There are anxieties for those who know where to look for them, however. This year, the S&P 500 Equal Weight index is doing better than the regular index, which is dominated by tech behemoths. Is that a change in leadership? Defensive sectors are rallying. Healthcare, one of last year’s worst performers, is this year’s best. Value stocks outperformed growth by 3.9 percentage points in February, one of the top 5% of months for relative value returns going back to 1979, according to BofA Securities. Meanwhile, shares in Europe and China are outperforming the U.S. this year.
All of this will leave indexers torn over whether to fiddle with their fund mixes. Three U.K. professors have released a report that doesn’t address this topic directly, but offers clues to how investors should think about long-term returns. Paul Marsh and Mike Staunton at London Business School, and Elroy Dimson at Cambridge University, compiled evidence on the exploits of stocks, bonds, bills, currencies, and consumer prices across countries and time periods, including ones that Wall Street doesn’t typically include in its glossy brochures.
The three presented their findings in a book near the turn of the millennium called Triumph of the Optimists: 101 Years of Global Investment Returns, and have since offered yearly updates, with the latest, sponsored by Swiss bank UBS, including 125 years of data. Yes, I have read it, and no, I’m not permitted to send you a copy, dear reader, much as you are one of my favorites. But here are some observations that stand out:
America has gone from exceptional to exceptional-er. In 2000, the U.S. had been the best-performing stock market of the prior century, swelling from 14% of the world market to 49%. That is perhaps unsurprising, given its economic dominance and relative insulation from the destruction experienced in Europe and Japan by two world wars. What is more surprising is how U.S. dominance hasn’t only continued but grown, reaching 64% of the world’s stock market value last year, and 73% of developed markets.
Dominant markets don’t have to lose their place to slip into underperformance. All that’s needed is for the good news to be fully reflected in stock prices. But there have also been stark lead changes. The U.K. is 3% of world stock markets, down from a leading 24% in 1900. And it isn’t the most extreme example….
Gung Ho isn’t a business comedy. It’s an investment horror prequel. Yes, I’m talking about the 1986 film starring Michael Keaton. A Tokyo auto maker attempts efficiency improvements at a Pennsylvania plant. Hilarity ensues, or doesn’t, judging by a 33% positive rating at RottenTomatoes.com. The plot reflected the angst Americans felt at the time over ceding their corporate dominance to Japan, which rose to 40% of the world stock market by 1989, versus the U.S. at 29%. It turns out that was just a giant asset bubble. Japan today is down below 6%. Time to buy? Maybe, but…
International diversification has worked. Except for Americans. Putting money overseas wasn’t a thing for most U.S. investors until a 1974 paper on the subject argued that doing so could reduce risk by half. Money soon trickled, then flowed, then flooded into international funds. Investors in most countries got the promised benefits. But for risk-adjusted returns, American investors would have been better off staying home. This is true whether they started at the time of that paper 50 years ago, or in 1980, 1990, or 2000. The U.S. stock market has outperformed, and non-U.S. markets have exhibited higher volatility.
That leaves an American eyeing overseas stocks in the awkward position of having sound theoretical support for something that hasn’t been proven in real-world results. “Even for a U.S. investor, it makes sense to diversify internationally,” says co-author Marsh. “But it isn’t guaranteed.”
Bonds stink. But you probably need them. The average real, or after-inflation, return on government bonds since 1900 was just 0.9% a year. And they aren’t as safe as you might assume. Volatility of returns has been lower for bonds than stocks, and stocks have seen worse crashes, but bonds have experienced much longer periods to break even. Investors who bought stocks at the peak before the Great Depression needed more than 15 years to get back to their starting point, adjusted for inflation. But those who bought bonds at their 1940 peak needed more than 50 years.
The real reason to buy bonds is that correlation between them and stocks are low. In other words, buy some bonds—they’ll probably stink long-term, but you’ll be happy to have them during rough rides for stocks.
Stocks are great. Just not most of them. U.S. stocks returned an annualized 9.7% over the past century and a quarter, or 6.6% after inflation. That was enough to turn a dollar into $2,911 of buying power. Even if you bought stocks everywhere but the U.S., you’ve made an annualized 4.3% and turned a dollar into $194. Not bad for an epic misstep. In fact, stocks were the best-performing asset class for all 21 countries with continuous 125-year investment histories.
But most individual stocks aren’t great. Or good. The professors point to a 2018 study showing that 57% of U.S. stocks had lifetime returns that were worse than Treasury bills. The net gain for the U.S. stock market over the past century is explained by just 4% of stocks. That’s the real reason to hold a big basket of stocks, like an index fund. It isn’t to dilute the damage from your losers. Most of them will be losers. It’s to cast the net wide enough to snag the winners. If you own an S&P 500 fund, you’ve been increasingly bullish on Nvidia since 2001. Congratulations on your foresight.
The U.S. stock market looks concentrated. Or maybe not. Three companies recently made up 19% of the market. Concentration is the highest in 92 years. Something has to give, or does it? The market was more concentrated in 1900—it was 63% railroads. Somehow stocks have done well since then, even though railroads are now less than 1%. And have you seen the concentration elsewhere? In France, three stocks are 23% of the market, Germany 36%, Korea 40%, and Taiwan 59%. Among the world’s dozen largest markets, the U.S. is the third-least concentrated, behind Japan and India.
Returns look stingier but still OK. U.S. stocks have returned a real 4.9% a year over the past quarter-century, versus 7% over the prior century. The professors predict lifetime returns by generation, and no one is matching the baby boomers. Generation Z can expect a real 3.9% a year on 60/40 portfolios of stocks and bonds—worse than other generations, including a point less than millennials, but hardly grim.
Write to Jack Hough at jack.hough@barrons.com. Follow him on X and subscribe to his Barron’s Streetwise podcast.
