British stocks are likely to deliver the world’s best returns over the next decade, according to a widely followed U.S.-based money manager. Patient investors who can stomach the risks around Brexit may want to pay attention.
All things being equal, British shares are poised to deliver annual total returns in local currency of about 5.9 per cent after inflation over the next five to 10 years, according to calculations published this week by AQR Capital Management in Greenwich, Conn. By way of comparison, it figures U.S. stocks are likely to produce after-inflation returns of only about 4.3 per cent a year.
AQR, which manages US$196-billion in assets, is renowned for its deep numbers-based dives into market trends. According to its models, the stock markets with the best expected local real returns over the next five to 10 years are Britain, followed by Australia (5.5 per cent) and emerging markets (5.4 per cent). Canada is middle of the pack, with a 4.5-per-cent expected annual real return.
There is, as you might expect, a lot of uncertainty around such forecasts and AQR emphasizes that no one should bet the farm on its latest capital markets projections. Still, it is intriguing to see how various markets stack up on some key metrics.
It is particularly interesting because of the relatively modest returns that are likely to prevail in coming years. AQR figures a traditional U.S.-focused 60/40 portfolio, consisting of 60 per cent U.S. stocks and 40 per cent U.S. bonds, will produce a payoff of a mere 2.9 per cent a year after inflation over the next decade. That would be just slightly more than half the 5 per cent payoff that such a portfolio has historically generated.
The math is similar for an all-Canada portfolio and offers a persuasive reason to hunt for better returns internationally.
AQR used two approaches to arrive at its estimates for how individual markets will perform. First, it employed an earnings-based formula that began by comparing today’s share prices with each market’s average annual real earnings over the past decade. Second, it built a payout-based projection that considered the current dividend yield in each market and factored in share buybacks as well.
Of course, no method can see the future with precision and AQR is right to emphasize the limitations of its analysis. Britain’s stock market offers a particularly tricky case for the prognosticators since so much of the near-term outlook hinges on the unpredictable politics around Brexit. A no-deal Brexit could punish the country’s economy by costing it easy access to the European market.
On the other hand, the British stock market offers a lush dividend yield of nearly 5 per cent, well above the payouts common in North America. Its constituent stocks are substantially cheaper than their counterparts on this side of the Atlantic when measured against the earnings that analysts expect them to deliver over the next year. In addition, the British market is home to many large oil producers, miners and global drug companies that should be able to prosper no matter what happens on the Brexit front.
Any deal with the European Union could deliver a boost to the British economy and British stocks in general. “In our view, the most likely [scenario] is that some kind of Brexit deal is agreed within the next six months and a lifting of the uncertainty allows economic growth to rebound later this year and into 2020,” Capital Economics wrote in a report on Tuesday. This is not a bet for everyone, but value hunters in search of an attractive long-term proposition should take a close look at what Britain has to offer.
Ian McGugan