Insight: long-term stocks win
The recent bear market has been particularly painful for equity investors, starting just five years after the vicious bear market of 2000-2002. For the ten years ending last December, stocks offered a negative real return of 3.15% to US investors, constituting the fourth worst ten-year period since 1871. This has led many to question whether the mantra of “Des stocks for the long term ”is always good for investors.
But a look at history shows that recent experience is not uncommon, and there is great feedback available for those who survive such difficult times. Since 1871, the three worst ten-year stock returns ended in 1974, 1920 and 1978. They were followed, respectively, by real stock returns after inflation of over 8%, 13% and 9% over the years. next ten years. In fact, for the 13 ten-year periods of negative returns that stocks have experienced since 1871, the next ten years have given investors real returns above an average of 10% per year. This yield has far exceeded the average real yield of 6.66% in all ten-year periods and is double the yield offered by long-term government bonds.
Strong future returns have also followed mediocre returns if one extends the analysis to the worst of 127 10-year periods since 1871. Without exception, for every ten-year return falling into the bottom quartile, the 10-year period following gave positive real returns and the median return exceeded the long-term average.
Equities are also overwhelming the returns of long-term fixed income assets. Even with the recent bear market factored in, stocks have consistently outperformed Treasuries in every 30-year period since 1871. And over 20-year periods, stocks have beaten Treasuries by almost 5%. cases.
In the depths of the bearish equity market last March, Robert Arnott, chairman of Research Affiliates, caused a stir, saying that over the past 40 years, investors who have turned to 20-year US Treasury bonds non-redeemable bonds slightly outperformed. actions. Indeed, at the end of March of this year, annual yields on long-term Treasuries have exceeded equities for the past 40 years, by 8.90% to 8.71%.
While the return on equities was below its long-term average, the return on Treasury bonds was well above average. Indeed, to achieve these bond yields over the next 40 years, long-term US Treasury bond yields would have to drop to around 2%, an extremely unlikely scenario. In fact, with the recent recovery in the stock markets and the decline of the bond market, stock returns have now greatly exceeded bond yields over the past 30 and 40 years.
The excellent historical returns of stocks are not limited to the United States. Three British economists, Elroy Dimson, Paul Marsh and Mike Staunton have examined the historical returns of stocks and bonds of sixteen countries since 1901 and published their research in a book titled Triumph of the Optimists: 101 Years of Global Investment Returns.
Despite the major disasters in many of these countries, such as war, hyperinflation and depression, all 16 countries offered substantially positive post-inflation stock returns and the superiority of equities over fixed income assets was decisive. in all the countries examined. The authors conclude “Concerns about survival bias [by examining only US data] can be overkill [and] investors may not have been misled by the focus on the United States. ”
Bill Gross, the head of PIMCO, joined other pessimists in saying that the US economy is heading towards a “new normal”, which he describes as slower economic growth and limited stock returns. This prediction is based on the decline in spending by American consumers who relax from the excess leverage accumulated over the past decade.
But these predictions ignore the fact that it is global economic growth, not just US growth, that will dictate future stock returns. Every dollar of US international debt is matched by one dollar of foreign assets. S&P 500 companies now make almost 50% of their revenues outside of the United States, and this share is likely to increase as growth in emerging countries continues to outpace that of the developed world.
Finally, US stocks are cheap relative to earnings expectations. For the S&P 500 Index, stocks are now selling at around 14 times expected operating profits for 2010. Since 1955, stocks have sold on average 18 to 20 times profits when interest rates and inflation are low, as now.
The recent behavior of stock prices highlights a phenomenon that has long puzzled economists: why do long-term stocks pay so much more than bonds? The pain that investors often experience, such as in the recent bear market, forces many people to give up stocks altogether. This lowers stock prices and improves their future returns. Stocks offer investors excellent returns for those who are willing to accept market volatility.
Jeremy J. Siegel is Russell E. Palmer Professor of Finance at the Wharton School, University of Pennsylvania, and author of Stocks for the Long Run.