Market briefing – 14th April 2020
Markets continue to be incredibly volatile, in great part due to the potential significant fall in gross domestic product (GDP) as large sections of the economy are closed down. In light of the potential effect on GDP, consideration will shortly turn to the extent of any bounce back once the lockdown is gradually eased.
Effects of lockdown on the economy (1)
For example, let’s consider the effect the lockdown is having on an individual industry, such as hairdressing. They have lost trade, as we have been stopped from going but once the lockdown eases, we are likely to rush back, causing a possible surge in demand. However, the longer the lockdown remains in place, the more trade hairdressers will miss out with almost no ability to recoup the lost revenue.
The example of the hairdressing industry also shows how the current economic crisis is different to the structural damage the economy experienced in the great financial crash of 2008, when the banking sector was on its knees. So far, structural damage to the UK economy has been limited, as bank reserves are significant. However, the longer we remain in lockdown, the greater the risk of structural economic damage grows.
Also, it is looking more and more likely that we cannot eliminate the coronavirus in the short term. This clearly will have an impact on the length of the lockdown and subsequent bounce back. However, other nations are showing ideas of how greater controls can be put in place to halt the spread of the disease, without resorting to shutting down the economy. The hope is that these ideas will be put in place in Europe and the UK over the coming months.
Don’t focus on the headline numbers
Often, when the return of a stock market index is quoted in the press…
… the quoted numbers show share price returns only (i.e. the price return), the example here being 5,842.66, rather than the total returns. This is potentially misleading, and understanding what figures are shown by the media is essential in counteracting anxiety.
The price return, in our example above being 5,842.66, only takes into account the capital appreciation of the investment, in this case the FTSE 100. Any dividend (the share of the profits generated by a company that someone holds shares in), is ignored. This contrasts with the total return, which takes into account the dividend generated in the investment. Focusing on the share price return is not accurate, nor is it fair. This is because equity investments, such as shares, typically generate returns from two sources:
i. capital appreciation (which is shown as changes in the share price return); and
ii. cash dividends.
In order to have a fair, like-for-like comparison, it is essential to include the returns from both sources. After all, a client would gain a total return performance from owning the asset in question.
“So what”, you may ask?
Share price return versus total return
Using the FTSE 100 as an example, the following chart shows only the share price return of the FTSE 100 for the 20 years between 31.12.1999 and 31.12.2019, with the share price only figure for those dates shown in the green and pink boxes respectively.
Source: FE Analytics (3)
If you had watched a business briefing TV programme, bought a newspaper financial supplement or looked on the internet, on 31.12.1999 the share prices only figure of 6,930.2 would have been shown, and for 31.12.2019, 7,542.44. A growth in the FTSE 100 share prices of 8.83% over 20 years.
But why does this matter? It matters as the financial differences are enormous! And knowing this will help reduce anxiety.
Note what happens when the dividends for these 100 stocks are re-invested on top of the price…
Source: FE Analytics (3)
… the green line still shows the growth in the share prices of 8.83%, but as shown by the orange line the actual growth including the re-investment of dividends – the total return – increases to 122.27%; that’s 13.84 times more than the share price only figure!
That may not seem much, so let’s change the percentages to pounds and look at what would happen if £100,000 was invested on 31st December 1999.
Source: FE Analytics (3)
At the end of the 20 years, based on the share price only figure, the £100,000 is worth £108,834. Whereas the actual, total return with dividends re-invested, would have seen the £100,000 grow to £222,271. An enormous difference in returns of £113,437; more than double the amount in cash terms than the share price only figure.
However, it is important to remember that when a company’s profits are down, they may reduce or even suspend their dividend. Consideration also needs to be given to some companies being unable to survive the current financial situation. A great example of ‘not putting all your eggs in one basket’. It should be noted that the figures displayed in the graphs above include similar challenges and show how the market has recovered.
So, when the media and press quote stock market figures, remember they are quoting the share prices only. This is misleading, since, it is the total return that is the only thing that matters, irrespective of whether that return is generated in the form of cash income (dividends) or in capital appreciation (share price). For example, if you hold a stocks and shares ISA, or a pension, you are interested in the total return, as you, the investor, hope to benefit from the increase in share price and any cash income that could be produced.
As we have seen, the difference between share price only and total return is enormous in cash terms. Yet the media rarely speaks about dividends. We need to remember that when it comes to shares and their graphs, share prices (which is what the media publishes!) make all the headlines. We need to include dividends on top, as dividends produce the real returns and reflect a far more accurate picture. Knowing this when you see dramatic headlines will help you to remain focused on the real, long-term returns of your investment.
Continue to keep calm
It is true that the short-term horizon is extremely uncertain due to the unpredictability of this situation. However, it is important to remember that we very often have a long-term investment time horizon.
We will continue to monitor the current financial situation and keep you notified of any changes that are made. Please seek professional advice if you wish to discuss your financial situation further.
(1) Square Mile Investment Services Limited
(3) Financial Express
This publication is marketing material. It is for information purposes only. This statement is for the sole use of the recipient to whom it has been directly delivered by their Foster Denovo Partner and should not be reproduced, copied or made available to others. The information presented herein is for illustrative purposes only and does not provide sufficient information on which to make an informed investment decision. This document is not intended and should not be construed as an offer, solicitation or recommendation to buy or sell any specific investments or participate in any investment (or other) strategy. Potential investors will have sought advice concerning the suitability of any investment from their Foster Denovo Partner. Potential investors should be aware that past performance is not an indication of future performance and the value of investments and the income derived from them may fluctuate and they may not receive back the amount they originally invested. The tax treatment of investments depends on each investor’s individual circumstances and is subject to changes in tax legislation.