This post looks at the evidence of historical returns from the UK stock market. In particular, it focuses on the one study that is frequently used by the industry: The Barclays Equity Gilt Study.
“In the long term, stocks produce attractive returns: They may fluctuate in the shod term … but historically, they yield an investment return of about 10%.”
Get Rich Slowly
Virtually all information published by the finance industry encouraging you to invest makes claims about projected returns from investing in the stock market in the long term. As the example on the previous page, these are usually in absolute returns – i.e., you will gain X% a year – although sometimes they are comparative, i.e., how much more you would have gained versus just holding cash, the so-called “risk-free return.”
The industry benchmark If you look into the footnotes of these (UK) websites and publications, you will notice many points to the Barclays Equity Gilt Study? This is an annual publication issued by Barclays Capital which summarizes data since 1899 on the returns on UK equities (ie, FTSE shares) and “cash”.4
Annual Real Returns on Equities and Cash (after inflation) 1899-2011 The latest published data covering the last 112 years shows that equities have returned nearly 5% a year above that of the rate of inflation. In contrast, holding cash has beaten inflation by only around 1%.
Take care with that word “cash”. Normally you’d expect it to mean the returns and interest you get from putting your money in a bank or building society account. However, as we’ll see later, it is actually referring to the returns from something called Treasury bills, which are issued by the government.
Annual fund charges
Based on data from:”Barclays Equity Gilt Study 2012″
This data is quite interesting and not what I expected to see. First, it shows that for nearly 90 years (1900-1990), the UK share index had effectively gone nowhere at all, once you strip out inflation. This clearly demonstrates, over that period, the benefits of owning shares were driven mainly by the dividends and the compound interest on them (after you take out inflation).
The other fascinating aspect of the above chart is the cycles it illustrates. Not only do you see the normal business cycle of 5-8 years, which gives the picture a very jagged appearance, but it clearly exhibits a longer-term wave.
These so-called secular bull and bear market periods for the index typically last around 15-16 years each, with the total down/up cycle always lasting 30-32 years. In 2012, we are 12 years into a secular bear market that started in 2000.
There is an adage, coined by Mark Twain, that “history never repeats itself, but it does rhyme”. Given this, it is quite possible that the current secular bear market (red) on the FTSE will put in a new, possibly final, low at some point between now and 2014 before turning to a new secular bull market (ie, changes to upward and green). The implications of this will be discussed further in next blog post
The loads-a-money era The last clear fact from the chart is that the period from 1982 to 1999 was strange from a historical perspective. The size of the increases in the index during this period were unusual. For the first time since the previous century, the returns exceeded those created by just dividends and inflation. The average real growth per annum (including dividends) over that time was 13.2% pa. In contrast, for the whole period from 1899 to 1981, the average return was just 4% pa.
So what caused the unusual rise of equity assets in the 1980s and 1990s? My personal view is that a key reason goes back to August 15th 1971, when President Nixon unlinked the dollar peg from gold.
This heralded the start of an era of so-called fiat currenciA in which it was possible for the finance industry to create infinite money – which they then used, among other things, to invest in shares.
The successful hedge fund manager Ray Dalio argues the rise seen during the 1980s and 1990s is a function of a much longer-term “debt cycle.” It lasts approximately double the 32-year secular bull/bear cycle and can be between 50-75 years. It is his view this will mean that economy is likely to suffer a prolonged period of deleveraging over the next decade as this cycle is worked through it.
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