Stocks and Bonds for the Long Run
Data and text in this post taken from the chapter House Prices, Stock Returns, National Accounts, and the Riksbank Balance Sheet, 1620–2012 in the book Historical Monetary and Financial Statistics for Sweden, Volume II.
- The long-run evolution of Swedish financial market returns over the past one hundred and fifty years
- The short-term risk-free rate of return is presented from 1856 and a representative long-term government bond yield from 1874
- A preliminary version of a new annual stock price and returns index for the period 1870–2012, using previously unexplored evidence of historical stock prices, dividends and equity capital from the last decades of the 19th century
Part 3: Swedish Markets – Bond Returns
“Turning to fixed income returns, Figure 6.6 shows the evolution of the yield on two securities: a long-term government bond and a short-term Treasury bill (actually, the Riksbank’s official discount rate) going back to the middle of the 19th century. As can be seen from the figure, there has been a high degree of correlation in the yield levels of these two instruments. The short-term rate lies somewhat below the longterm government bond rate in the latter part of the 20th century, except during the turbulent era in the 1990s when the Riksbank raised its short-term rates to dramatic levels in an attempt to support the fixed exchange rate (which was abolished after a short time).”
“A comparative view of the long-run evolution of inflation-adjusted returns on stocks, bonds and bills is provided in Figure 6.7. The main message is that stock investments have performed dramatically better over the course of the past 112 years than any of the fixed-interest securities. Note, however, that this only holds when dividend yields are incorporated; by themselves, stock price gains do not outperform yields on government bonds or bills. The order of magnitude is of interest. A stock investment of 100 SEK in 1901 rendered a portfolio worth 44,200 SEK in 2012 when dividends were reinvested and only 900 SEK when they were not. For government bonds, the same investment would give a portfolio of 1,300 SEK and for shortterm Treasury bills 700 SEK. Note that these ex post comparisons do not take into account the additional risk associated with stock investments.
While stocks outperformed fixed-interest securities over the period as a whole,
this was not the case in the first half of the 20th century. Up to 1950 both government bonds and bills represented a better investment than a stock purchase regardless of how dividends are treated. This is explained by the dramatic collapse of stock prices during the financial crises in the 1920s and 1930s. The total value of the stocks on the Stockholm Stock Exchange dropped by two thirds between December 1917 and December 1920 and by half between December 1930 and December 1932.”
“As already mentioned in the introduction and data sections above, this chapter also presents a new stock price index and a new stock returns index for Sweden beginning in 1870, which allows an analysis of the entire era up to modern times. Due to a scarcity of data, at present these indices are only available annually. Furthermore, one sub-period (1892–1901) is based on a relatively small set of traded stocks and is therefore potentially less representative than both earlier and latter periods. Figure 6.8 displays the evolution of nominal and inflation-adjusted stock prices and returns on the Stockholm Stock Exchange during the late 19th century. There were two boom years, 1871–1872, when prices rose by a total of 56 per cent and returns by almost 80 per cent. This was followed by an international financial panic and long depression, when prices fell and even total returns were negative for a few years. In the period as a whole, it can be seen that capital gains were modest and most of the total return came from the dividend yield. As reported in Table 6.1, total returns averaged eight per cent a year between 1870 and 1901 and capital gains were somewhat over three per cent.”
“Table 6.3 presents summary statistics for bond and bill returns, both for the entire period and for the same sub-periods as for stock returns in Table 6.1. The average annual real return on a Swedish government short-term security was 1.7 per cent over the entire 20th century and up to 2012. For long-term government bonds the average annual real return was only marginally higher, 2.1 per cent. There is, however, a considerable variation across decades. Nominal yields were highest in the early era up to 1930 and in the 1980s and 1990s, largely due to relatively high inflation. Overall, comparing long-term and short-term yields suggests that the term premium, i.e., the return to investors for holding securities with longer maturities, has been significantly positive in almost every period in the past.
The typical argument for the existence of an equity risk premium is that investors demand compensation for holding volatile and risky corporate stocks instead of fixed-interest securities with lower returns, volatility and default risk.19 Table 6.3 shows the equity risk premium calculated as the difference between the nominal stock market return and the nominal short-term bond, both over a holding period of one year. Looking at the entire period 1901–2012, the equity risk premium is 2.5 per cent per year using geometric average returns and 4.7 per year using arithmetic average returns. Extending the period back to 1870 increases the premia to 3.8 per cent and 5.6 per cent, respectively. Interestingly, these premia are closer to what Frennberg and Hansson (1992b) found for the period 1919–1990: 3.6 and 5.5 per cent, respectively. In other words, the historical time dimension matters for the estimation of equity premia, as has been found for other countries (see Goetzmann and Ibbotson, 2006) and now also for Sweden.
A closer look at the equity premia across time periods reveals a striking degree of variation. There are decades when the equity premium is virtually zero (e.g., the 1900s and 1970s) or even negative (the 1910s through the 1930s and the 2000s), and decades when it is substantial (the 1950s, 1980s, 1990s). Holding stocks for one year has thus not been a universally successful strategy, not even when averaged over a decade.”