David Stevenson: Iran’s demographics back up a strong equity market

This week, I’m going to attempt to make a link between the Iranian stock market and the ideas contained within the latest BarCap Equity Gilt Study of long-term stock market returns. I admit that it’s a bizarre coupling but both provide a strong argument for a) going against the grain, by buying what everyone else is keen to sell and b) investing in line with demographic forces.

Let’s start with the Equity Gilt Study by Tim Bond and colleagues at BarCap (you can listen to my audio interview with Tim and Michael Dicks, head of research at Barclays Wealth, at www.ft.com/moneyshow).

Tim Bond’s concern is that, for much of the last few decades, there has been a surplus of savings – and, by and large, that money has been frittered away on useless stuff such as wasteful takeovers and bidding up house prices. But demographics suggest that, in a few decades, we’ll face a savings deficit as both western baby-boomers retire and the Chinese run into the disastrous consequences of their one-child policy. This will mean a decline in the pool of available global investment, which will increase the rate of return demanded by investors from equities. But the change will come at the same time that investors rightly insist on lower price/earnings (p/e) multiples for shares. Why would we pay p/e ratios of 16 or more for developed world equities with poor prospects for long-term economic growth?

A drop in the p/e multiple from 16 to, say, 12 in the next decade sounds like dreadful news. However, it’s mitigated by likely earnings growth. Overall, Bond reckons we should expect pre-inflation returns from equities to be around 7 per cent a year – better than the last decade but below the historic average of 9 per cent (before inflation). He reckons bonds will have a much tougher time because he expects long-term interest rates to increase substantially.

The study also contains an illuminating essay from Michael Dicks, proposing a simple contrarian approach for timing moves into different assets: when returns are below the long-term risk-adjusted average, buy – and vice versa. In other words: trade against the market!

And, this is where Iran comes in. I’ve mentioned the Turquoise Partners Iran fund before in this column – it invests in stocks on the Tehran stock exchange. Personally, apart from North Korea, I couldn’t possibly think of a more contrarian play than this clearly misgoverned oil super state. But my extreme cynicism is not necessarily borne out by the facts. The case for the defence, made ably by the Turquoise managers, is four-fold.

● The equity market is strong and resilient. Since president Mahmoud Ahmadi-Nejad’s “re-election”, the local exchange is up 20 per cent – and not one of the resulting protests resulted in a fall of more than 2 per cent the next day.

● The local consumer and industrial metals sectors are both buoyant.

● Most of the returns from investing in Iranian shares have come from dividends, with yields of 12 to 14 per cent or more quite common. As privatisation increases (the regime may be repressive but it believes in economic liberalisation), those dividends should increase as more income- rich blue chips find their way on to the exchange.

● Iran is a demographically young country undergoing a profound transformation – more than 60 per cent of university students are women. This young, educated, generation is already becoming more materialistic and consumerist. Turquoise’s managers cite the recent opening of Porsche’s first outlet in Tehran.

Obviously, Iran has huge problems but it is clearly not a Zimbabwe-like basket case. Better still, its stock market is pricing in the bearish sentiment: it trades on a forward p/e ratio of under six.

adventurous@ft.com