Triumph of the Optimists: 101 Years of Global Investment Returns - Hardcover

Dimson, Elroy; Marsh, Paul; Staunton, Mike

Hardcover

ISBN 10: 0691091943 ISBN 13: 9780691091945

Publisher: Princeton University Press, 2002

Synopsis

Investors have too often extrapolated from recent experience. In the 1950s, who but the most rampant optimist would have dreamt that over the next fifty years the real return on equities would be 9% per year? Yet this is what happened in the U.S. stock market. The optimists triumphed. However, as Don Marquis observed, an optimist is someone who never had much experience. The authors of this book extend our experience across regions and across time. They present a comprehensive and consistent analysis of investment returns for equities, bonds, bills, currencies and inflation, spanning sixteen countries, from the end of the nineteenth century to the beginning of the twenty-first. This is achieved in a clear and simple way, with over 130 color diagrams that make comparison easy. Crucially, the authors analyze total returns, including reinvested income. They show that some historical indexes overstate long-term performance because they are contaminated by survivorship bias and that long-term stock returns are in most countries seriously overestimated, due to a focus on periods that with hindsight are known to have been successful. The book also provides the first comprehensive evidence on the long-term equity risk premium--the reward for bearing the risk of common stocks. The authors reveal whether the United States and United Kingdom have had unusually high stock market returns compared to other countries. The book covers the U.S., the U.K., Japan, France, Germany, Canada, Italy, Spain, Switzerland, Australia, the Netherlands, Sweden, Belgium, Ireland, Denmark, and South Africa. Triumph of the Optimists is required reading for investment professionals, financial economists, and investors. It will be the definitive reference in the field and consulted for years to come.

About this title

About the Author

All three authors are at the London Business School. Elroy Dimson is Professor of Finance. Paul Marsh is Esmee Fairbairn Professor of Finance. Mike Staunton is Director of the London Share Price Database.

From the Back Cover

"This will become the definitive empirical basis for analysis of the world's capital markets over the twentieth century. It is an important work of scholarship; no one else has calculated the equity premium of a large number of countries over the long term. In doing so, the book contributes to the very lively debate on the magnitude of the equity premium and will make a splash."--William Goetzmann, Yale University

"Recent years have seen unprecedented public interest in the stock market, but there is a tendency for investors to concentrate on recent U.S. stock market performance. Progress in understanding financial markets requires a much longer timeframe and a global perspective. This book presents and analyzes data from many countries in a simple, standardized way that makes comparisons easy. It makes a number of extremely important points and goes well beyond simple summaries of average returns and historical volatilities to look at such issues as seasonality and industrial structure."--John Campbell, Harvard University

"No investor can afford to risk a penny in the markets without studying this book and absorbing its fascinating lessons. That advice applies whether you are professional or amateur, a youngster or hardened from experience, bold or conservative. This book is history at its most challenging and illuminating. The facts are astonishing, the presentation dazzling, the analysis brilliant, and the lessons profound."--Peter L. Bernstein, author of Capital Ideas and Against the Gods

"This is an important addition to the investment literature and will be widely used by both the academic and business community. To have the scope of data and analysis contained in this book available in one place represents a major contribution and improvement over what is now available."--Martin J. Gruber, New York University

From the Inside Flap

"This will become the definitive empirical basis for analysis of the world's capital markets over the twentieth century. It is an important work of scholarship; no one else has calculated the equity premium of a large number of countries over the long term. In doing so, the book contributes to the very lively debate on the magnitude of the equity premium and will make a splash."--William Goetzmann, Yale University

"Recent years have seen unprecedented public interest in the stock market, but there is a tendency for investors to concentrate on recent U.S. stock market performance. Progress in understanding financial markets requires a much longer timeframe and a global perspective. This book presents and analyzes data from many countries in a simple, standardized way that makes comparisons easy. It makes a number of extremely important points and goes well beyond simple summaries of average returns and historical volatilities to look at such issues as seasonality and industrial structure."--John Campbell, Harvard University

"No investor can afford to risk a penny in the markets without studying this book and absorbing its fascinating lessons. That advice applies whether you are professional or amateur, a youngster or hardened from experience, bold or conservative. This book is history at its most challenging and illuminating. The facts are astonishing, the presentation dazzling, the analysis brilliant, and the lessons profound."--Peter L. Bernstein, author ofCapital Ideas and Against the Gods

"This is an important addition to the investment literature and will be widely used by both the academic and business community. To have the scope of data and analysis contained in this book available in one place represents a major contribution and improvement over what is now available."--Martin J. Gruber, New York University

Excerpt. © Reprinted by permission. All rights reserved.

TRIUMPH OF THE OPTIMISTS

101 Years of Global Investment ReturnsBy Elroy Dimson Paul Marsh Mike Staunton

Princeton University Press

Copyright © 2002 Elroy Dimson, Paul Marsh, and Mike Staunton
All right reserved.
ISBN: 978-0-691-09194-5

Contents

Preface.....................................................................xiPart One: 101 years of global investment returns............................1Chapter 1 Introduction and overview.........................................3Chapter 2 World markets: today and yesterday................................11Chapter 3 Measuring long-term returns.......................................34Chapter 4 International capital market history..............................45Chapter 5 Inflation, interest rates, and bill returns.......................63Chapter 6 Bond returns......................................................74Chapter 7 Exchange rates and common-currency returns........................91Chapter 8 International investment..........................................105Chapter 9 Size effects and seasonality in stock returns.....................124Chapter 10 Value and growth in stock returns................................139Chapter 11 Equity dividends.................................................149Chapter 12 The equity risk premium..........................................163Chapter 13 The prospective risk premium.....................................176Chapter 14 Implications for investors.......................................195Chapter 15 Implications for companies.......................................211Chapter 16 Conclusion.......................................................220Part Two: Sixteen countries, one world......................................225Chapter 17 Our global database..............................................227Chapter 18 Australia........................................................229Chapter 19 Belgium..........................................................234Chapter 20 Canada...........................................................239Chapter 21 Denmark..........................................................244Chapter 22 France...........................................................249Chapter 23 Germany..........................................................254Chapter 24 Ireland..........................................................259Chapter 25 Italy............................................................264Chapter 26 Japan............................................................269Chapter 27 The Netherlands..................................................274Chapter 28 South Africa.....................................................279Chapter 29 Spain............................................................284Chapter 30 Sweden...........................................................289Chapter 31 Switzerland......................................................294Chapter 32 United Kingdom...................................................299Chapter 33 United States....................................................306Chapter 34 World............................................................311References..................................................................316About the authors...........................................................331Index.......................................................................333

Chapter One

Introduction and overview

The year 2001 was scarred by terrorism, and financial markets were beset by turmoil. As we look to the future, investors have more cause than ever to ask: Where are the markets heading? What returns can be expected from equities, bonds, and bills around the world? What are the long-term risks of stock and bond market investment? What are the likely long-term rewards?

Corporations also need answers to these questions to understand what returns their stockholders and bondholders require, and to ensure they raise and use capital to best effect. Similarly, these are crucial issues for governments, since market returns provide the yardsticks for judging the worth of public sector projects, and for raising and managing government debt. Regulators, too, need to know the cost of capital to set appropriate rates of return for regulated industries.

It is hard to form a judgment about future prospects, or about required or allowable rates of return, without making comparisons with the past. Recent market returns are widely publicized. But it has hitherto been difficult to get a reliable impression of what investors have achieved over the long-term. Accurate historical records are available for the United States. However, the US economy has been remarkably successful. It would be dangerous for investors to extrapolate into the future from the US experience. We need to also look outside of the United States.

We also need to look long-term. Brief snippets of stock market history are not very helpful, unless our principal focus is on short-term volatility. For example, if we were interested in the volatility that can be anticipated over the next five years, the variability of the last 60 one-month returns or 260 one-week returns might be informative. But if we wish to say something about the expected return over the next five years, we cannot extract much information from the last five years. Further, the annual rate of return estimated from the last 60 months or 260 weeks is the same as the annual rate of return estimated over a single five-year interval. To estimate the expected return, we need a long run of data. We cannot improve estimates of the expected return by subdividing an interval into many short subperiods. While there are also benefits to looking at risk over the long haul, the need for long-term data is especially great when we are interested in expected returns.

To answer the key central questions about markets and investment prospects, we therefore need evidence that spans time and spans the world. The purpose of this book is to provide this evidence, and to point readers toward analysis that can help answer their questions.

1.1 Need for an international perspective

This book provides a comprehensive record of past investment returns around the world. It aims to help readers understand the historical record so that they can make informed judgments about the future. It does this by documenting the returns from equities, bonds, and bills, as well as inflation rates and currency movements, in four continents and sixteen countries, over the whole of the 101-year period from 1900-2000. We also have century-long evidence on the small-firm and value/growth phenomena. We have put significant effort into compiling complete financial market histories, so that we can present consistent and comparable records for different countries. But Triumph of the Optimists is about much more than just data, since it has description and analysis at its core.

There is an obvious need for a reliable and truly international dataset for the investment industry as it continues relentlessly toward full market globalization. One of the many changes taking place in the investment business is the increasing demand for locally sourced research placed in a global context. Another innovation is the growing number of truly global mandates being given to fund managers. Globalization may be a clich, but for portfolio managers it is fast becoming a reality. Access to a properly constituted and rigorously maintained international database is a sine qua non for the start of any investment process.

The period since spring 2000 has come as a shock to those who had become used to the bull market conditions of previous years. The bursting of the technology bubble, the rapid decline in economic growth rates, especially in the United States, and the advent of international terrorism raised questions about what we can expect for the future. We assert in this book that the single most important variable for making investment decisions is the equity risk premium, and we argue that high long-term returns on equities, relative to bonds, are unlikely to persist. Even after the setbacks of 2000-01, it is necessary to justify the relatively high rating of today's stock markets in terms of a historically low forward-looking equity risk premium. For the investment strategist this raises the most fundamental question of all: Do investors realize that returns are likely to revert to more normal levels, or do current valuations embody exaggerated expectations based on an imperfect understanding of history?

Good data is the key to understanding history. With this as our guiding principle, assembling the data for this book was a major task. For the United Kingdom, ABN AMRO supported us in compiling an authoritative record of UK equity market performance over the last 101 years. We did this because we were not satisfied with the data that previously existed, and there was anyway no comprehensive record of equity returns extending back to 1900. To construct our UK indexes, we devoted intensive efforts to financial archaeology. This involved transcribing original source data from dusty newspaper archives and ancient reference books into our database. A resulting benefit is that we have not simply assembled an index, but we also have the underlying stock-by-stock data, so we can now study the performance of segments of the market, such as industry sectors and market-capitalization bands. We also compiled a series of UK government bond indexes especially for this study.

For the other fifteen countries covered in this book, we have linked together the best quality indexes and returns data available from previous studies and other sources, a number of which are previously unpublished, and some of which are still work in progress. In addition to the United Kingdom, we cover two North American markets, the United States and Canada; ten other European markets, namely, Belgium, Denmark, France, Germany, Ireland, Italy, The Netherlands, Spain, Sweden and Switzerland; two Asia-Pacific markets, Australia and Japan; and one African market, namely, South Africa. Taken together, these sixteen countries make up over 88 percent of today's world market capitalization, and were also dominant at the start of the twentieth century. We estimate that in 1900 these countries represented at least as high a proportion of the world equity market as they do today.

In each country we cover the same asset classes: equities, bonds, bills, inflation, and the local currency. We are therefore able to make comparisons between the investment performance of different asset classes, in different economic and political environments while focusing on whichever time period is of interest. We also have annual gross domestic product (GDP) data for all sixteen countries over the entire period.

Unlike most previous long-term studies of global markets, our investment returns all include reinvested income as well as capital gains. Our new indexes are more representative than those used in any previous study, and cover a longer time span for a larger number of countries. Furthermore, the common start date of 1900 facilitates cross-country comparisons. We can now set the US data alongside comparable length series for the same asset classes for fifteen other countries, and make international comparisons that help set the US experience in perspective.

Measuring what has happened in the past is only the starting point for assessing the future. Interpretation of the data and being able to apply it to a modern-day canvas are as important. Throughout this book, therefore, our emphasis is not simply on describing the past, but also on interpreting what has happened, with an eye to what it tells us about the future.

1.2 The historical record

Our story opens in the following chapter, not at the beginning but at the end of our 101-year period. We look in chapter 2 at world markets as they stand today-their overall size and significance and the split between markets and countries. Global league tables set in perspective the importance of the sixteen countries covered in this study. We look back to the beginning of our period to review what stock markets looked like 101 years ago, at the start of the twentieth century, and at how, and why, they had evolved since their origins several centuries before.

Using the detailed stock-by-stock data that we have assembled for the United Kingdom, together with comparable data for the United States, we provide some snapshots of how the corporate landscape has changed over the twentieth century. In particular, our analysis of industrial composition reveals some major contrasts-and some surprising similarities-between the structure of the US and UK equity markets today and 101 years ago. We also show how stock exchange concentration has increased in recent years, while showing that markets have several times in the past been even more concentrated than today.

In chapter 3, we begin by considering the guiding principles that underpin measures of long-term investment performance. Even with good index construction, an index is only as reliable as the underlying data and sample, so we also discuss the coverage of indexes, both across securities and over time. We highlight the dangers of survivorship and success bias. Taking the United Kingdom as an example, we show how these biases have in the past exaggerated the historical attractiveness of investing in common stocks.

Turning to the international evidence, when making comparisons across markets there has been a reliance on index series for countries that have not experienced a material break in trading. Even more marked, however, is the impact of initiating an index series after unrest, or wars, and their aftermath have been resolved. We show that this "easy data bias," the tendency by researchers and index compilers to limit their research and indexes to easily obtained data, has provided investors with a misleadingly favorable impression of long-term equity performance.

The remainder of the book is therefore devoted to a detailed examination of stocks, bonds, bills, inflation, and currencies over the period since 1900. Chapter 4 provides an overview of international capital market history, focusing on our 101-year study of the United States, the United Kingdom and fourteen other markets. We quantify the impact of inflation on the total return from US and UK equities, and then examine real and nominal stock market performance across our full sample of international capital markets. We show the extent to which rates of return on equities have been higher than the return on government bills and bonds, though this is by a smaller margin than many investors have perceived.

We report on the volatility of equity and bond returns, and show the extent to which diversification across stocks reduces the risk of a domestic equity portfolio. We examine how risk varies across asset classes and countries. We find that while equities were riskier than bonds, which in turn were riskier than bills, these risks were rewarded. Equities performed better than bonds in every single country, while bonds beat bills almost everywhere.

The next two chapters deal with the returns from investing in short-term deposits (treasury bills) and long-term bonds. Chapter 5 describes the historical record on interest rates and inflation. Chapter 6 presents the evidence on bond returns and bond maturity premia-the reward from investing in long- rather than short-term bonds. We compare bond maturity premia across different time periods and national markets. We also analyze inflation-indexed government bonds and corporate bonds for countries that present a sufficiently long history for these assets. In chapters 5 and 6, we see the twentieth century through the lens of the financial markets. The financial data reveals the turbulence of the past-inflation and hyperinflation, extreme periods when even bond and bill investors lost everything, deflation, and the Great Depression, as well as two world wars and their legacies.

For the international investor, currency movements matter since investment returns need to be converted from local currencies into the investor's reference currency. Exchange rate changes thus impact performance, and are critical for measuring and comparing the returns from different countries. In chapter 7, we report on the exchange rate fluctuations that were experienced by our sixteen countries over the course of the 101 years from 1900-2000.

(Continues...)

Excerpted from TRIUMPH OF THE OPTIMISTSby Elroy Dimson Paul Marsh Mike Staunton Copyright © 2002 by Elroy Dimson, Paul Marsh, and Mike Staunton. Excerpted by permission of Princeton University Press. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Edition details

• Publisher: Princeton University Press
• Publication date: 2002
• ISBN 10: 0691091943
• ISBN 13: 9780691091945
• Binding: Hardcover
• Language: English
• Number of pages: 352