CITI: The Rise And Fall Of The Equity Cult


Photo: Citi Investment Research & Analysis

The Financial Times had two pieces this week talking about the “death of equities.”Barron’s Michael Santoli offered his rebuttal on Saturday saying that the FT’s observations where late and the ultimate conclusions tend to be faulty.

But the most thoughtful and comprehensive examination of this call was a meaty 28-page report titled Equity Cult Still Dying published on May 9 by Robert Buckland, Citi’s brilliant Chief Global Equity Strategist.

In this report, we revisit the cult of the equity. We find that it continues to look sickly, if not dead, across the world. Emerging Markets remain a notable exception. This is not necessarily bearish for global share prices, but does suggest that a meaningful rerating is not imminent. Perhaps the greatest hope for a recovery in the equity cult is an intense bear market in bonds. But perhaps we should be careful what we wish for.

The Rise Of The Equity Cult

In the late 1950’s, all of the conditions were just right to spark a massive global shift into stocks from bonds.  The FT and Goldman Sachs Peter Oppenheimer would tell you it happened in 1956 when Ross Goobey, the manager of UK’s Imperial Tobacco pension fund, rocked the world when he said stocks provided better long-term inflation adjusted returns than bonds.


Photo: Citi Investment Research & Analysis

Buckland writes that it was actually the groundbreaking work of Nobel prize winning economist Harry Markowitz, the father of modern portfolio theory.The rise of the equity cult coincided with the rise of modern portfolio theory. Harry Markowitz provided equity cultists with their most powerful preaching aid; that a diversified portfolio of individually risky equities could be constructed to maximise return and minimise risk.

The combination of Markowitz’s theory, the Ross Goobey moment, and the extraordinary real returns in the stock market (the 1950s was the best decade for real returns in the 20th century), ignited the beginning of the cult of equity.

As you can see in the chart above to the right, pension funds aggressively shifted their assets into stocks in the 1950s.

And stock and bond valuations, based on yield, switched places in 1958.  This trend lasted for 50 years!


Photo: Citi Investment Research & Analysis

The Fall Of The Equity Cult

As you can see in the charts above, pension funds have been shifting out of stocks and valuations crossed again.

Buckland goes through all the reasons why the equity cult has come under attack:

…Most importantly, the returns from equities have collapsed. US real annual equity returns in the 2000s were a miserable -3.5% while bonds returned +4.0%. Performance chasers have been switching back to bonds accordingly.

Pension funds saw equities as a less clean fit with their maturing liability profiles. Index-linked bonds offered a better inflation hedge. The rise of defined contribution pension funds, where individuals take on more of the return risk, has generally encouraged more cautious investment strategies, which tend to minimise equity exposure. Even modern portfolio theory has been questioned by the recent financial crisis. Rising correlations across equity markets have diluted the apparent benefits of diversification.

Death Of Equities

The shrewd Buckland recognised that writing this report would bring out the contrarians who would cite the last time there was a call for the “death of equities.”

After all, Business Week famously put “The Death Of Equities” on its front cover back in 1979 just as the S&P set off on a 20-year bull run. If, instead of buying that copy of the magazine in 1979, an investor had put the $1.25 magazine cover price into the S&P instead, then it would have been worth $33 in 1999. That’s a serious opportunity cost.

Having said that, Buckland believes that the unfavorable underlying secular fundamentals of the market may trump all of that contrarian-ness.

The building blocks of the last equity cult remain elusive. Equities have not put in a decade of strong performance relative to bonds. The legacy of the financial crisis means that equity-friendly economic growth is less evident. Baby boomers are retiring. The TIPs market offers a more obvious inflation hedge. Modern portfolio theory is not such a compelling marketing tool. Equities are not especially cheap (on a straight dividend yield basis; they look better if we include buybacks).

Here’s a summary that Buckland supplied


Photo: Citi Investment Research & Analysis

Hope For Stocks?

Buckland believes that the “best hope” for a comeback in the equity cult is the fact that bonds look expensive.  “The current combination of investor risk aversion and QE-influenced financial repression leaves bonds looking pricey,” he wrote.

There’s also the matter of Tobias Levkovich, Citi’s top U.S. equity strategist, and his”Raging Bull” thesis saying that improving housing prospects, increasing energy self-sufficiency, favourable demographics, and the US manufacturing renaissance will be bullish for U.S. stocks at least in the medium-term.

Buckland acknowledges Levkovich’s thesis but argues that “a return of the equity cult is not needed” to fuel the “Raging Bull” rally.  The equity cult represents a much deeper and much longer-term trend.

For now, Buckland ultimately believes that the U.S. equity cult is not yet dead. Just sick.

Unfortunately, this can’t be said for some other countries.


Photo: Citi Investment Research & Analysis

SEE ALSO: CITI: These 6 Trends Should Make You A ‘Raging Bull’ On America >

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