I’ve been investing in and following the stock market for almost 35 years now.
By the mid-1990s, twenty years ago, I was married, with a family portfolio worth over $100,000, and a well-established daily routine of reading about each day’s stock market action in the morning newspaper. I read stock market statistics the way most men read sports scores. I’m about as attentive and engaged as a complete amateur can be.
I’ve lived through the great boom of the 1990s, the bust of the early 2000s, the recovery of the mid-2000s, the Great Recession of 2008, and the recovery since.
The New Normal
I can’t remember when I first read about “The New Normal.” I think it was almost fifteen years ago, as the dot.com bust gathered steam. Since the Great Recession, almost everyone who reads the financial pages has heard the term.
In brief, the doctrine of the new normal says, “The rules of investing have changed. It’s not your father’s stock market anymore.”
I’m here to tell you that whole shtick is a load of crap.
On the numbers, the stock market is the same kind of investment arena as it was twenty years ago, holding the same pitfalls and offering the same rewards. Statistically, it looks the same now as when historical data first became widely available to ordinary investors.
Let me explain.
Stock market history
The relevant statistics are the real return on stocks, and the standard deviation of (nominal) returns. Return determines how much money you can make in the stock market, and standard deviation determines how much volatility you must bear to harvest that return. In turn, volatility refers to how much of a roller coaster ride you have to withstand to get the (presumably) attractive returns available from stock. A five year bank CD has no volatility over that period–it gives the same small return each year. How much bouncing around must you endure to harvest the more attractive returns supposedly available from stocks?
The long term values show a total return on stocks of 7% real (10% nominal, from which inflation estimated at 3% is subtracted), along with a standard deviation of about 20%. These numbers refer to the S&P 500 index, as measured from the beginning of 1926. By the early 1990s, that gave a 65 year stream of data.
Recent stock market returns and risk
I’ll take as my time period the past 20 years, from the end of 1995 to the end of 2015. Quite the roller coaster, eh? First, year after year of 25 and even 30% returns, followed by the dotcom bust that took markets down by 50%, followed by a recovery to old highs, followed by an even steeper drop during the Great Recession—a decline of 57%–followed by year after year of recovery, to new highs, with the market tripling off its 2009 bottom.
Not. Annual volatility over the period, as indexed by the standard deviation, was a little lower than the historical average, at a hair under 19%. Translation: the markets have been a tad subdued over the past 20 years, although not by much. Real return has been just under 6%, a little depressed from the historical 7%; but you would still have more than tripled your real wealth over the period, as opposed to over the entire historical record, when you would have not quite quadrupled it.
The differences are so small that moving the start and end dates up by one year—to the twenty years from end 1994 through 2014—brings the standard deviation up to 19.6% and the real return up to 7.3%.
Conclusion
The past twenty years in the stock market have been as close to “normal” as we would expect to see in any randomly chosen twenty year period. Everything has gone as expected—if you extrapolated from the long term historical data widely reported beginning in the 1980s.
If your subjective sense of the past twenty years has been that it was a rough ride, full of shocks; or a disappointment, with sub-par returns; then you did not really understand the historical data about stock market returns and volatility that were available to you by the early 1990s.
What did you think a standard deviation of 20%, around an arithmetic mean of 12%, implied?
Notes
- I got the S&P 500 data from https://ycharts.com/indicators/sandp_500_total_return_annual
- I got the inflation data from http://data.bls.gov/cgi-bin/cpicalc.pl Inflation ran lower than the historical three percent during the period.
- Keep in mind the difference between the arithmetical average of yearly returns (=average function in Excel) and the geometric or compounded return (multiply 1+ return across the 20 years, and then put that index value in into the Excel function =power(index, 1/20). Total return is compounded return, BTW.
- If you are interested in long term stock returns, and want to go to the original sources, search for Roger Ibbotson, Robert Schiller, and Jeremy Siegel
Be First to Comment