LAST week saw the passing of a significant five-year anniversary where everything, at least in financial market terms, changed forever.
On August 9, 2007, BNP Paribas made the decision to stop withdrawals from three of its investment funds on the basis that it could no longer accurately value the underlying holdings in the wake of the rupturing of the US sub-prime mortgage bubble.
From this date financial markets began to seize up as what started as a relatively isolated incident quickly spread throughout the global financial system.
The ECB responded to BNP Paribas decision by injecting €94.8bn into the banking system to help liquidity. One of the most infamous knock-on effects a month later were the scenes of queues forming outside Northern Rock which started the first bank run in the UK for over a century.
The overriding response from Western central banks to the continuing crisis has been to pump money into the economy in an attempt to shore up the financial system. In the period following the final bursting of the credit bubble in 2007/08 the unintended consequences of this unconventional monetary activity affected virtually every asset class.
An example of this was the inflationary problems that affected commodity prices across the Middle East which resulted in the ‘Arab Spring’.
Financial markets, however, have increasingly come to rely on the regular liquidity injections by governments and central banks. So much so, that investors are turning a blind eye to the effects of this policy on related phenomena such as negative short-dated German bund yields.
We now exist in a world where the financial markets are seemingly oblivious to anything taking place in the real economy. Bond yields in certain parts of Europe signal that a eurozone collapse is still a real possibility, yet stock markets have continued their low volume ascent.
This has been good news for investors in shares as interest rates continue to be kept close to zero. The stock market has become the place to locate capital through necessity, as well as choice, for anyone seeking to derive an income from their savings.
The prolonged economic malaise has meant that the corporate sector has been unwilling to invest for the future and so companies have been using the build up of cash on their balance sheets for substantial share buy-backs and dividend increases.
Data from Capita Registrars shows dividend growth in the UK amounted to 14.5% over Q2 2012. They have forecast that over 2012 dividends as a whole, including special payouts, could increase by 15%, which may yet prove to be a conservative estimate.
As an example, last week Legal & General announced they were increasing their interim dividend by 18%.
The FTSE 100 has enjoyed three sizable rallies in the intervening period since August 2007. Although five year returns may be modest, for those investors prepared to be nimble, it is still possible to make good returns. Investors should remain committed to equities as investing in good quality companies long-term should benefit patient individuals regardless of short-term volatility.
This is especially apparent when reinvesting income. A lot of companies are paying solid dividends having sorted out their balance sheets four years ago. Investors should remember that this income can be reinvested in order to grow the portfolio and it is largely forgotten that historically dividends have provided a significant chunk of investment returns.
