When Stocks Didn’t Perform

When Stocks Didn’t Perform

Remember that time bonds beat stocks over a 50-year period?

Of course not. Nobody who remembers that time is alive today.

But remember it or not, it happened. And as George Santayana famously observed, “Those who cannot remember the past are condemned to repeat it.”

Way back then, the long-term performance of stocks was absolutely dreadful. Over this 50-year stretch, stocks compounded at less than 1% per year!

Clearly, I must be cherry-picking! I must have selected an especially bad period that ends during the Great Depression, right?

Wrong.

Photo credit: Pixabay, artist Geralt

In my interview with Paul Merriman, he mentioned a book called Common Stocks as Long Term Investments. Mr. Merriman told me that the book, drawing on data from the late 1860s through the early 1920s, represented the first time the mainstream public was introduced to the idea of investing in stocks!

I thought that was interesting, and was curious about the findings of that old period. Mr. Merriman informed me that, if you extend the data out through 1933, you were better off in bonds than in stocks!

I knew that 1933 was during the very depths of the Great Depression, so I figured he was just trying to make a point about diversification.

But recently, I started poking around with data published by Yale professor Robert Shiller, author of Irrational Exuberance. He makes the data freely available on his university webpage [warning: this link takes you straight to the spreadsheet download, in .xls format].

Dr. Shiller’s data goes all the way back to January of 1871! And, unlike the data I’ve used in previous posts, this dataset goes month-by-month. That increased precision has its appeal, especially when I’m exploring with no particular purpose in mind.

I figured it would be interesting to look at the distant past, over 100 years ago, to see how the market performed back then. After all, it was a very different time, with different legislation and a different culture and different demographics…

When you’re looking at a timeframe measured in decades, it’s wise to look at different environments. Different countries, different time periods, etc. That way, you don’t get lulled into a false sense of security.

Many investors know about Japan’s asset bubble of the 1980s. Famously, the Nikkei 225 index still hasn’t recovered from its 1989 peak.

After that peak, the market did drop until September 1990. Though the Japanese market has bounced around since 1991, its value didn’t actually reach that 1991 level again until about 2018. Imagine putting some money into the market, then not getting back to the break-even point for over 25 years!

But again, that’s relatively recent history. Why did this stagnation happen? What could have prevented it? Was the market truly stagnant, or did the price merely reflect investor reluctance to get back into stocks?

The verdict is not yet in. Until that chapter is firmly in the rearview mirror, nobody will be able to see clearly enough to answer these questions thoroughly and dispassionately.

So, I figured, I’ll look at the U.S. data from 150 years ago. That’s firmly in the rearview mirror!

The period from 1871-1920 includes the Spanish-American War, World War I, about 4-5 financial crises (called “panics” back then: e.g. Panic of 1873, Panic of 1907), an explosion of railroad-building, the invention of the automobile, and the invention of powered flight, among other things.

Some good stuff and some bad stuff. Just like any other period in history.

The S&P is well-known for returning about 10% per year, on average. I was expecting to find returns that were noticeably lower. Maybe on the order of 5-6% per year, averaged out over the entire 50-year period.

Boy was I in for a surprise!

Over the 50 years from January 1871 through December 1920, stocks compounded at 0.89% annually, including dividends.

That bears repeating. 0.89% per year. And that’s including dividend payouts! That’s less than one-tenth the rate of return that we see since 1928.

Think of it this way: if you started with $100 in 1871, you would end up with $155 in 1920. After a full 50 years!!!

Compare that to the 50 years from 1970-2019:

Yikes!

No, that’s not strong enough. Holy $#!+muffins!!!

There, that’s better.

If you just look at more recent U.S. history, especially post-WWII data, you might be forgiven for thinking that, in general, the market always goes up over the long term.

Clearly, that’s not always true.

Okay, technically, it is true. But look at those returns over a 50-year span! You’d be better off with a savings account! Even in today’s low-interest-rate environment, you could find CD rates rivaling that measly return!

Now, a skeptic would say that the financial and regulatory environment was totally different back then. They’d say that the government has a better handle on the financial system, and that America’s position in the world is much stronger than it was in the 1800s.

Indeed, that would be quite correct.

But the point of this whole exercise is to predict what kind of returns we can expect in the future. And, of course, we have no clue what the future will bring.

Until I ran these numbers, I was confident that I could count on returns of at least 7% per year for the rest of my working lifetime. Maybe 5% if I’m really unlucky.

Now, I’m not so sure.

Just to double-check my findings, I ran the gains on some shorter periods during that time. For the 28 years from 1871 to 1899, the returns were 1.01% per year. From 1871 to 1904—33 years—the S&P returned 1.83% annually. From 1871 through 1909 (a 38-year period), the annual returns were 2.20%. For the 41 years ending in December of 1912, the annual returns were 1.94%.

So it’s not like I’m just ending at a terrible spot in 1920. The returns were pretty meager throughout this entire timeframe.

Of course, if I were interested in cherry-picking, I could start in January of 1878 and stop in 1902, to get an annual return of 3.78%. Or better yet, I could start in June of 1877 and stop in September of 1882, to get a very nice 16.26% annual return.

That’s the nice thing about looking at past events—you know what to do and when to do it! But we don’t have a crystal ball. Or a time machine. So those practices don’t really help us plan for the future. That’s why I like to look at long, pre-defined periods of history, like 50-year increments.

So how can we prevent ourselves from getting trapped in a stagnant market? The brief answer is: diversification, diversification, diversification.

It certainly looks like there are some new players on the world stage, players that have a ton of potential for economic growth. Think of countries with natural resources and big populations, such as China, India, Brazil.

China’s already laid a template for how to achieve rapid economic growth over the course of 20-30 years. China appears to be on a trajectory to be the dominant economic power by 2030. Of course, they have their challenges looming in the future too.

But it’ll be relatively easy for another country with ample natural resources and committed leadership to follow China’s template, avoid making big mistakes, and attain a prominent position in the world. Think India, Brazil, or even Russia. Maybe South Africa, or perhaps Nigeria.

The point is that a lot of growth potential remains in the world. But developed countries like the United States, Europe, and Japan? Maybe the post-WWII growth won’t repeat itself during my lifetime. Maybe it won’t repeat itself again for centuries!

That’s why I’ve started to hedge my bets. Though over half of my investments remain in the U.S. stock market, I’ve started to lean toward international stocks, and value funds. I also hold a small (~5%) stake in emerging markets; I expect that percentage to grow in the future.

My bond allocation has diminished a bit over time, but I still keep over 10% of my investment dollars in a total-market bond index fund. The scenario described above explains why I insist on keeping some bond exposure.

You just never know what the future may hold.

I’ve already described my position on cryptocurrency, and I don’t see that changing. While I’ve considered purchasing a little bit as a speculative gamble, I’m much more concerned with actual income-generating investments, like stocks, bonds, and real estate.

Next time somebody promises you that an investment is certain to make you wealthy, remember this post. 0.89% per year, for 50 years.

0.89%.

***
Want to know more about how to invest? Check out my interview with Paul Merriman!
Or you can buy his latest book by clicking on the cover below: