Long term stock market performance can be deceptively misleading. It can often lead to costly assumptions by investors.
The first issue is that no one ever experiences the long run. That is unless you began investing in 1871 or 1926 or whatever year is the currently accepted start of “reliable data.”
Next is the vast difference in the industry breakdown of markets today versus the past. Railroads and banks dominated markets in the late 1800s/early 1900s. How relevant are those returns to today? Industries like technology and healthcare didn’t exist a century ago. The rest was a sliver of the overall market.
Then there’s the problem with averages. The long-run average return smooths out and hides the extreme experiences investors face in the short term. The nature of markets is far less certain than its long-run average return projects. Surprises abound.
Finally, how long is long enough for long-run data to be reliably useful? For instance, there’s been nine (or is it ten now?) bull markets since 1926. What kind of conclusions can we draw from a sample size of nine? That bull markets come in all shapes and sizes seems to be the best conclusion so far.
Peter Bernstein came to similar conclusions in 1974 after auditing a century of stock market performance. However, he didn’t write off long term performance entirely. He shared a few lessons that should help when making assumptions about the future.
We all know that history can never predict the future. But we also know that it can give us some sense of what kind of forces have determined the trends of whatever it we are trying to predict. Furthermore, although the structure of the stock market and the names and numbers of the players have surely changed over the years, the fundamental considerations that motivate an investor to buy or sell are essentially the same as those that motivated the investor a hundred years ago: price relative to earnings, dividends, and competing outlets for investable funds…
And this experience can teach us the following:
First, we should view with great skepticism predictions of high returns from appreciation over the long run. The really long-run trend of stock prices is nothing to get excited about; the shorter-term performance of stock prices is highly variable and therefore treacherous from a prediction standpoint.
Second, the larger part of the return accruing to shareholders over time seems to come from dividends. This is true any time price performance is poor, but dividend income is important even when price performance is good. Obviously, it is better to buy when yields are high rather than low, all other things being equal. But since all other things are seldom equal, the successful investor must make a tough-minded analysis of whether the appraisal of other investors as expressed in dividend yields is or is not justified.
Third, nothing in the record of the past hundred years or so can tell whether stocks are or are not a good hedge against inflation. They are a good hedge when they are cheap according to conventional standards of valuation, but not when they are expensive. Surely they will be a poor hedge unless inflation by itself has failed in the past to produce enough price appreciation to justify buying stocks for that reason alone.
Fourth, bond yields are indeed an important determinant of stock prices, but the rate of change in bond yields seems to be even more important than their level.
Finally, Great Bull Markets are rare birds indeed, and they have unpredictable life-spans (which also means they have predictably surprising demises). Investors would be well advised to plan their strategies on the assumption that upward movements in stock prices are likely to be limited in magnitude and even more likely to be limited in duration. When tempted to violate this precept, the investor should carefully review the special conditions that created the Great Bull Markets of the past before convincing himself that the Really Big One lies just ahead.
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