The performance of the American stock market
The performance of the American stock market
The performance of the American stock market is perhaps best measured by comparing the total returns on stocks, assuming the reinvestment of all dividends, with the total returns on other financial assets such as government bonds and commercial or Treasury bills, the last of which can be taken as a proxy for any short-term instrument like a money market fund or a demand deposit at a bank. The start date, 1964, is the year of the author’s birth (The Ascent of Money - Niall Ferguson). It will immediately be apparent that if my parents had been able to invest even a modest sum in the US stock market at that date, and to continue reinvesting the dividends they earned each year, they would have been able to increase their initial investment by a factor of nearly seventy by 2007. For example, $10,000 would have become $700,000. The alternatives of bonds or bills would have done less well. A US bond fund would have gone up by a factor of under 23; a portfolio of bills by a factor of just 12. Needless to say, such figures must be adjusted downwards to take account of the cost of living, which has risen by a factor of nearly seven in my lifetime. In real terms, stocks increased by a factor of 10.3; bonds by a factor of 3.4; bills by a factor of 1.8. Had my parents made the mistake of simply buying $10,000 in dollar bills in 1964, the real value of their son’s nest egg would have declined in real terms by 85 per cent.
No stock market has out-performed the American over the long run. One estimate of long-term real stock market returns showed an average return for the US market of 4.73 per cent per year between the 1920s and the 1990s. Sweden came next (3.71), followed by Switzerland (3.03), with Britain barely in the top ten on 2.28 per cent. Six out of the twenty-seven markets studied suffered at least one major interruption, usually as a result of war or revolution. Ten markets suffered negative long-term real returns, of which the worst were Venezuela, Peru, Colombia and, at the very bottom, Argentina (-5.36 per cent).’ ‘Stocks for the long run’ is very far from being a universally applicable nostrum. It nevertheless remains true that, in most countries for which long-run data are available, stocks have out-performed bonds - by a factor of roughly five over the twentieth century.
It nevertheless remains true that, in most countries for which long-run data are available, stocks have out-performed bonds - by a factor of roughly five over the twentieth century. This can scarcely surprise us. Bonds are no more than promises by governments to pay interest and ultimately repay principal over a specified period of time. Either through default or through currency depreciation, many governments have failed to honour those promises. By contrast, a share is a portion of the capital of a profit-making corporation. If the company succeeds in its undertakings, there will not only be dividends, but also a significant probability of capital appreciation. There are of course risks, too. The returns on stocks are less predictable and more volatile than the returns on bonds and bills. There is a significantly higher probability that the average corporation will go bankrupt and cease to exist than that the average sovereign state will disappear. In the event of a corporate bankruptcy, the holders of bonds and other forms of debt will be satisfied first; the equity holders may end up with nothing. For these reasons, economists see the superior returns on stocks as capturing an ’equity risk premium’ - though clearly in some cases this has been a risk well worth taking.