One of the best-known lessons from personal finance classes is that investing in U.S. stocks can involve significant short-term risk, but over the long term, a patient investor receives a higher reward for that short-term risk. Long-term returns. David Chambers, Elroy Dimson, Antti Ilmanen, and Paul Rintamäki discuss this and other patterns in “long-term return on assets” (Financial Economics Annual Review2024, Volume 16). The particular strength of these studies is that for them ‘long-term’ means not going back to the 1980s or 1950s, but to the 19th century and sometimes earlier.
On the issue of higher returns from stocks than bonds over the long term, they wrote:
Since the early 20th century, there has been ample evidence that total returns on stocks have exceeded those on (government) bonds in the United States over a variety of long-term periods.Ibboson & Cinkfeld 1976; Siegel 1994, 2022) and in the rest of the world (Jorion & Goetzmann 1999; Dimson, Marcy & Staunton 2002). First, we address one of the key questions in empirical asset pricing: whether stocks consistently outperform bonds over the long run. As mentioned above, this evidence relies primarily on data series starting in 1900 or, for the United States, in 1926, which is when the University of Chicago’s CRSP data begin. This section first discusses the history of stock and bond returns prior to 1900/1926. The key message is that the U.S. equity premium for (government) bonds above 5% in the 1900s was significantly higher than estimates in the 1800s. It ranges from +1.6% to -0.6%. … 224 estimates for the UK’s annual stock-bond premium are in the 2-3% range, well below the 20th century premium of 4-5%.
Simply put, it’s been a century of good stock returns, especially in the U.S. economy. But for a few centuries it wasn’t so good.
For bonds, the key question is that interest rates appear to have been historically low in recent decades.
[B]Before the 20th century, inflation was very low and there was little difference between nominal and real rates of return, both falling to 3-4% around 1900. The 20th century saw more sustained price increases. This is especially true due to the great inflation of the 1970s. Nominal interest rates are up to double digits, levels last seen in the 1500s. The Great Moderation after 1982 saw inflation rates converge globally towards 2%. This is a return to the low levels that characterized the economy before 1900.
Even after inflation expectations stabilized at a low level in the 2000s, real yields and policy interest rates continued to fall into negative territory. Eventually, nominal yields also turned negative in many European countries and Japan, while elsewhere (such as the US and UK) they reached record lows. Rising global inflation in 2021-2022 has finally pushed bond yields higher after 40 years of decline. Centuries of return evidence confirms that recent low (even negative) bond yields have truly been exceptional.
What about corporate credit risk, measured by how much corporate bond yields exceed government bond yields? They discuss the weakness of the evidence on this point, but argue that corporate credit risk does not appear to really appear in the data until 1973.
What about home investment? “When reviewing the evidence on real estate investment performance, we discuss the challenges posed by the heterogeneity and illiquidity of this asset class. The evidence focuses primarily on housing and suggests that total returns are lower than equity returns.”
What about the return on raw material investments? “We then turn to commodities and critically examine recent research claims that point to surprisingly high long-term returns. From this, we conclude that the long-term historical returns of a diversified futures portfolio are closer to those of stocks.”
Generalizing from my personal experience, I sometimes tend to think of “long-term” returns as those that accrue over several decades of savings for retirement. But of course, ‘Janggi’ is not interested in my birthday. Taking a longer-term perspective opens up new ways of thinking about possible outcomes and how and why financial markets distribute rewards.
