12.4 Historical Picture of Returns to Stocks
3 min read•june 18, 2024
U.S. equities have historically outperformed bonds and cash over long periods, with the averaging 10% annually from 1926 to 2021. However, short-term can lead to significant fluctuations in annual returns, impacted by major events like recessions and geopolitical crises.
Different equity styles and sizes behave differently based on economic conditions. often outperform during expansions, while shine in downturns. Small-cap stocks typically offer higher returns but with greater volatility compared to large-caps, reflecting the cyclical nature of equity performance.
Historical Equity Market Performance
Equity market performance across periods
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- Long-term historical returns of U.S. equities consistently outperform bonds and cash investments over extended periods (decades)
- From 1926 to 2021, the S&P 500 generated an average annual return of approximately 10%, showcasing the long-term growth potential of stocks
- Reinvesting dividends contributes significantly to the of stocks over the long run ()
- Short-term volatility in equity returns leads to significant fluctuations in annual performance
- Annual can deviate considerably from the long-term average due to market fluctuations and economic conditions
- Volatility measures, such as , quantify the degree of variation in stock returns over a given period
- Impact of major events on equity market performance can lead to periods of negative returns and increased uncertainty
- Economic recessions ( 1929-1939, 2007-2009) often coincide with significant market declines and increased volatility
- Wars and geopolitical events (, ) can disrupt financial markets and lead to short-term sell-offs
Behavior of equity styles and sizes
- Performance of growth vs. value stocks varies depending on economic conditions and market sentiment
- Growth stocks (technology companies) tend to outperform during periods of economic expansion and optimism
- Value stocks (utilities, consumer staples) often perform better during economic downturns and recovery periods due to their more stable business models
- Returns of small-cap vs. large-cap stocks exhibit different risk and return characteristics
- Small-cap stocks () have historically generated higher returns than large-cap stocks (S&P 500) due to their higher growth potential
- However, small-cap stocks are generally more volatile and sensitive to economic conditions, leading to larger price swings
- Cyclical nature of equity style performance leads to periods of outperformance and underperformance for different styles
- Different equity styles and sizes may outperform or underperform depending on the stage of the economic cycle (expansion, peak, contraction, trough)
- Investors can use strategies to adapt to changing market conditions by shifting allocations between growth, value, small-cap, and large-cap stocks
Market Dynamics and Performance Factors
- influence equity performance over time
- are characterized by sustained periods of rising stock prices and investor optimism
- represent extended periods of declining stock prices and pessimistic investor sentiment
- provide a more accurate picture of real investment growth by accounting for the effects of inflation on purchasing power
- Total return includes both capital appreciation and dividend income, offering a comprehensive measure of investment performance
- , which represents the total value of a company's outstanding shares, can impact stock performance and risk characteristics
- The suggests that stock prices reflect all available information, making it difficult to consistently outperform the market
Interpretation of equity market data
- Reading and understanding stock market index charts helps identify trends and key price levels
- Upward or downward movements in index values (S&P 500, ) indicate broader market sentiment over different time periods
- Support and represent key price points where the market has historically found buying or selling pressure
- Analyzing historical return distributions provides insights into the range and frequency of returns
- or frequency distributions visually represent the distribution of returns over a given period
- Statistical measures, such as mean (average), median (middle value), and mode (most frequent value), help summarize the return distribution
- Comparing relative performance using line charts allows for the assessment of different equity segments
- Plotting the performance of different equity styles, sizes, or sectors (technology, healthcare) relative to each other or a benchmark index (S&P 500) helps identify periods of outperformance or underperformance
- compares the performance of one equity segment to another or the broader market to identify leadership trends
Key Terms to Review (48)
9/11 Terrorist Attacks: The 9/11 terrorist attacks were a series of four coordinated terrorist attacks carried out against the United States on September 11, 2001. The attacks involved the hijacking of four commercial airliners, two of which were flown into the twin towers of the World Trade Center in New York City, a third plane hitting the Pentagon just outside Washington, D.C., and the fourth plane crashing in Shanksville, Pennsylvania. The attacks resulted in the deaths of nearly 3,000 people and had a profound impact on the global economy and financial markets.
Bear Markets: A bear market refers to a prolonged period of declining stock prices, typically characterized by a decline of 20% or more from recent highs. Bear markets are often associated with negative investor sentiment, economic recession, and a general lack of confidence in the financial markets.
Berkshire Hathaway (BRK): Berkshire Hathaway (BRK) is a multinational conglomerate holding company led by Warren Buffett. It owns a diverse range of businesses and has significant stakes in various public companies, making it a major player in the U.S. stock market.
Buffett: Buffett refers to Warren Buffett, one of the most successful investors in history and the chairman of Berkshire Hathaway. Known for his value investing strategy, Buffett's principles are often studied in finance courses for their practical insights into stock valuation and market performance.
Bull Markets: A bull market refers to a financial market in which prices are rising or expected to rise, creating a positive, upward trend in the overall market. This is typically characterized by investor optimism, increased buying activity, and a general sense of confidence in the economy's future performance.
Compound Growth: Compound growth refers to the exponential increase in a variable over time, where the growth rate itself grows with each successive period. This concept is particularly relevant in the context of investment returns, where the reinvestment of gains leads to an accelerating accumulation of wealth.
Credit Suisse: Credit Suisse is a global financial services company headquartered in Zurich, Switzerland. It provides investment banking, asset management, and private banking services worldwide.
Damodaran: Damodaran is a prominent finance professor known for his extensive work on valuation, corporate finance, and investment management. His methodologies and frameworks are highly regarded in the field of financial analysis and capital structure.
Diversification: Diversification involves spreading investments across various financial assets to reduce risk. It aims to minimize the impact of any single asset's poor performance on an overall investment portfolio.
Diversification: Diversification is the practice of investing in a variety of assets to reduce the overall risk of a portfolio. It involves spreading investments across different asset classes, industries, and geographic regions to minimize the impact of any single investment's performance on the overall portfolio.
Dot-com Bubble: The dot-com bubble, also known as the internet bubble, was a speculative financial bubble that occurred in the late 1990s and early 2000s, characterized by a rapid rise in the valuation of internet-based companies, followed by a dramatic collapse in their stock prices. This phenomenon was closely tied to the historical picture of returns to stocks, as it had a significant impact on the overall stock market performance during that period.
Dow 30: Dow 30, also known as the Dow Jones Industrial Average (DJIA), is a stock market index that measures the performance of 30 prominent companies listed on stock exchanges in the United States. It is one of the oldest and most widely followed equity indices in the world, used to gauge the health of the US economy and stock market.
Dow Jones Industrial Average: The Dow Jones Industrial Average (DJIA) is a stock market index that tracks the performance of 30 large, publicly traded companies in the United States. It is one of the most widely followed and reported stock market indicators, providing a snapshot of the overall health and direction of the U.S. economy.
Dow Jones Industrial Average (DJIA): The Dow Jones Industrial Average (DJIA) is a stock market index that measures the performance of 30 significant publicly traded companies in the United States. It is one of the oldest and most widely-recognized indices in the world, often used as a barometer for the overall health of the U.S. stock market.
Efficient Market Hypothesis: The efficient market hypothesis (EMH) is an investment theory that states that asset prices fully reflect all available information, making it impossible for investors to consistently outperform the overall market through active stock selection or market timing. This hypothesis suggests that the financial markets are highly efficient in processing information, and that stock prices adjust rapidly to new information, making it difficult for investors to generate above-average returns.
Equity Premium: The equity premium is the additional return that investors expect to receive for holding risky equity (stock) investments compared to the return on a risk-free asset, such as government bonds. It represents the compensation that investors demand for taking on the higher risk associated with equities.
Federal Reserve: The Federal Reserve, commonly known as the Fed, is the central banking system of the United States that is responsible for conducting monetary policy, supervising banks, maintaining financial system stability, and providing banking services. It plays a crucial role in influencing inflation and stock market returns.
Fundamental Analysis: Fundamental analysis is the study of a company's or asset's intrinsic value by examining its financial health, management, competitive position, and economic conditions. It aims to determine the true worth of an investment and identify potential mispricing in the market.
Gates: Gates are mechanisms used in financial markets to control the flow of trades and capital, often implemented to manage risk and volatility. They can include restrictions on trading volumes or specific measures to prevent market crashes.
Giving Pledge: The Giving Pledge is a commitment by the world's wealthiest individuals and families to donate the majority of their wealth to philanthropic causes, either during their lifetimes or in their wills. It was initiated by Bill Gates and Warren Buffett in 2010 to encourage billionaires to address society's most pressing problems.
Global Financial Crisis: The Global Financial Crisis (GFC) was a severe worldwide economic downturn that began in 2007 and reached its most acute phase in 2008-2009. It was characterized by a collapse in asset prices, a freezing of credit markets, and a global recession that impacted various sectors, including stocks.
Graham: Graham refers to Benjamin Graham, an influential economist and investor often considered the father of value investing. His principles are fundamental in understanding historical stock performance and market behavior.
Great Depression: The Great Depression was a severe and prolonged economic downturn that occurred in the 1930s, primarily in the United States and Western countries. It was characterized by a dramatic decline in industrial production, widespread unemployment, and a significant drop in stock prices and consumer spending.
Growth Stocks: Growth stocks are shares of companies that are expected to experience above-average growth in earnings and revenue compared to the overall market. These stocks are typically characterized by high price-to-earnings (P/E) ratios, as investors are willing to pay a premium for the potential of future growth and capital appreciation.
Histograms: A histogram is a graphical representation of the distribution of numerical data. It displays the frequency of different values or ranges of values in a dataset, providing a visual summary of the data's statistical properties.
Inflation-Adjusted Returns: Inflation-adjusted returns, also known as real returns, refer to the investment returns that have been adjusted for the effects of inflation. This allows for a more accurate assessment of the true purchasing power of the investment gains, providing a clearer picture of the real value of the investment over time.
Jeremy Siegel: Jeremy Siegel is a renowned finance professor and author who has made significant contributions to the understanding of historical stock market returns. He is particularly known for his research and analysis on the long-term performance of stocks compared to other asset classes.
Lower-volatility investments: Lower-volatility investments are financial assets that exhibit smaller price fluctuations over time compared to higher-volatility investments. These assets are often considered safer and more stable, making them attractive for risk-averse investors.
Market capitalization: Market capitalization, or market cap, is the total value of a company's outstanding shares of stock. It is calculated by multiplying the current share price by the total number of outstanding shares.
Market Capitalization: Market capitalization, often shortened to 'market cap,' is the total value of a company's outstanding shares of stock. It is calculated by multiplying the current market price of a single share by the total number of shares outstanding. Market capitalization provides a measure of a company's size and is an important factor in various financial analyses and investment decisions.
Market Cycles: Market cycles refer to the recurring patterns of expansion and contraction observed in financial markets over time. These cycles are characterized by alternating periods of growth and decline, reflecting the broader economic conditions and investor sentiment.
Market risk premium: The market risk premium is the additional return expected by investors for taking on the higher risk of investing in the stock market over a risk-free asset. It is a key component in determining the cost of equity using the Capital Asset Pricing Model (CAPM).
Relative Strength Analysis: Relative strength analysis is a technical analysis technique that compares the performance of a security or asset to a benchmark or peer group. It helps investors identify stocks or assets that are outperforming or underperforming the market or their competitors, providing insights into their relative strength and potential future performance.
Resistance Levels: Resistance levels refer to price points where the upward momentum of an asset, such as a stock, is expected to be met with significant selling pressure, causing the price to level off or potentially reverse direction. These levels act as barriers to further price increases, reflecting areas where buyers and sellers are in equilibrium.
Risk Premium: The risk premium is the additional return that investors expect to receive as compensation for taking on the higher risk associated with a particular investment. It represents the extra yield that investors demand to hold riskier assets compared to safer, less volatile investments.
Russell 2000 Index: The Russell 2000 Index is a stock market index that tracks the performance of the 2,000 smallest publicly traded companies in the United States. It serves as a benchmark for small-cap stocks and provides insight into the historical picture of returns to stocks.
S&P 500: The S&P 500 is a stock market index that tracks the performance of the 500 largest publicly traded companies in the United States. It is widely regarded as one of the best representations of the overall U.S. stock market and is a key benchmark for evaluating the performance of various investment portfolios and strategies.
Standard deviation: Standard deviation is a statistical measure that quantifies the amount of variation or dispersion in a set of data values. It is used to assess the risk and volatility of an investment's returns in finance.
Standard Deviation: Standard deviation is a statistical measure that quantifies the amount of variation or dispersion of a set of data values around the mean or average. It provides a way to understand how spread out a group of numbers is from the central tendency.
Stock returns: Stock returns represent the gains or losses made on an investment in stocks over a particular period. They are typically measured as a percentage change in the stock price, including dividends received.
Style Rotation: Style rotation refers to the cyclical shifts in investor preference between different investment styles, such as value versus growth, or small-cap versus large-cap stocks. These shifts occur as economic and market conditions change, leading investors to favor certain styles over others in pursuit of better returns.
Support Levels: Support levels refer to specific price points where there is a high likelihood of a stock's price finding support and halting a downward trend. These levels act as points of demand, where buyers are expected to step in and prevent the price from falling further.
Technical Analysis: Technical analysis is the study of market action, primarily through the use of charts, for the purpose of forecasting future price trends. It is a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and trading volume, in an effort to determine probable future prices.
Total Return: Total return is a measure of the overall performance of an investment, including both the capital appreciation (or depreciation) and any income generated, such as dividends or interest. It provides a comprehensive view of the total gains or losses experienced by an investor over a given period of time.
Value Stocks: Value stocks are shares of companies that are trading at a lower price relative to their fundamental financial metrics, such as earnings, dividends, or book value. These stocks are considered undervalued by the market and have the potential for significant appreciation as the market recognizes their true worth.
Volatility: Volatility refers to the degree of variation in the price or value of a financial asset, economic indicator, or market over time. It is a measure of the uncertainty or risk associated with the size of changes in a variable's value. Volatility is a crucial concept in finance, economics, and risk management, as it helps understand the stability and predictability of various financial and economic phenomena.
Wilshire US Small-Cap Index: The Wilshire US Small-Cap Index is a market-capitalization-weighted index that measures the performance of small-cap stocks in the United States. It includes companies typically ranked below the top 750 largest companies by market capitalization.
World War II: World War II was a global military conflict that took place between 1939 and 1945, involving most of the world's nations forming two opposing military alliances: the Allies and the Axis powers. This war had a significant impact on the historical picture of returns to stocks, as it was a major event that influenced the global economy and financial markets.