Optimistic investors can find some reassurance in the latest edition of the Global Returns Yearbook, compiled annually for UBS by Elroy Dimson, Paul Marsh and Mike Staunton. Since the study has its origins in Triumph of the Optimists, a book they published in 2002, this is hardly surprising. In it, they chart the progress of the global economy and financial markets since 1900.
Since then, US equities have provided a compound annual return of 9.8%, compared with 4.6% for Treasury bonds, 3.5% for short-dated bills and inflation of 2.9%. This gives an annual real return of 6.6% for equities and 1.6% for bonds. Since 1960, emerging markets have outperformed, too, returning 10.9% annually against 9.6% for developed ones. The charts over time all stretch reassuringly from bottom left to top right. Setbacks, even in real terms, are overcome, and every peak is higher than the last, as is every low point.
“Inflation has an important impact on long-term returns,” the authors caution, with real returns highest when inflation is lowest, especially if economic growth is also higher. Gold “has been effective at beating inflation over the long term”, with the real gold price multiplying 5.2-fold since 1900 in real terms in dollars and 12.2 times in sterling. However, barring the bubble in the 1970s, almost totally unwound by 2000, it was a dud investment for the first 100 years.
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Optimistic investors still have to tread carefully
Therein lies a problem with taking too much comfort from the data; long-term investors may think in terms of ten years, but nobody invests for 100 years. The FTSE 100 took more than 21 years to regain its millennium-eve peak of nearly 7,000; in the meantime, dividend income was earned, but inflation ate away at real values. Wall Street didn't regain its 1929 peak until 1954 and traded sideways from 1966-1982, as did UK equities. The Stock Trader's Almanac shows a pattern of markets struggling in periods of inflation (as in the 1960s and 1970s) and then roaring back as inflation fell.
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This isn't the only problem. International investment is a relatively recent concept; for most of the 126 years, investors were largely confined to their domestic market. Exchange controls remained in place in the UK until 1979 and even “global” portfolios were normally 50% weighted to the UK until considerably later. The US, the Yearbook points out, accounts for 62% of the MSCI All Country World index, yet the US's share of developed markets' GDP peaked at around 62% in 1950. It is now 36% and slowly rising, as is China's at 23%. In 1900, the UK was the largest stock market, accounting for nearly a quarter of the world's total. New York, with 16%, was only just ahead of France, and Russia was just behind Germany at 9%. The Russian market disappeared in 1917 and again in 2022.
Historian Niall Ferguson has shown that World War I was neither predictable nor expected – it was a total shock to investors until Austria's ultimatum to Serbia. When war started, most bond and equity markets closed, some for years and some never to reopen. This, he argues, averted the greatest market crash of all time. Global investors have had to be nimble and country investors lucky.
Sector and stock selection have also mattered; getting stuck in the wrong stocks has been a disaster. “Of the US firms listed in 1900, some 80% by value was in industries that are small or extinct today, including railroads (most of the total), textiles, coal, iron and steel. Technology and healthcare, now half the market, were almost totally absent from stock markets in 1900.” Railways accounted for nearly half the UK stock market in 1900; its exposure to technology is still tiny.
Growth drives markets, not shocks
The lesson for optimistic investors is that you may be able to bury gold for 100 years, but you can't bury a stock portfolio. The market changes gradually, but those changes can accumulate and end up huge over time. Investors should fear an extended period of high inflation, of which there have been three since 1900, two associated with world wars. The very low inflation of a few years back is probably gone for good, but that does not make a return to the inflation of the late 1960s and 1970s likely.
The period since 1900 has been punctuated by geopolitical events, but as the Yearbook shows, “economic risk has proved more significant”. Market analyst Ed Yardeni endorses the point, showing that earnings growth and economic expansion drive markets, not geopolitical shocks. Media pundits have been surprised and disappointed by the limited impact of the latest Gulf war on equity and bond markets and claim that markets (ie, investors) have got it wrong.
Usually, though, markets are right and the pundits are wrong, so it makes more sense to ask why their analyses are flawed. This isn't difficult. Each unit of economic growth consumes only 30% of the energy of 50 years ago. Pundits like to claim that 20% of the world's oil passes through the Strait of Hormuz, but that includes oil bound for India and China, which is being let through. The Saudis have a major pipeline to the Red Sea and the pipeline from Iraq to the Mediterranean could be reopened.
Most importantly, a period of high rises will lead to a boom in exploration and production around the world. Oil and gas prices have probably peaked already and will fall sharply in the years to come. That the markets have been resilient on the downside and recovered sharply on any prospect of good news does not suggest that they are complacent, but that there is plenty of upside when an end to the conflict becomes visible.
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