Deutsche Bank: No, We Are Not In A Low Return World

Over the past few years, plenty of analysts have made the case that after the financial crisis, we’ve been stuck in a low return world. The introduction of stringent regulations, bank recapitalizations, austerity, political deadlock, a lack of business confidence and over-easy monetary policy have all been blamed for holding back returns and growth.

However, according to a new research note from analysts at Deutsche Bank, while it may seem as if the world is stuck in a spiral of low returns, compared to history today’s rates and business performance metrics are not that abnormal.

Low Return World? Not Really says Deutsche Bank

According to Deutsche's report, while bond yields today are at 40-year lows, if you go back to the first half of the last century, yields are more 'normal.' Indeed, according to the analysis, in the 65 years between 1900 and 1965, the 10-year fluctuated in a band between 2% and 5% before breaking out over the next 15 years and peaking at 16% in 1981. So, "since 1996 10 year yields and potential returns have simply moved back into the range they were in during 1900 to 1965." Deutsche describes this period as "the old normal" with the 30-year period in between the "aberration."

It's not just the fixed income market where metrics conform to the "old normal." For example, the economic return on physical capital has been at the upper end of its historical range (from 2.7% to 6%) for the last five years:

"The return on physical capital fell to a low of 3.5% during the Great Recession, to about the level where it bottomed in the previous 2001 recession. These two lows were well above the lows seen in prior recessions when the return on physical capital bottomed around 2.7% which defines the bottom of the longer historical range. Following the lows hit during the Great Recession, the return on physical capital rose relatively quickly to the top of the historical range and even slightly above it, briefly hitting 6.8%."

Meanwhile, the return on corporate equity for the S&P 500 of 13.3% is slightly above its historical average of 12.6% despite " the well-known declines for the Financials and recently Energy." Excluding contributions from these two sectors, S&P 500 ROE has been running at "very robust all-time highs" of 18% for the past four years.

And finally, Deutsche's analysts point out that the market return on equities in this cycle of 14% (since 2010) has been "somewhat higher than the average return historically (11%) since 1900."

Overall, the report concludes that the above indicators show we are not living in a low return world.

If anything, returns have moved back to historical averages, and equities have produced returns far greater than they have in the past. That being said, just because equities have put in an above-average performance during the past seven-and-a-half years does not mean that they will continue to do so. As Jamies Montier recently pointed out, over the last 10 years the majority of the market's returns have come as a result of profit margin growth and multiple expansion. Assuming the market's price-earnings (P/E) multiple returns to its equilibrium of 16, down from the current 24.4, and profit margins revert to the equilibrium of 5.7%, compared to 6.9% currently, investors should expect an annualized return of -3.9% for the next seven years.