Richard Northedge

Investment

Fifty years on, the yield gap reverses

Next year will be a good one for anniversaries. A century since Lloyd George’s People’s Budget, 60 years since Attlee’s devaluation, 25 since inflation swept away the ha’penny coin and £1 note. And it’s the golden jubilee of the reverse yield gap.

Yet the reverse yield gap will not be present at its own celebrations. This pillar that has supported the basis of equity investment for the past half-century has suddenly disappeared. Since 1959, shares have consistently yielded less than gilt-edged stocks. But now it is government bonds that are again paying the higher return. The reverse yield gap has reversed.

Until that day 50 years ago, when Cliff Richard and the Shadows topped the hit parade with ‘Living Doll’ and the Mini had just been launched, it had been carved in stone that shares yielded more than gilts. To the Victorians and their successors, it was obvious there had to be a yield gap: equities were riskier than government stocks. Their return thus had to reflect the associated dangers.

It was inflation that undid the argument and George Ross Goobey, head of Imperial Tobacco’s pension fund, who recognised the fallacy. Inflation undermined the value of gilts so that the sum redeemed on maturity bought far less than the capital originally invested. And inflation would raise company profits over time, allowing dividends to be increased. The traditional yield gap should thus be turned upside-down: gilts needed a high coupon to compensate for their erosion of spending power and their fixed income, while investors should accept a lower initial yield from equities because the dividends, as well as the share price, would rise. The ‘cult of the equity’ was born.

Through thick and thin thereafter, equity yields remained lower than gilt returns, even during market crashes.

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