The great financial educator William Bernstein said: “You have to understand what market history looks like. What market history tells you is that the very, very best investments are made when things look the worst.”

It’s for similar reasons that I write so often about the past. I want to try to understand what fleeting or lasting horrors my investment choices might inflict even before any rewards come due.

This means examining as fully as possible the asset classes that comprise today’s investing mainstays.

First-world problems

Most Monevator readers’ portfolios are dominated by World equities – that is, developed world stocks.

But there’s a problem if you want to know how the World index has performed over the long-term. 

Which is that the two benchmarks that stretch back farthest are pay-walled.

Fair enough, I suppose. Professors’ Dimson, Marsh and Staunton’s DMS database and Global Financial Data’s indices are both based on exhuming stock returns from fusty old journals and ancient newspaper archives. Someone’s got to keep the wonks fed and watered.

But that doesn’t help the investor in the street. People like us who are keen to avoid becoming investors out on the street, by educating ourselves in the ways of the investing world.

True, you could simply use the MSCI World’s easily-accessed tale of the tape. Its data runs from 1970.

But in my view that paints too benign a picture.

No Great Depression, no World Wars, no decade of deflation, no deglobalisation.

While 50-odd years sounds like a long time, we can only really see how equities responded to a wide set of conditions by retrieving the greater part of the 20th Century.

Introducing a new world index

We need more open-source data. And I’ve found it!

Enough to create a World index reaching back to 1919:

• I’ve taken historical country-level stock market returns from the Macrohistory database.
• I then weighted each country using stock market capitalisation data from the paper, The Big Bang: Stock Market Capitalization in the Long Run.
• Then I currency-converted all the results to GBP1 using exchange rate data from the Macrohistory team. 

This process enabled me to assemble a World index in GBP that begins in the aftermath of World War One. At the other end of the timeline, the new index segues into the MSCI World GBP from 1970.

The resulting World equity index is not perfect (and I’ll explain why further down) but I believe it’s good enough.

So I’ll use this index to represent the World equities portfolio in future Monevator long-term performance articles.

In the meantime, the rest of this article will chart how world equities have fared from 1919 to 2023.

Then I’ll briefly pop the bonnet on the index as a treat for the hardcore at the fag end – I mean the grand finale – of this piece.

Investing returns sidebar – All returns quoted in this piece are real annualised total returns. That is, they’re the average annual return (accounting for gains and losses) realised in a given time period. These returns include the impact of reinvested dividends, but strip out the vanity growth delivered by inflation that does nothing to boost your actual spending power. Local currency returns have been converted to GBP.

World index: long-term equities growth

Here’s the World equities growth chart using our new index versus two rival long-term benchmarks: US and UK equities:

Data from JST Macrohistory2, The Big Bang3, MSCI, Aswath Damodaran, and FTSE Russell.
August 2024

The graph reminds us again that the rest of the advanced world has struggled to keep pace with US equities since the mid-1990s, aside from a brief panic room huddle during the Global Financial Crisis.

We can also see that home bias cost UK investors dearly throughout – even though the UK has remained one of the world’s top-performing markets over time.

World index annualised returns in GBP (% per annum)

Let’s now look at the long-term average real return numbers with dividends:

The US wipes the floor with the rest of the world across every timeframe. Particularly in the last ten years as the ascendency of Big Tech – and its concentration in US stock markets – has left competing sectors looking like yesterday’s news.

It would be interesting to see whether the US still dominates in an alternative world with the Big Tech winners stripped out. We’ll save that for another time.

World index: annual returns

Annual World index results resemble any other crazy equity returns chart. They look like an abstract cityscape of soaring skyscrapers and deep shafts boring into negative space.

Happily however the towering returns outnumber the dark days lost in bunkers.

Thus somehow our long-term financial wellbeing emerges from this profile of sky-dwellers and underlanders.

Annual returns: World vs US vs UK stock market indices

A question: does diversifying across the world take the edge off those trips to the bargain basement?

This chart indicates that the World index might provide some downside protection relative to single country markets.

The cyan bars seem to punch shallower holes than the USA’s red. Though also notice how dynamically America tends to bounce back.

Drawdowns: World vs US vs UK stock market indices

This is the trauma room chart: a raw record of loss and terrible stock market slashes. All the same, you can see how the Great Depression is mitigated by the World index versus the US during the 1930s. (The impact of the Great Depression was not so severe in the UK, for one thing.)

World War 2 and subsequent recessions were also typically blunted by a World stock assemblage.

A notable exception is the early 1990s slump when the Japanese stock market bubble burst. The Tokyo stock exchange comprised over 40% of the index in 1989 but it made up only 11% ten years later.

Holding the World portfolio also exacerbated the Dotcom Bust of the early 2000s, as Japan continued to sell off and the UK piled on the pain too.

The risk-adjusted view

All told, our eyes do not deceive us. The numbers show that the World index has inflicted less volatility on investors over the long-run (1919-2023):

The higher your Sharpe ratio, the better your risk-adjusted returns. That is, the more return you get per unit of risk as measured by volatility.

From this we can conclude that the World has proved about as worthwhile a buy as the US when returns are costed against the volatility you endured to attain them. (This is the essence of the Sharpe Ratio measure.)

Viewing the benchmarks on the single dimension of returns would imply that world equity diversification has proved sub-optimal, compared to if you’d gone all-in on the US.

But taking that broader view reveals how the rest of the world offers good reason not to pin all our hopes on perpetual American exceptionalism.

World index market share

The MSCI World is utterly dominated by the US stock market these days. It currently weighs in at a 71.7% share of the index:

Source: MSCI. August 2024

Our investing fate is inevitably reliant on the world’s most important capital market, though that’s nothing new.

This next chart compares the market capitalisation of each of the major developed world stock markets:

Source: The Big Bang. August 2024.

We can see that the US has almost always been the biggest player – offset to a greater or lesser degree by the UK, Japan, France, Germany, and the plethora of smaller fish known as ‘Other’.

Since 1919, the US share of the world market has ranged from 31% (1988) to 73% (1951).

For what it’s worth, the US is close to its historical ceiling right now.

Inside the World index

I want to emphasise that the World index presented here is not the global index.

I’m relying on MSCI World figures from 1970 onwards. That index excludes the emerging markets. Its Asian representatives are limited to Japan, Singapore, and Hong Kong.

Pre-1970, I use Macrohistory’s country list. That is limited to the Anglosphere, Japan, and Europe.

Macrohistory’s research omits Austria, New Zealand, Ireland, and Eastern Europe.

Indeed, it’s the absence of Austria and Russia that enforced our 1919 cut-off. Those two imperial stock markets weighed about 5% each before World War One intervened (by the light of the DMS database).

South Africa is the other notable no-show. Its stock market accounted for a couple of percentage points of the whole during most of the period.

Every benchmark makes some exclusions for reasons of practicability. Ours are imposed by the limits of publicly available data.

Even so, we’re happy that our numbers are a credible representation of the historical World index. The loss of fidelity versus commercial alternatives doesn’t change the lessons we can learn.

Finally, I’d just like to thank the academics responsible for the Macrohistory database and The Big Bang research. They have created an immense resource and been incredibly generous in freely sharing it with the world.

Thank you Òscar Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, Alan M. Taylor, and Kaspar Zimmermann.

Take it steady,

The Accumulator

1. British Pounds Sterling. [↩]
2. Òscar Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan M. Taylor. 2019. “The Rate of Return on Everything, 1870–2015.” Quarterly Journal of Economics, 134(3), 1225-1298. [↩]
3. Dmitry Kuvshinov and Kaspar Zimmermann. 2021. The
   Big Bang: Stock Market Capitalization in the Long Run. Journal of Financial Economics,
   Forthcoming. [↩]

What caught my eye this week.

I am just back from two days away for a wedding with a slightly sore head, a very favourably updated impression of Liverpool, and our regular weekend links only now finalised and tidied up.

Oh, and also to the discovery this morning that I hadn’t done as badly as I’d gathered from furtive half-glimpses at my live portfolio-tracking spreadsheet in the quiet moments before the cake was cut.

Rather, I’d forgotten one of my recently re-upped stocks was due a 10-to-one stock split at the end of the week!

Phew – it turns out there’s a benefit to my usual active obsessiveness after all. But also an even-bigger case for slipping my reading glasses into my wedding suit and never mind lumpy pockets in the photos.

Alright that’s it for a soaring treatise waffly intro this week. Thanks to my email software, I know a select few of you are out there banging ‘refresh’ repeatedly in your eagerness to get your weekly investing reads.

Enjoy, and have a great weekend!

[continue reading…]

Here’s some useful data on US historical asset class returns, both in regular ol’ USD terms and, more usefully for UK investors, GBP flavour.

By converting US returns into sterling and subjecting them to the wealth-stripping acid of UK inflation, we can see if American investment exceptionalism holds up for Brits.

We’ll start with US asset class real returns including reinvested income (in USD) since 1900:

Data from JST Macrohistory1 and Aswath Damodaran. July 2024.

As you can see, equities (stocks) have done much better than bonds or cash over the long-term.

Three important caveats:

• The seemingly inexorable rise of equities disguises many setbacks, such as the 2008/9 bear market.

• The US has been one of the very best performing countries in stock market terms over the past 124 years. Extrapolating this to other regions (or even into the future) could be misleading.

• A UK investor putting money to work in the US faces currency risk, which can increase or reduce your returns, as we’ll see below.

Let’s now look more closely at US historical annualised2 asset class returns including gold and commodities.

US asset class annualised returns (% per annum)

Data from Summerhaven3, BCOM TR, JST Macrohistory4, Aswath Damodaran, The London Bullion Market Association, and Measuring Worth. July 2024.

Investing returns sidebar – All returns quoted are inflation-adjusted, annual total returns (including dividends and interest). Investing fees are not included.

As the table shows, US equities have delivered returns far ahead of inflation.

There are only a few other stock markets in the world that can compete with the US, as our World equities post reveals. (That article needs an update, but if you’re thinking Scandinavia and the other Anglophone countries are contenders – plus South Africa – then you’re on the right lines.)

While USD gold and commodity results are nothing to write home about, their government bond and cash returns have trounced their UK equivalents even more soundly than equities in relative terms.

But the question is: do monster-truck size US profits hold up for UK investors once brought ashore?

US asset class annualised returns in GBP (% per annum)

Source: see table one

The pound strengthened against the dollar in 2023, weakening US returns once translated into sterling. Moreover, our annual inflation rate was considerably worse too, reducing a UK investor’s real return further.

Over longer periods, the secular decline of the pound has boosted US returns for UK investors: a useful hedge for the loss of purchasing power associated with our waning influence.

And yet over the very long-term, it’s mattered little whether you consumed your US profits in pounds or dollars. On the UK side, the currency gains were mostly offset by our higher inflation (see the 124-year column).

Most Monevator readers likely invest in a global tracker fund and thus their fortune depends far more upon US equities than any other market.

But should we also be positioned in US Treasuries ahead of gilts?

Well, read that article and you’ll see that superior US bond returns don’t always arrive when we need them – i.e. in the midst of a stock market crisis.

Using historical asset class returns

An understanding of historical returns is important because it helps us get over behavioural quirks such as recency bias.

Recency bias is the tendency we all have to think that things will continue in the same vein as they have recently, even when the long-term data says otherwise.

For instance, if you go out in a T-shirt and shorts in October in Scotland without checking the weather forecast – just because it was sunny yesterday and the day before – then you are suffering from recency bias.

(You’ll probably soon be suffering from the flu, too!)

Hence it’s very misleading to consider just the last couple of years of asset class returns when deciding how to construct a long-term portfolio.

Only cash and very short-term government bonds provide a secure return over a short period.

All other asset classes are too volatile for that.

For example, let’s consider the equivalent historical data for the US as seen from the vantage point of 2013.

Returns to 2013: US asset class annualised returns in GBP (% per annum)

Source: see table one

You can see the long-term return figures are little changed (for instance, equities had returned 6.4% p.a. over the 114 years to 2013, versus 6.9% p.a. over 124 years to 2023).

Shorter-term though, things are different.

Against popular expectations, 2013 was a stellar year for US stocks. Yet 10-year returns still bore the scars of the Global Financial Crisis, while bonds and gold were uplifted by the same.

Over the longer term, the traits of the different asset classes typically reassert themselves, although the true potential of gold is still a mystery.

The long and short of it

Stocks tend to outpace other asset classes over the medium to long-term precisely because they are far riskier over the short-term.

If the expected returns from equities weren’t higher than bonds, then nobody would choose to own them over less volatile and ultra-safe bonds – and the prices of stocks would accordingly fall until their expected returns rose.

That’s exactly what happened after bubbly periods for equities such as 1999 or 1929.

But while all this looks obvious in hindsight, timing the market to try to avoid booms and busts is notoriously difficult.

Nearly all the methods of stock market forecasting you’ll read about have proven very unreliable, and the best method isn’t much better than that.

This means that most people trying to save and invest for the future are best advised to follow a passive investing strategy, rebalancing their portfolios periodically to smooth out the booms and busts.

Over the long term – such as 40 years of investing towards retirement – the characteristics of different asset classes such as stocks, bonds, and cash should play out like they have in the past.

For that reason, if you’re using an investment return or compound interest calculator then it’s okay to use long-term historical returns as a proxy for the interest rate function required. Just bear in mind that the US stock market has been one of the best-performing of all developed world nations.

UK historical asset class returns offer a more cautious reference point.

1. Òscar Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan M. Taylor. 2019. “The Rate of Return on Everything, 1870–2015.” Quarterly Journal of Economics, 134(3), 1225-1298. [↩]
2. The average annual percentage amount by which each asset grew (or shrunk) over the period. [↩]
3. Bhardwaj, Geetesh and Janardanan, Rajkumar and Rouwenhorst, K. Geert, “The First Commodity Futures Index of 1933,” Journal of Commodity Markets, 2020. [↩]
4. Òscar Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan M. Taylor. 2019. “The Rate of Return on Everything, 1870–2015.” Quarterly Journal of Economics, 134(3), 1225-1298. [↩]