investment. This is what positive compounded returns do for investors.
Table 1 shows those same investment trusts, this time alongside their initial dividend yields, and their actual annualised returns 20 years later. Scottish Mortgage, with its emphasis on technology, and F&C Global Smaller Companies are the two outstanding winners over this period, but all did well.
Even Alliance Trust, burdened for most of the period with high board costs only suitable for a large and successful financial services company, produced results that most unit trusts can only envy.
Keeping investment simple
Therein lies a lesson for all investors. These investment vehicles, incorporated under company law that enables them to keep back profits against future ‘rainy days’, have remained true to their Victorian founding precepts. These are to identify firms with strong cashflows, supported by solid business prospects, willing and capable of paying a rising dividend, and then to diversify internationally to avoid the risks inherent in any one economy or region. In other words, invest for annual income and not capital growth.
These principles built, over 150 years, the enviable success of Genevan private banks and their British equivalents, the partnership stockbrokers. But then came the computer, and shortly afterwards the university professor. These quickly showed that markets were efficient, and that no one could beat them.
