Editor’s Note: This is the second in a series of articles that challenge the conventional wisdom that stocks always outperform bonds over the long term and that a negative correlation between bonds and stocks leads to effective diversification. In it, Edward McQuarrie draws from his research analyzing US stock and bond records dating back to 1792.
CFA Institute Research and Policy Center recently hosted a panel discussion comprising McQuarrie, Rob Arnott, Elroy Dimson, Roger Ibbotson, and Jeremy Siegel. Laurence B. Siegel moderated. The webinar elicits divergent views on the equity risk premium and McQuarrie’s thesis. Subscribe to Research and Policy Center, and you will be notified when the video airs.
Edward McQuarrie:
My inaugural post on the equity risk premium presented a new historical account of US stock and bond returns that tells a different, more nuanced story than the account offered by Siegel in his seminal book, Stocks for the Long Run, now in its 6th edition.
This blog series stems from my Financial Analysts Journal article, “Stocks for the Long Run? Sometimes Yes, Sometimes No,” which is open for all to read on Taylor & Francis.
A reader of my first post objected to my conclusions, arguing that the 19th century US data presented was just too far in the past to be meaningful to investors today.
I anticipated that objection at the end of my last post. Here, I refute that notion with the help of recent international data.
New International Data is Available
When Siegel began his work in the early 1990s, international market history was more terra incognita than 19th century US market history. In recent years, Elroy Dimson and his colleagues have shed light on historical returns. In 2002, they published Triumph of the Optimists, an account of 15 markets outside the United States, replete with historical returns on stocks and bonds dating back to 1900.
The Dimson-led effort was not the only expansion of the international record. Bryan Taylor at Global Financial Data, and Oscar Jorda and colleagues at macrohistory.net, have also developed historical databases of international returns, stretching back in some cases to the 1700s.
Indeed, many financial historians, including William Goetzmann, Editor of the Financial Analysts Journal, have spent entire careers digging into historical data to extract insights that shape our evolving understanding of markets and their role in shaping society.
A few years after Triumph‘s publication, the Dimson team began to update and expand their database on an annual basis, producing a series of yearbooks, most recently the 2024 edition. Along the way, they’ve expanded the markets covered.
Triumph had been criticized for survivorship bias, i.e., including only the markets that fared reasonably well and excluding markets that went bust, such as Russia in 2017 and those that fizzled, such as Austria after the war.
Most important, the Dimson team began to calculate a world ex-US index of stock and bond performance, allowing a better assessment of the differences between US stock returns and returns elsewhere.
None of this data had been compiled when Jeremy Siegel started out. I presented portions of it in my paper as an out-of-sample test of the Stocks for the Long Run thesis.
The United States in Context
The 120-year annualized real return on world stocks ex-US is now estimated by the Dimson team to be approximately 4.3%. Siegel estimated real long-term returns of 6% to 7%. That difference does not sound like much, but Dimson and colleagues note: “A dollar invested in US equities in 1900 resulted in a terminal value of USD 1937 … An equivalent investment in stocks from the rest of the world gave a terminal value of USD 179…less than a tenth of the US value.”
We might say that international investors suffered a 90% shortfall in wealth creation.
Regime Switching
A key concept in my paper is the idea of regime switching, when asset returns fluctuate through phases that can last for decades. In one phase, bonds may perform terribly, as seen in the United States after World War II. In another phase, stocks may languish, as seen in the United States before the Civil War.
Because returns are not stationary in character, it may not be useful to calculate asset returns over centuries and sum these up by offering one single number. In my view, there’s too much variance for one number to offer investors meaningful guidance, or to set expectations for what might happen over their unique horizons.
The Range of Returns: the Good, the Bad, and the Ugly
Here is an analogy to highlight the problem. Let’s say that the 100 students who attended my lecture this morning had their shoes ruined. The carpet cleaner last night used a solvent rather than the intended cleaning solution. This caused the carpet to lift in patches, which bonded to the students’ shoe soles. The University wishes to make amends by purchasing a new pair of shoes for each student.
As an academic educated in statistics, I suggest to administrators that they simplify their task by buying 100 pairs of shoes all in the average shoe size, because the mean gives the best linear unbiased estimate.
How many students will be happy with their new shoes?
Returning to market history, what investors need to understand is the range of returns, not the all-sample average. Investors need to grasp how much returns can vary over long time horizons that correspond to the periods over which they might seek to accumulate wealth, such as 10-, 20-, 30-, or 50-year spans.
The accepted approach for doing so is to calculate rolling returns. Thus, we can look at the set of 20-year returns: 1900 to 1919 inclusive, 1901 to 1920, 1902 to 1921, etc. Rolls allow us to examine how investors fared across all available starting points: the good, the bad, and the ugly. In my paper I looked at 20-, 30-, and 50-year returns for 19 markets outside the US, using data as far back as were available.
First, however, we need to deal with an objection that quickly arises when international returns are compiled: many nations outside the US suffered grievously during war time. Some were defeated and their economies destroyed. Others were invaded and occupied with accompanying economic and cultural devastation. And others dissolved into civil war.
As a US investor in the 21st century, I don’t believe that returns in those nations during those periods are relevant to my investment planning. If the United States gets invaded and occupied in the late 2020s, I’ll have other things to worry about than my portfolio.
My solution was to exclude from the sample the rolls for war-torn nations and periods. For Belgium, for example, I removed 20-year rolls that included 1914 to 1918 and 1941 to 1945. By contrast, I didn’t remove any rolls for the United Kingdom because, however costly wartime was to that nation, it did not suffer invasion or occupation.
Again, the purpose here is to test two theses derived from Stocks for the Long Run on World ex-US stocks:
- Among intact nations outside of wartime, for holding periods of 20 years or more, real stock returns will be approximately 6% to 7% per annum.
- There won’t be any 20-year holding periods in which government bonds outperformed stock. The equity premium will stay close to the value of 300 basis points to 400 basis points.
I was able to decisively reject the first thesis. Table 1 illustrates the worst-case outcomes over 20-, 30-, and 50-year rolls.
Table 1: Worst Multi-Decade International Stock Returns Excluding War Losses
| Nation | 20 years | Ending in: | Nation | 30 years | Ending in: | Nation | 50 years | Ending in: |
| Italy | -7.34 | 1979 | Norway | -4.40 | 1978 | Italy | -0.54 | 2011 |
| Norway | -5.92 | 1977 | Italy | -2.35 | 1991 | Norway | 0.43 | 1995 |
| Sweden | -5.17 | 1932 | Portugal | -1.64 | 1949 | Austria | 1.10 | 1996 |
| Japan | -5.02 | 2009 | Sweden | -1.10 | 1932 | Sweden | 1.61 | 1948 |
| Switzerland | -4.39 | 1981 | Austria | -1.02 | 1976 | Belgium | 2.04 | 1908 |
| Austria | -4.26 | 1981 | Switzerland | -0.78 | 1991 | Spain | 2.34 | 2020 |
| Spain | -3.36 | 1983 | Japan | -0.78 | 2019 | Switzerland | 2.41 | 2011 |
| France | -2.98 | 1981 | ||||||
| Portugal | -2.34 | 1939 | ||||||
| South Africa | -1.40 | 1920 | ||||||
| UK | -1.27 | 1920 | ||||||
| Belgium | -1.27 | 1976 | ||||||
| Germany | -1.20 | 1980 |
Note: Table shows all negative 20- and 30-year returns found, and all 50-year returns less than 2.5%. Annualized real percentage returns. Rolls calculated by Bryan Taylor using Global Financial Data series, as shared with me in Spring 2021.
As you can see, negative returns over two decades are easily found, and not uncommon over 30-year periods. For context, a 5% annualized decline over 20 years turns $10,000 into $3,585, a wealth loss of nearly 65%. And a 2% annualized decline over 30 years leaves $5,455 in wealth, a loss of about 45%.
Stocks are indeed risky, regardless of the holding period. Looking outside the United States in the 20th century and getting better data on the United States in the 19th century allowed me to confirm this fact.
I was also able to decisively reject the second thesis. The international record provides many examples of lengthy holding periods in which bonds outperformed stocks, just as I found for US stocks in the 19th century.
Table 2: Lowest Equity Premia Observed Internationally
| 20 years | Ending in: | 30 years | Ending in: | 50 years | Ending in: | |
| Australia | -1.98 | 2008 | -0.64 | 2016 | 1.48 | 2019 |
| Austria | -8.50 | 1943 | -5.05 | 1953 | -2.46 | 2011 |
| Belgium | -4.21 | 1948 | -1.73 | 1886 | -1.69 | 1886 |
| Canada | -5.41 | 1886 | -3.06 | 1884 | -0.56 | 1902 |
| Denmark | -5.28 | 1932 | -3.95 | 1946 | -2.80 | 1932 |
| Finland | -3.26 | 2019 | 1.64 | 2018 | 3.57 | 1967 |
| France | -3.03 | 1821 | -2.93 | 1831 | 0.27 | 2011 |
| Germany | -3.90 | 1980 | -1.47 | 2002 | -0.99 | 2011 |
| Italy | -5.10 | 1979 | -4.56 | 2016 | -2.99 | 2011 |
| Japan | -9.10 | 2009 | -3.85 | 2019 | -1.41 | 2011 |
| Netherlands | -6.10 | 1932 | -2.26 | 1934 | 1.09 | 1950 |
| New Zealand | -6.19 | 2006 | -4.35 | 2016 | 0.37 | 1952 |
| Norway | -10.03 | 1938 | -7.46 | 1947 | -4.49 | 1967 |
| Portugal | -8.18 | 1993 | -6.26 | 2003 | -2.26 | 2014 |
| South Africa | -3.03 | 1985 | -1.43 | 1985 | 0.61 | 1932 |
| Spain | -5.63 | 1920 | -4.25 | 1915 | -3.38 | 1936 |
| Sweden | -8.08 | 1932 | -3.29 | 1932 | -0.74 | 1932 |
| Switzerland | -1.18 | 1974 | -0.66 | 1991 | 0.78 | 2011 |
| UK | -1.52 | 1939 | -1.14 | 1849 | -0.16 | 1759 |
| Deficit in: | 19/19 | 18/19 | 12/19 |
Note: Data from GFD except Portugal from Jorda et al. (2019). Shaded cells include years where the nation was defeated in war, suffered civil war, or was invaded and occupied. These periods are included here but not in Table 1 because both bonds and stocks should suffer under wartime devastation.
It’s clear that stocks are riskier than bonds, and that risk does not disappear when the holding period extends to 20 years or more.
Because stocks remain risky regardless of the holding period, stocks often outperform, because investors get compensated for taking that risk. Stocks are a good wager over the long term, on favorable odds. But stocks remain a bet, one that can go bad for any randomly selected investor over their personal time horizon. Understanding this allows us to manage regret risk.
My next post in this series will address common misperceptions of my new research. “McQuarrie wants me to sell stocks and buy bonds,” for example. Nope.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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