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moneysense.ca, 29/01/09
Poor 10-year Stock Returns is not Unprecedented
The poor performance of stocks over the past decade has resulted in a lot of columns in the mainstream press questioning if stocks do really provide generous returns over the long-term. Are poor returns over 10-years really unprecedented? It is instructive to look at the long-term record, keeping in mind that there is no law that says that stocks return X% over X years and just because something hasn’t happened in the past, it doesn’t mean it won’t happen in the future.
In Stocks for the Long Run, Jeremy Siegel finds that stocks have outperformed bonds and bills about 80% of the time over 10-year holding periods between 1802 and 2006. In 10-year periods between 1871 and 2006, stocks outperformed bonds and bills about 82% and 85% respectively. Interestingly, even over 20-year holding periods, stocks had better returns than bonds about 96% of the time. The past record indicates that in roughly one out of five 10-year periods bonds do better than stocks. In other words, the recent record is hardly unprecedented.
moneysense.ca, 29/01/09
Good post. In the Intelligent Asset Allocator, Bernstein graphed out 30 year returns of the stock market in the last 100 or so years. None of those periods returned less than 8% annualized.
Stocks do have good returns over long periods – the main exception is easy to demonstrate with a little test. If you’re convinced that stocks will always return 10% per year and you buy one share of Google for $1M today, will that still be true?
I’m sure that in the last decade you can find many examples of people paying a negative equity premium, with the obvious results.
In the Intelligent Investor, Graham writes how everyone was bearish on stocks in 1940′s as many people were still negatively affected by the depression and the wars, despite the fact that stocks were very cheap.
Stocks are cheap now; they could always get cheaper of course, however i believe that now is the time to start accumulating. do not sell..
Silicon Prairie, your argument is specious. Siegel never states that an individual stock can be expected to consistently, safely and reliably outperform bonds over a given time period. He confines his analysis to the returns of various indexes. In other words, Siegel’s data that show stocks, as an asset class, almost invariably outperform any other asset class. Notably, Siegel’s findings (i.e., deriving stock market returns from an index) is replicable by the average investor, and considerably less risky that loading up on a single share of GOOG.
TEMPLE
Silicon Prairie: “Stocks” always means a diversified portfolio of stocks. Individual securities have numerous risks, in addition to market risk. Granted the data is for the US market and it would be interesting to see data for the Canadian market.
Hi CC, I think that Siegel studied quite a few of the various indexes worldwide, and found similar results. That study might be in his second book, though? I don’t recall if he included Canadian markets, but I remember that the results were surprisingly consistent between the different indexes worldwide. If I get a chance, I can try to dig around and see if any of his studies have included Canadian data.
TEMPLE
This only reinforces the thruth that a prudent investor needs to diversify accross asset classes and never invest solely in stocks. Increasing time horizon seem to improve the odds that stocks will outperform bonds but never makes it certain. If time horizon is very long (I don’t have proof for this) it could be that bonds and stocks performance converge on the same return.
As someone who works in the field of climate change, I find it fascinating to see the parallels in long-term trends such as stock-index prices and global average temperature. In both cases there are long-term upward trends, but in both cases the growth is dynamic, with periods of a decade or more where temperatures or stocks fell or failed to rise. And the reaction to these periods of contraction is exactly the same: as soon as the news came out that 2008 was cooler than 2007 and not even in the top 7 warmest years on record, popular wisdom on the street was that “global warming is over.” Similarly, when stock prices tumbled in this major recession, people started claiming that stocks were no longer a good investment. I suppose it’s just human nature to focus on short-term phenomena and lose sight of the longer trend, but fascinating nonetheless.
TEMPLE: I was browsing through Siegel’s book this morning and though it had average long-term return data for stocks, bonds and bills (sourced from Triumph of the Optimists), I couldn’t find 10-year breakdowns of returns. Triumph of the Optimists has this data for 16 developed markets, including Canada but I don’t have a copy of the book. At $135, it’s been hard to justify buying it… I might one of these days. I do think there will be plenty of instances where 10-year stock returns have been very poor.
Basil: You’re right that as time horizon increases so does the odds of stocks outperforming bonds. But the odds are never 100%. I think a 96% chance that stocks will beat bonds over 20 years is still a very good bet to make.
brad: There are a bunch of ridiculous arguments being made. Another is that just because the last 10 years were bad, the next 10 would be too. There is nothing to support this statement. If anything, stock returns are mean-reverting and poor performance is likely to be followed by a good one. Like you point out, we anchor our expectations to recent experience.
I agree that in the past, stocks have outperformed bonds in the long term. Investors have demanded an equity premium in return for the increased risk of stocks. Will this equity premium persist in the future? Nowadays, it is common knowledge that in the past, stocks have performed bonds in the long term. Were investors less aware of this in the past? If present day investors are more aware of this, does this mean that they will invest more in stocks? If they invest more in stocks, does this mean that stock returns will decrease relative to bonds in the future (and in the last 10 years?). My argument is based on other investing ideas such as “Dogs of the Dow”. That strategy was effective. However, once it became common knowledge, its effectiveness decreased.
Hi CC,
Based on the historical statistics, how can we be sure that this remains true in the future?
For centuries, Europeans believed that all swans were white until black swans were discovered in Australia. Likewise, we have always assumed that stock indexes tend to rise in the long run (and hence are great long term investments) until we saw data on the recent S&P 500 and that of the Nikkei index.
@17th Avenue Money Talks: Nobody can be sure of anything in the future (well, there are a few certainties, such as the fact that we will die, but we don’t know when). Any non-secure investment carries risk. Uncertainty is a necessary element of risk. Without uncertainty there would be zero risk.
There are many plausible and not-so-plausible theories about why stocks may or may not continue their long-term upward trend in prices after this recession, how quickly they will rise, etc. Your guess is as good as mine. But to me it seems likely that the long-term trend of stock prices is not going to change based on current events. Yes, there will be a downward blip in the trend, and yes that blip may last a good few years, longer than most of us would like it to. But it’s just one of many short-term downward cycles in a trend that has moved inexorably (but not steadily) upward over the long term.
Taleb’s analogy of the black swan doesn’t refer to the long-term trend, it’s referring to short-term traders and economists and economic experts who missed all the danger signs and ignored all the warnings that presaged the current recession and crisis in the markets. That’s a short-term phenomenon.
Doug: In theory, investors *should* always demand a premium for investing in riskier assets. In practice, it doesn’t always happen but when it doesn’t, markets tend to correct and investors rediscover risk all over again.
It is true that anomalies in the stock market tend to get arbitraged away. But, the equity risk premium (or demanding a higher return for higher risk) isn’t an anomaly.
It isn’t even a recent phenomenon. In The Four Pillars of Investing, Bernstein shows that over the centuries, risk and reward have been a fundamental factor in all kinds of markets. After all, if investors expect stock and bond returns to be close, why would they take the risk of being in stocks?
17th Avenue: I’m not sure what you are referring to as “this remains true”. Are you referring to stocks outperforming bonds over the long run? If so, what I’m saying is that you get very good odds that stocks will do better than bonds over 20 years, say better than 96%, based on past experience. The longer the time horizon of an investor, the better the odds become.
I also disagree that if bonds outperform stocks over 30 or even 40 years, it would be a “black swan” event. While the US experience has been that stocks outperformed bonds always over 30-year holding periods, other countries have not been so lucky. IIRC, the Netherlands had one 40-year period in which bonds did better than stocks. It may be a “black swan” for US investors but investors in other countries have seen these swans before.
Indexes are a better example than individual stocks, but the difference in volatility doesn’t change the fact that no level of performance is guaranteed or even likely when you overpay in the first place. The average returns for the last 10 years are more likely than most people think, but one of the biggest causes is that 10 years ago people were happy to pay too much for stocks – thinking that average returns (if they even set their sights that low) would hold regardless of what price they were starting with. When you look at it that way it goes from being a 20% chance to something much higher.
It’s probably a good thing that I wasn’t investing 10 years ago but recent history has demonstrated many important investing lessons at other people’s expense. Those whose memory is longer than the market’s will do well.
Basil: bond and stock returns aren’t likely to converge much. As other comments mentioned reasonable investors should demand a higher return from stocks (unless you’re comparing stocks of stable companies with bonds that have a 10% chance of being repaid). This means they have to buy stocks at lower prices and sell at higher prices when possible. If a stock index has given you a return of 3% per year you probably won’t think that it’s time to sell and lock in your profits.
Doug: This effect probably had a lot to do with the last 20 years, but it doesn’t mean that it will keep driving returns down. People have “realized” this many times before, then forgotten it. Whether it happens slowly because lower returns don’t make as much news or quickly (which is probably the case after the last 6 months) the end result is that it gets easier to buy stocks. Whether the popularity of stocks are rising or falling seems to have an effect on the market over 10-20 years but it doesn’t look like it changes the long-run average much.
Brad: There are still long-term risks. For example, usually stock market returns are only calculated for the markets that still exist. It may not be a big risk but there’s few things that fit the definition of a “black swan” better.
Silicon Prairie, you are making the incorrect assumption that a person would invest in a given asset class with a lump sum at one time only. Very few people invest like that. Also, in a broader sense, lump sum investing or not, no asset class can give you a guaranteed return, because you can never know what inflation will do to your purchasing power. That is, bonds probably look better relative to stocks right now, but factor in inflation and you are getting a guaranteed but feeble return, and losing the chance to have a much higher return if those same funds were in stocks. Such an opportunity cost is especially damaging when you consider that the long term performance of stocks are better than any other asset class almost 100% of the time.
TEMPLE
[...] Canadian Capitalist (who was also featured in the Globe and Mail!) discusses the poor performance of stocks for the past 10 years and shows that it’s not out of the ordinary. [...]
For a recent presentation, I worked up the table below using figures for the indices globefund uses for money market, bond and Canadian equity funds. It supports the idea of higher returns for stocks over the long run.
Gail Bebee
Author of No Hype – The Straight Goods on Investing Your Money
Return Rate, %
2008 1988-2008
Cash 3.13 5.51
Bonds 2.85 6.91
Stocks -33.00 7.48
For the last twenty years, the equity premium has been 0.57%. For the risk that one takes, the premium is small.
[...] is nothing weird about this [...]
Temple: It’s true that you can’t expect anything from such an inconsistent investment plan but that’s all a 10-year return measures. It would be nice to see more information about the returns for regular investments over the whole period.
There’s still some use in looking at the direct return between two dates though. For example, if you plan to work for 40 years before retiring you might expect a lot of portfolio growth in the last decade because you’re starting with more assets, but if your portfolio return for the last 10 years is negative you won’t get any of that growth on you previous investments unless you can hold on to them much longer.
Doug: perhaps this is an indication that investors won’t be willing to pay prices that high in the near future?
[...] 4. Poor 10 – year Stock Returns is Not Unprecedented by Canadian Capitalist: A fresh look at the current stock market downfall. [...]
The key is to have cash to fall back on in case of bad times like this. I like 2 years worth of fcash and the rest across a broad stock portfolio. Getting pretty hairy right now but I think in another year the strategy will show that it will end up meeting the needs of investors. Of course raising income from call writing on the same portfolio, while forcing you to give up some upside, will help insure that you will always have the income that you need.
Unless a fixed income portfolio can generate income greater than you need to live, due to inflation you will need to either lower your standard of living from year or start taking principal guaranteeing that you run out of money eventually.