Inflation, Mean-Reversion, And 113 Years Of Bond & Stock Returns

Tyler Durden's picture

The baby boomers now retiring grew up in a high returns world. So did their children. But, as Credit Suisse notes in their 2013 Yearbook, everyone now faces a world of low real interest rates. Baby boomers may find it hard to adjust. However, McKinsey (2012) predicts they will control 70% of retail investor assets by 2017. So our sympathy should go to their grandchildren, who cannot expect the high returns their grandparents enjoyed. From 1950 to date, the annualized real return on world equities was 6.8%; from 1980, it was 6.4%. The corresponding world bond returns were 3.7% and 6.4%, respectively. Equity investors were brought down to earth over the first 13 years of the 21st century, when the annualized real return on the world equity index was just 0.1%. But real bond returns stayed high at 6.1% per year. We have transitioned to a world of low real interest rates. The question is, does this mean equity returns are also likely to remain lower. In this compendium-like article, CS addresses prospective bond returns and interest rate impacts on equity valuations, inflation and its impact on equity beta, VIX reversions, and profiles 22 countries across three regions. Chart pr0n at its best for bulls and bears.

Over 113 years, the relative size of world stock markets has shifted significantly...

But the changes have been very cyclical...

The last 13 years have been somewhat special... as real yields around the world have collapsed...

and that has historically tended to mean low equity returns...

The busts of the dot-com era, LTCM & Russia, and Lehman/Credit Crunch had a very different profile to previous risk flares in VIX...

and while they suggest that mean-reversion has provided upside potential for stocks (in the past, staying in stocks at the start of the year when real rates are negative has proved a better bet that exiting), the concept of a shifted world paradigm (see VIX and global real rates) suggests perhaps it is different this time.

And the argument of equities as an inflation hedge is flawed due to its non-linearity...

Though valuations at the current inflation expectations seems to be 'cheap', one can only question the actual inflation expectations... as the official spot data diverges from market expectations...

And as CS notes, extrapolating from such a successful market can lead to “success” bias. Investors can gain a misleading view of equity returns elsewhere, or of future equity returns for the USA itself.

until recently, most of the long run evidence cited on historical asset returns drew almost exclusively on the US experience. Focusing on such a successful economy can lead to “success” bias. Investors can gain a misleading view of equity returns elsewhere, or of future equity returns for the USA itself. The charts opposite confirm this concern. They show that, from the perspective of a US-based international investor, the real return on the world ex-US equity index was 4.4% per year, which is 1.9% per year below that for the USA.

But what is clear from the above charts, in the 50 years since 1963, Bond and Stock returns are far more similar than different, no matter what your RIA tells you..


Because, it's fiscally - for the USA - very different this time...


2013 Yearbook Final Web by

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willwork4food's picture

One can always count on hitting the lottery. {sigh}

Dear Infinity's picture

It would be nice. Like many readers, I am betting on a steep rise in the value of "physical" wealth, probably going to occur right about the time we've gone "FORWARD!" over the cliff... 

I have found the website to be extremely useful for aforementioned acquisitions as it offers a very nice tabulated way of viewing the underlying metals markets (read: physical wealth).

PUD's picture

Nonsense. High rates of return equal high cost of money. Your gain is someone else's pain. You get 10% on money someone else is paying 10% it's a zero sum game with the leaches taking their cuts along the way. So far as equities are concerned that is was and will be nothing but a pyramid scheme based upon demographics and politics which have conspired to funnel more money into the coffers of wall st. Inflation is a bank fabricated device to ensure that asset prices keep climbing so that there is always blood to be tapped with the churning and flowing of money. The idea that "high rates of return" is some natural state is as ludicrous and fanciful as perpetual motion machines. Only work, effort, innovation, construction, production and creation build wealth. There is no such thing as putting money to work, making money from money or creating real wealth from the extension of money. That would be like saying you can trade buckets of water for buckets of water and create more water.

Black Markets's picture

Yes but credit allows you to pull money from the future to the present.

I can sell work I haven't yet done. Banks can write loans and give me $500,000 for work I haven't yet done and they can create this $500,000 so long as they have $25,000 in reserves.

I can go and spend the proceeds of my future work today.

I can't drink water that hasn't fallen from the sky yet.

That's why governments try and fight recessions by borrowing money from the future.

You can't fight draughts by borrowing water from the future.

There is no "promise to rain" !!

sasebo's picture

Money without something to purchase is meaningless.

Wealth is stuff. And it takes stuff to produce more stuff. Sorry.

Matt's picture

But what do you do once you have wealth? Should the money just sit there in a pile? Without inflation, people would just hoard money.

With no inflation or deflation, a person working 47 years from 18 to 65, and expecting to live to 80, would need to save around 33% of their income, and just hoard it until retirement. Is that really a better model to go with? 


PUD's picture

Fund science, help the needy, cure cancer, go to mars, save the planet, explore a planet, build a hospital school or community center...the list is infinite of what you can do with surplus wealth

Matt's picture

There is no surplus wealth if you have to hoard it for retirement as cash or gold in a vault. The surplus only exists because you can lend it out for interest or invest it into a business.

Marge N Call's picture

No Matt, the money would be invested to create more wealth. Keeping up with inflation is not wealth. The whole point of investing is to take your wealth and put it to work to create even more wealth. Before your goverment, and its shills, the media, destroyed the real notion of capitalism, that's how it worked.

Oh, you want a riskless way to increase your wealth? Go to DC, there's plenty of snake oil to be had.

There IS NO RISKLESS investment. Reward is always a function of risk. Period. No matter what Ben, Timmay, and Krugina tell you. I would rather risk mine on people, not goverment.


Matt's picture

How would you save for retirement with no credit and no equities to invest in, as PUD is suggesting, besides hoarding cash?

How would you risk your money on other people, if you could neither lend nor invest?

No one said anything about riskless investments. PUD said s/he didn't want credit or equities or inflation.

bnbdnb's picture

Stop trying. Tomorrow is not guaranteed anyways.

JR's picture

Well said regarding inflation, PUD.

Or, as a former executive secretary of FEE, Robert G. Anderson, once put it, nflation is an assault on capital and money markets no longer perform, they become devices for speculators.

"Long-term capital markets vanish with the creditors, as everyone tries to become a debtor. The order of the day in an age of inflation is to consume capital in 'things' before it is consumed by the ravages of inflation.

"Inflation's message is clear to all. Increae consumption, save nothing." The exact Keynesian message Bernanke is pushing with Fed policy.

"The outcome," said Anderson, "is the inevitable destruction of accumulated capital with no incentive to replace it. The tragic price is lost prosperity."

SpykerSpeed's picture

It's okay.  Baby boomers' grandchildren won't be using dollars, anyway.  We have Bitcoin.

Everyman's picture

That last chart is the very bad one.  Where the Dems and RINOS are arguing for "more spending" because spending cuts will reduce GDP, well, that makes little difference according to thelast chart.

Seasmoke's picture

how can this be, i am paying property taxes , for the public leeches, whose pensions swear @ 8% per year

Matt's picture

Well, if they put 10 percent of their portfolio into Illicit Narcotics, they should be able to get that 8 percent no problem. The trick is, they just need to be a big enough pension fund as to be Systemically Important, so the regulators can only give them a slap on the wrist and no criminal charges when they inevitably get caught.

LawsofPhysics's picture

"a world of low interest rates and no inflation". - good fucking luck.  Overcrowding and a rapidly lowering standard of living is what is coming.  Tell me Mr eCONomist, what is the price of an essential commodity you need for survival, but that I refuse to sell?

Stupid motherfuckers.

pashley1411's picture

The rate of return of financial assets is repressed and distrorted by money printing and government manipulation.    Similarly, GDP calcuatlions are warped by money velocity.

I would like to see data on production, rather than the collective-increase-of-financial-assets-drowning-in-fiat-money.   I suspect global per capita global production, with China, looks fairly robust, with so many people playing development catch-up.  

Spaceman Spiff's picture

A bit off topic, but does anyone know of a good website that categorizes food inflation of everyday products  (not only price but food packaging)....   some low information morons I know could use a schooling.

NEOSERF's picture

Check out my as well...allows you to enter weighting for what you personally buy to get the real inflation rate...mine has been averaging about 8% excluding 2009 deflationary event.

Go Tribe's picture

Tyler - Could you please come up with a Doomsday Beacon you can run on articles that we absolutely must read now or suffer dire consequences? This article isn't one of them and is just more guessing with math, another false alarm.

Use the Doomsday Beacon when we should read the article for sure then grab our go bags and round up the family.

machineh's picture

The Credit Suisse report was written by Dimson, Marsh and Staunton, authors of a book detailing equity returns for the past hundred years.

They provide 100-year historical returns for 22 world equity markets.

Far from 'guessing with math,' this is solid data based on painstakingly-collected real-world results.

What have you contributed lately?

tarsubil's picture

He came up with the Doomsday Beacon idea.

jonjon831983's picture

Hmm size of "not in 2012 yearbook": 13%? vs 2% since 1899?  Wherever these are, they gotta get crackin!

CheapBastard's picture

That "0.1%" return is really hurting seniors. There's a fellow in my neighborhood who retired back in 1999 with about $250,000 in his plan thinking that was enough. He is now working for minimum at JCPenny's 7 days a week just to eat.

JR's picture

This is the voice of the enemy; the grand lie that the destruction of sound money and the increase in fast track, high-powered new trading vehicles in a government-dominated economy is good for business.

Nonsense. It leads only to market disruption and capital consumption, i.e., economic death.

If “we have transitioned to a world of low real interest rates” with high unreported inflation, then the current monetary system cannot survive.  We have transitioned to unsound money, and it is a world dominated by debt and at the collection window, it’s the banker.

“Whenever money is not generally accepted, it loses its value and ceases to be a medium of exchange.”Money: A Historical Look

machineh's picture

Did you even read the report? From page 6:

What matters to investors is future purchasing power, and hence the real yield. Figure 3 shows the real yields on inflation-protected bonds since 2000.

This quote in no way supports 'the destruction of sound money' or 'high-powered new trading vehicles.' On the contrary, it says traditional, plain-vanilla sovereign bond investors must pay attention to preserving purchasing power.

Uninformed, shoot-from-the-hip comments like yours only serve to discourage quality material from being posted on ZeroHedge. When know-nothings dominate the comments, the smart people post somewhere else.

JR's picture

I’m not mentioning any names, but those writers who would suggest this report reflects the true state of America's economic future and the majority of boomers are not providing “quality” writing.

Yes, I read the report. The reality is that Bernanke’s ZIRP annually is transferring $400 billion of interest income from savers and senior citizens – you know, those boomers not in the top 20% -  to the Wall Street bankers; and that’s based on a low-ball inflation figure that defies reality. Transitioning to unsound money, i.e., a world of low real interest rates with high inflation, is destroying the purchasing power of these people’s stored labor, let alone their grandchildren's who won’t inherit anything because there won't be anything.

And I‘ve read other reports, including this one today: John Williams: How to Survive the Illusion of Economic Recovery, an interview with The  Gold Report. As for reality,  when William was asked for his overall prediction for 2013 inflation, he said: I can't give you a hard number but I expect inflation to increase rapidly. It will certainly be picking up by the end of the year. It is unlikely that the Fed will be able to back off its quantitative easing.

Here is just one exchange:

TGR: Retail sales is another indicator people look at to determine the strength of the economy. You reported a contraction in the third quarter of 2012. The Census Bureau reported a 4.7% growth year over year based largely on increased car sales. Why are those numbers different and where do you see that going in the rest of this year?

JW: I look at those numbers adjusted for inflation, and, as an aside, that third-quarter contraction was quarter-to-quarter, not year-to-year, although the annual growth is close to new-recession territory. The government adjusts the GDP for inflation as a way, theoretically, to measure underlying economic activity as opposed to measuring activity that can be affected heavily simply by rising prices.

It is the same thing with retail sales. If you back out official CPI inflation, as is done by the St. Louis Fed, you'll find that a lot of the headline retail sales growth has been tied to inflation, but the official CPI inflation rate is understated. That results in too high an inflation-adjusted growth rate. Again, we also face the fundamental issue of bad quality month-to-month numbers because of a variety of seasonal adjustment problems. That should leave the average person without much confidence in what's actually being reported month-to-month.

You really need to look at the underlying fundamentals in order to make any sense of what is happening in the real world. Fundamentally, retail sales and housing growth are based on the condition of the consumer. The consumer increasingly is illiquid. Reports of median household income, adjusted for inflation, show that household income plummeted well into 2011 and has been stagnant at the lowest levels of the current cycle ever since. The average guy is not staying even with inflation. That is important, because income drives consumption, and consumption accounts for more than 70% of GDP. If, net of inflation, you don't have sustained growth in income, you're not going to have sustained growth in consumption.

Concludes John: "You need to hold the hedge through the tough times. If gold is up at $100,000/oz, don't get excited and take profits, because the gain there just reflects maintenance of your purchasing power"

And if that don't get your attention to how sound the dollar is, what will?

dolph9's picture

To avoid the coming disaster, avoid bonds at all cost.

As far as public equities, I wouldn't buy them, but I think there are some opportunities there if you only buy the best.

Just as banks have destroyed capitalism, the brokerages have destroyed equities because they incentivize borrowing money for short term trading.  This allows the brokerages and firms which use HFT to make money.

I personally would stick with metals, tools, survival skills, and productive land or rental properties.


willwork4food's picture

..and guns, alcohol, tobacco and beef jerky.

Lord Of Finance's picture

Yeah. Trying to explain to these deceiptful keynesian crumbs that real wealth comes from real savings, not real low interest, is like trying to explain multiplication to a five year old. It just can't be done.

   Now the only question I am split on is wether they really know what they are doing, and the carnage it will cause, AND they really just don't care. 

  -or, they really do have the mind/logic of a 5 year old.


In other words. . .

            Are they intentionally engaging in fraud and monetary crimes, which means they are devilishly decieptful. Or are they complete ignoramuses, which means they are childishly infantile?

AlphaHunter001's picture


Ah, the problem once again of a little bit of information is a dangerous thing.


The real lesson is that timing is important. During the past decade, equities have actually doubled in price twice! The key was getting in and out at the right time.


It's the same with every asset, was buying a house a good or bad thing? That depends on if you bought in 2006 or 2010.


Everything cycles up and down, that's the ONLY constant. One needs to look at the risk to reward. Looking at bonds, I think it's nuts to buy bonds after such a run, the same with gold. We're clearly in the 8th or 9th inning. What's the upside in gold or bonds? Very small, but the downside is large.


The biggest mistake people make is equating the US government with US stocks/companies. US companies have never been stronger. Apple is being sued because they have TOO much cash! How is that a bearish sign for equities? LOL  Apple has twice as much cash than all of the gold by the ETF GLD!

Clearly US companies are in outstanding shape, the US government though is a mess. One needs to make this distinction