The Guarantee of Return on Equity

The Guarantee of Return on Equity

A friend recently posted a question on a group, Quote;

“Are Equities really the best investment for the long run? This is the ‘mantra’ usually given to every new investor by the investment gurus. But is this always true ??? Most countries have had very long periods, during which equities have actually been losing money heavily. The longest period of negative real returns from equities was 66 years (for France), 55 years (for Germany), 51 years (for Japan), 22 years (for Britain) and 16 years for US. Considering the average human 'lifespan of investments' to be around 35 years (starting your career at, say, 25 and ending at the retirement age of 60), long term investments in France, Germany, Japan etc, would thus have not been beneficial to even long-term investors. So the important caveat is – investments are subject to market risks !!!
What about investing in 'up-and-coming' Economies ???An investor in Germany, may have started investing for (say) thirty five years starting from 1900 (when Germany was a rising star), only to see their assets wiped out in the 1940s – due to hyperinflation, as a result of the Second World War. Similarly investments made in recessionary markets like the US may never ever see any gain, for the foreseeable lifetime of even a long-term investor …”
UnQuote.
The question and the observation is certainly very and instead of a rhetorical reply calls for a serious research and treatment of our opinion that Equity pays off in the long run. The question calls for a serious treatment since on it depend our retirement benefits and peace of mind, amidst the cacophony and volatility of the markets.
By simply requisitioning Google or Wikipedia, one can instantly get information of all the countries on the two sides before during and after the WWI and in a war that consumed 7 million civilians and 9 million soldiers . It is not difficult to further estimate the economic loss to  property and the damage to the economy of the countries that were involved in the war. Loss was also incurred by the countries that were not directly drawn into the war. As their economies that depended on exports of agricultural and meat products did not have any takers.
Since our goal here is not to discuss the political upheavals, rather the economic returns we will only try to limit ourselves to the conditions that affect the economic conditions and these unfortunately means everything.
It is impossible in the matter to time and again not think of “Wealth of Nations” by Adam Smith. One may not even need to read it but when one just thinks logically regarding how a Nation’s wealth would get built with time one would start to understand the issue at hand.
The wealth of a Nation is dependent upon the economic activity that its citizens carry out both internally and  externally (export the product and services to other countries),under congenial conditions provided by its own government and the government of those countries with which it is  interacting ( or carrying on trade with).
Here the “congenial condition” is an important word. It signifies conditions that are favorable to economic activity. It may be possible that the trade between two countries may be suspended due to poor political conditions, but the requirement for certain items may still exist. Under such conditions, a third country is drawn in the equation which serves as a transit point for “exchange of goods” for both countries. The goods in such case may become expensive for both countries to import, but the trade can carry on nonetheless.
However under normal conditions a country may progress up the economic curve by simply carrying on its economic activity. The government sometimes tries to get the share of the pie , by starting its own industrial and commercial enterprises and competes with private companies of the countries in a fair or unfair manner. This becomes unimportant as the net assets of the country rises in any case. Agriculture, Industrial, Financial and Service sectors keep adding to the wealth of the nation month after month and year after year… under normal and favorable conditions ( like we say in chemistry NTP and STP conditions).
Now sometimes the conditions do not remain so normal or standard. E.g.

·         A country has a famine condition due to failed seasonal crop due to “Acts of God” like floods, Tsunami, failed rains, epidemic for humans, livestock or the crop itself. This a country is able to cope up with by importing the crop from other countries or on back of it’s buffer stock. The dent caused due to agricultural income loss may be compensated by the industrial or service sector, and the national wealth may not be affected much in the long run. In fact it may even grow further due to flourishing Industrial sector or Financial sector growth.

·         Slow down in the growth of the countries to which exports were being made. Hence the Rate of Increase of Growth may be affected temporarily.

·         Internal disturbance in country lie a civil war, rebellion causes a large scale destruction of national wealth just like the natural factors. In fact the damage may be much more to the economy as the infrastructure for producing and transporting goods  (factories, roads, railway lines , airports) may be damaged beyond imagination and prevent an immediate economic recovery.

·         External War with one or more countries. This is the most serious of the conditions . As in these conditions the whole nation starts to concentrate on the war and all productivity of the country comes to an actual halt. In quite a few countries the entire machinery starts getting used to make equipment for war and hence other productive manufacturing becomes zero. Due to exchange of fire cities, villages and towns get wiped out taking with them all the means of economic wealth generation and distribution. Eligible Human resource is diverted to the battle ground both at the front and the support system for the war. Food ,commodities  and other inputs of economic activity become expensive for the civilian population due to government procurement at elevated prices- hence the inflation- rather flares up.

·         The picture in case of war is generally well imaginable as everything wrong happens and even after the war the recovery is not easy as would be in case of a natural disaster. A decisive loss for the loser results in it paying a heavy reparation or “fines” for the loss.

This was precisely what happened in Europe, Japan and Turkey in WWI and WWII.

I agree with my friend that Germany (not in its modern geographical version) was a virtual economic powerhouse at the turn of 1900s. But the war that ensued completely destroyed it as it did England , France, Italy and Bulgaria too and many other countries. After the first war Germany was made to pay for the war in terms of A,B and C bonds, which it could not pay fully and was the main reason for the loss of self esteem of Germans.

This further impoverished Germany and led to the rise of nationalism and Hitler and further WWII.  This further impoverished England, France, Poland, Yugoslavia etc. I am again not going into the political details, rather simply stating that entire Europe virtually was under war from 1918 to 1945. During this period there were no producers, no major production, no major exports or importers and consumers as the war had it’s allies even in Asia and Africa who were being forced to support the war in terms of men and material and food. In essence the entire world came to a stand still. There was no creative production or economic growth in most part of the world except the US on whose land the war was not being fought.

Now to come back to the question of my friend. What is the guarantee of the suggested growth in equities in India or other parts of the world?

How to know that the corpus that we are collecting for our retirement will actually continue to grow.

Frankly none!!!

I have very often thought and said that the reason we invest in a company is because of our faith in it and its management. Similarly we have decided to invest in India because we have faith in our country and Its peace and progressive policies. When things don’t work with one government we patiently wait and bring another party to power and hope that they will perform for the benefit of the country.

As is the case with present government and expectations with the GST, Land Bill, Labour reforms and Rate reduction. The market went up because the industries expected to grow with favorable policies which would have been evident in the share prices and hence the MF returns.

If our government was to decide on an aggressive foreign policy with neighbors or the developed nations and had it led to a war or a economic blockade. Naturally the economic development would have suffered in the way that I mentioned in the beginning.

FIXED INCOME RETURNS: A question that my friend could have asked was , what was the rate of return in the European countries on the debt instruments or Fixed Income avenues?

How were the government bonds performing?

What was the rate of interest of banks during the era?

What about the private money lenders?

This is another question that we must inspect in close detail t another occasion.

But as would be evident to you immediately that return on such bonds would have been a suspect to say the least as there was a strong case of Capital risk and exchange rate risk in such case.