What 120 years of stock market data tells us about where to invest today

Looking at the very long run return of stock markets can help investors ignore short-term market swings, explains Sam Benstead. 

Investors today are bombarded with an onslaught of financial news and data, and can trade shares and funds in an instant from their mobile phones or computers.

This means they are tempted to think short term and focus too much on what markets are doing in a week, month or year – rather than putting their money to work for the long term.

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Looking at financial history helps you take a step back and focus on the big – rather than small – picture.

While most stock market indices go back only 40 years, there are ways of calculating market returns over more than 100 years.

This is what London Business School professors Elroy Dimson, Paul Marsh and Mike Staunton, alongside Credit Suisse, have managed to do with their 2023 Global Investment Returns Yearbook, which looks at 123 years of global stock market data.

They argue that the volatility of markets means that, even over long periods, investors can still experience “unusual” returns – and so looking at more than 100 years of data is critical.  

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They say: “Consider an investor at the start of 2000 who looked back at the 10.5% real (inflation-adjusted) annualised return on global equities over the previous 20 years and regarded this as ‘long run’ history, and hence providing guidance for the future. But, over the next decade, our investor would have earned a negative real return on world stocks of −0.6% per annum.

“Golden ages, by definition, are exceptions. To understand risk and return in capital markets – a key objective of the Yearbook – we must examine periods much longer than 20, or even 40, years. This is because stocks and bonds are volatile, with major variation in year-to-year returns. We need very long time series to support inferences about investment returns.”

UK returns

Although the real (inflation-adjusted) return on UK equities was negative over the first 20 years of the 20th century, the story after was one of steady growth broken by periodic setbacks, according to the researchers.

Over the full 123 years, the annualised inflation-adjusted return on UK equities was 5.3%, versus 1.4% for bonds.

Unlike in America, the worst setback was not during the Wall Street Crash period, but instead in 1973 to 1974, the period of the first OPEC oil squeeze following the 1973 war in the Middle East, the researchers found.

UK bonds also suffered in the mid-1970s due to inflation peaking at 25% in 1975. However, investors who kept faith with UK equities and bonds were eventually vindicated. As in the US, equities greatly outperformed bonds.  

US returns

American shares have returned more than UK shares, delivering a real return of 6.4% annually over 123 years and a 1.4% real return from bonds.

But there were setbacks, including during the First World War, the Wall Street Crash of 1929 and its aftermath, the OPEC oil shock of the 1970s, and four bear markets (declines of 20% or more) so far during the 21st century.

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Each shock was severe at the time. At the depths of the Wall Street Crash, US equities had fallen by 80% in real terms. Many investors were ruined, especially those who bought stocks with borrowed money.

The researchers said: “The crash lived on in the memories of investors for at least a generation, and many subsequently chose to shun equities.”

Global returns

The 6.4% annualised real return on US equities contrasts with the 4.3% real return, in dollars, of global shares excluding US stocks. This difference of 2.1%, when compounded over 123 years, leads to a large difference in wealth creation.

The researchers calculated that a dollar invested in US equities in 1900 would today have turned into $2,024 in terms of real purchasing power. The same investment in stocks from the rest of the world gave a terminal value of $176, less than a tenth of the US value.

Projected returns

But, as we all know, past performance is not a reliable predictor of future performance. Many factors affect the outlook for returns, from the inflation rate, to starting valuations and interest rates.

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Expensive shares today and high inflation lead to lower expected future returns. The researchers’ long-term forecast is 4% real returns annually for global shares and 3% real returns for a 60:40 global stocks to bonds portfolio, and 1.5% above inflation for global bonds.

Source: Credit Suisse Investment Returns Yearbook 2023.

Vanguard, the fund manager, sees US shares returning between 4.4% and 6.4% a year for the next 10 years, before taking inflation into account, while global equities, excluding the US, are expected to return between 6.7% and 8.7%. Value shares are expected to perform better than growth shares, according to Vanguard. The fund manager sees UK shares returning between 4.2% and 6.2% annually for the next decade.

Emerging market companies are predicted to return 6.3% to 8.3%, however, this market is expected to be the most volatile. 

Investors looking to track global stock markets, including emerging markets but excluding US shares, have to build their own portfolio of tracker funds as there are no global trackers for UK-based investors that exclude US shares.

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Vanguard says that rising interest rates, inflation and geopolitical risks have forced investors to reassess their rosy expectations for the future. But it notes the silver lining is that poor returns in 2022 have improved the outlook for global equities.

“Expectations around 10-year asset-class returns are more attractive than they were a year ago,” it says.