Recent months have been eventful for the markets. Despite political and geopolitical turmoil — and numerous warnings — equities have recovered following the sharp correction earlier this spring. Market commentators are puzzled by the resilience and increasingly wonder how long the good times can last.
As always, short-term developments are difficult to interpret. It helps to zoom out. A recent Barron’s podcast titled Did the Optimists Triumph? offers just that long-term perspective.
Around the year 2000, professors Paul Marsh and Mike Staunton of the London Business School and Elroy Dimson of Cambridge published their groundbreaking book Triumph of the Optimists, analysing a century of global investment returns. The Barron’s podcast explores a recent update of that research, extending the data to 125 years.
A century and a quarter of lessons
What does the expanded dataset reveal? First, that equities — especially US equities — have delivered exceptional returns. Since 1900, the average annual return on US stocks has been 9.7 percent, or 6.6 percent after inflation. In fact, equities delivered the best long-term returns in all 21 countries studied, though the authors again stress that past performance is no guarantee of future results.
Second, global markets have changed dramatically. In 1900, the US accounted for just 14 percent of the global equity market. By 2000, that figure had grown to 49 percent. As I noted in a previous column, that share has now climbed to roughly 70 percent, a development that even surprised the authors. By contrast, the United Kingdom led the global market in 1900, with a 24 percent share. Today, that has dropped to just 3 percent. Japan, which peaked at 40 percent in 1989, now represents only 6 percent.
The composition of markets has shifted in terms of sectors as well. In 1900, railroads dominated: in the US they made up 63 percent of total market value, and 50 percent in the UK. The largest sectors today — technology and healthcare — were virtually non-existent at the start of the 20th century.
Concentration and the case for diversification
The professors also examine market concentration, finding that a handful of stocks dominate not only in the US. It’s widely known that Nvidia, Microsoft and Apple together account for 20 percent of the S&P 500’s market capitalisation. But similar dynamics exist elsewhere: in France, the top three companies make up 23 percent of the market; in Germany, 36 percent; in South Korea, 40 percent; and in Taiwan, a staggering 59 percent.
That’s one more reason to diversify. Casting a wide net helps ensure you don’t miss the big winners. Diversification matters not just across asset classes, but within equity portfolios too.
When bonds disappoint
The podcast host made a blunt observation: “Bonds stink.” Since 1900, the average real return on bonds has been just 0.9 percent. So yes, less than 1 percent. Still, bonds were generally safer than equities. During the Great Depression, for example, equities lost 80 percent of their value between 1929 and 1932, and it took 15 years for that loss to be recovered.
But bond safety also has its limits. After peaking in December 1940, bonds lost 67 percent of their value over the next 40 years. The authors of Triumph of the Optimists make a strong case for diversification, while warning that correlations are not stable. Sometimes diversification doesn’t work, or not as expected.
Long-term optimism, short-term caution
The authors conclude that over the long term, equity investors — the optimists — tend to come out ahead. That said, other studies, such as Stocks for the Long Run? Sometimes Yes, Sometimes No by Edward F. McQuarrie, remind us that there are also decades in which equity returns were dismal.
Yes, over time it makes sense that companies should, on average, generate higher returns on equity than the interest rates at which they borrow. But in the short term, there are no hard rules. Diversification remains the most reliable guideline.
Anne Gram is an independent expert and serves as a board member and adviser to Dutch pension funds, investment committees and supervisory boards.