Special Edition: Long-term equity returns

In this Special Edition of What’s Up with Stonks, we will talk about long-term equity returns. This time the review also includes raw materials, which have often provided a good hedge against inflation.

Credit Suisse published a new investment returns yearbook a while ago, on which this the material in this post is based.

Studying long-term stock returns is important because it provides useful insights for the investor. By looking at over 100 years of returns, we get a clearer picture of the environments in which equities are a good investment and those in which they are not. Just a few silly decades are not enough.

A good example is the 60/40 portfolio that many people are familiar with, which is balanced between equities and bonds. For the last 40 years, the portfolio performed well, as both equities and bonds excelled. If stocks fell for a while, bonds rose to compensate for the stock losses. This strategy completely exploded last year when inflation threw both equities and bonds into the dumpster. Looking further back in history, this should come as no surprise. I wonder how many investors started investing in 2000 on the assumption that stocks would continue to deliver 10% annual returns as they had done for the previous 20 years. For the next ten years, global equities returned on average -0.6% per annum.

The stock exchange is a relatively old institution, so there is plenty of data. In Amsterdam, for example, the stock exchange has been operating for more than 300 years. A forward-looking investor might question why stock market data from more than 100 years ago would be relevant today. That was the time when cars disrupted horses as modes of transport.

While technology changes, the fundamentals of investing do not. Companies need to make a return on capital, whether their investments are old-fashioned steam engines or modern data centers.

One of the strengths of this data set is its international nature. When we read about long-term stock market returns, it’s often about US equity returns. This is misleading because few countries have had such a fertile environment for the stock market to flourish. Stocks don’t generate returns in a vacuum, but companies make their profits in a real economy. The attractiveness of that economy is determined by politics, institutions, regulation, social stability, available human capital, and physical capital et cetera. In the US, with its vast natural and intellectual resources and being protected by two oceans, conditions for stocks have been exceptionally good.

This graph shows the total return on stocks, bonds, and cash in different countries from 1900 to 2022.  Returns are in real terms, i.e., they take into account the erosive power of inflation. A few observations: First, shares consistently yield more than bonds. This is logical, because equities are much riskier, and you have to tolerate uncomfortable down markets more often with them. Investors often forget this point at the peak of a boom, when they greedily lower their required returns.



US equities have returned 6.4% per annum including dividends. The world's best returns have come from South Africa and Australia. Sweden and Finland are also among the top. Common denominators for the top of the table include stable institutions and a business-friendly environment.

The biggest markets have changed radically over time. This graph shows the relative size of world stock markets in 1899 and 2023. The most significant change is the emergence of the United States as by far the largest market and the shrinking of the European countries that were more devastatingly entangled in the World Wars. Note the weight of Tsarist Russia in that graph on the left. Russia was a hot emerging market at the time, with money pouring in from abroad, but investors lost 100% of their money in the revolution of 1917. (Always a timely reminder of the risks of emerging economies.)

Here is the same data as a time series. The United States has been dominant for 70 years. The Japanese stock market bubble of the late 1980s is clearly shown in the graph, with Nippon stocks briefly being as valuable on paper as US stocks.

This shows the stock returns for the world excluding the US, measured in dollars. Returns are lower at 4.3% per annum in real terms. When calculating realistic expected returns for equities over the long term, I would rather look at global returns if there are no US equities in your portfolio or your diversification is international. Many investors look to recent decades to gauge their expectations for the future, but recent decades have been exceptionally generous in terms of returns. More realistically, the returns of the last 100 years include the grittiness of stock market life.

The study makes an interesting observation about how real interest rates and future stock returns go hand in hand. The real interest on cash and bonds refers to the interest that’s left after inflation. Interest rates reflect economic growth. So often a high real interest rate indicates a situation where inflation is under control and the economy is growing, inflating earnings. This is a good reminder because during the period of zero interest rates, many investors got the impression from American stocks that low interest rates were automatically good for stocks. However, this is not the case and in fact stocks actually flatlined during the period of zero interest rates from 2010 to 2020 in other parts of the world. Low real interest rates reflect weak economic growth or high inflation.

The study provides a good perspective on a familiar concern: inflation. Research also provides a remedy for the ailment, and that is raw materials.

History doesn’t paint a flattering picture of a rapid cooling of inflation once it has been unleashed. Inflation above 6% is very difficult to reduce to below 3%. Based on historical data, it has taken between 6 and 20 years to reverse inflation of more than 8%, with a median time of more than 10 years. 

Equities are a mediocre or even poor hedge against inflation, as investors have again discovered. This graph shows the real return on equities in different economic growth and inflation environments. Whether the economy is growing fast or slow, high inflation has always meant poorer stock returns and low inflation better. The bad news is that the period of low inflation of recent decades seems to have come to an end, replaced by stubbornly high, volatile inflation. If economic growth is slow and inflation is high, equity returns have turned negative.

Fortunately, if you fear high inflation will continue, there is a cure. In terms of diversification, raw material futures have worked well. Physical raw materials are quite heavy and impractical. I mean, who would want a barrel of oil in the bedroom, corn in the kitchen and copper in the living room? More seriously, physical raw materials require storage, transport, collateral and everything else that eats into investor returns.

In contrast, a well-diversified raw material futures portfolio has worked well. In practice, from a retail investor's point of view, this is easily accessible through the numerous raw material ETFs. This graph shows the return on 30 raw materials compared to equities and bonds. After 150 years, equities are still the kings, but raw materials are in second place. In raw materials, diversification is key. This shows the returns on several individual raw materials. With the exception of copper, many raw materials chiefly flatline in real terms.



This graph shows the correlation between inflation and several asset classes. Only raw materials have a positive correlation. In this sense, they can serve as an effective diversification tool as part of an investment portfolio. Interestingly, based on this graph, even inflation-protected bonds and real estate seem to take a hit from inflation.


But raw materials aren’t a shortcut to happiness. This graph shows the magnitude of the collapses in raw materials and equities from their peaks. In both cases, 20-50% collapses are by no means a rare phenomenon. While commodities thrive in inflation and at the peak of the economic cycle, they are brutalized at the beginning of a recession and disinflation in particular.

All things considered, equities are a good asset class in the long run, but you shouldn’t expect miracles in returns over time. A real return of 4-5% over the next few decades is already a big deal. And that's not even taking taxes into account. In inflation, equities fare worse. The safety of bonds masks their weaker historical returns. Raw materials can offer some support in one corner of the portfolio, bringing diversification if they suit your taste.

Thank you for reading the post, read analysis, pay attention to inflation, think about raw materials, and make good stock picks!