CapitalatWork

One of the pitfalls of modern financial markets is the extremely short-term view they impose on companies. Companies publish quarterly results, which leads some of them to attach too much importance to short-term results. One of the pitfalls of modern day asset management is the overvaluation of short-term results by investors. Investors attach too much importance to these short-term results. Investors evaluate their asset-managers over ever shorter-term horizons. It seems everybody loses respect for the overwhelming importance of “Time at Work” in financial markets. We at CapitalatWork want to educate our clients differently.

Before explaining our different attitude, let’s have a brief look at historical returns. The reference work on historical returns is written by professor Jeremy Siegel, “Stocks for the long run”. This is a book we strongly recommend to everybody with an interest in investing.

Figure 1 shows the annual stock market returns from 1802 to 1997 in the United States. The most striking conclusion is the stability of the real return (= nominal return – inflation) of 7% of equity investments over the periods 1802-1997 or 1871-1997, or the three major sub periods. This long-term stability is remarkable if one takes into account the dramatic changes that have occurred over these two centuries. This does not deny that over shorter-term horizons returns can fluctuate. Very striking in this respect are the differences in real returns over the time periods 1966-1981 and 1981-1997. It appears that over shorter time frames of 15 years returns can fluctuate wildly. Nevertheless, these fluctuations, mask the undeniable reversion to the mean that seems to be present in investing. Witness to that is the fact that over the period 1966-1997, covering the two different sub periods, the real rate of return of 6% is close the long-term average of 7%.

Figure 1: Historic Stock Returns

An analysis of fixed-income returns also leads to some interesting conclusions. Table 2 shows that the average real Fixed-Income return over the past two centuries has been 3.5%. But, opposed to real Equity returns, in the three major sub periods, we do not see the same stability in real returns. In fact, the real return for Fixed Income has fallen dramatically from 4.8% to 2% over the period 1926-2006. Also, the view that Fixed-Income is the safer asset should be questioned when looking at the post-war period from 1966-1981. The real return for Fixed-Income in that period was -4.2%. Fixed-Income investors lost 50% of their purchasing power in that disastrous period. So far for the safety of Fixed-Income, even over a 15-year period. The dominance of stocks over fixed-income securities is overwhelming for investors with long horizons.

Figure 2: Fixed Income Returns