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Hi,
Thanks to Ben Felix's Rational Reminder Youtube channel I have became aware of some really interesting papers and I thought I'd share them.
"Stocks for the Long Run? Sometimes Yes. Sometimes No." tackles problems with historic data series and looks at interesting questions like the probability of stocks beating bonds over periods up to an including 50 years.
Are Stocks Really Less Volatile in the Long Run? which looks at stock versus bond volatility and implications for investors with long horizons.
and finally On Index Investing looks at whether index funds affect price efficiency. Spoiler alert: they don't.
There really is a lot to take in from these papers and I'm far from finished myself. I hope you find these stimulating reads. I know my mind is racing with implications.
Cheers,
Me 🙂
Thanks for the links.
At a sub-3% yield in the 10y Treasury, I'll still take my luck with stocks, though!
Thanks for the link to the Grossman-Stiglitz analysis. I made this point in my post ( https://earlyretirementnow.com/2020/07/01/passive-investing-bubble/) a while ago. Indexers are free-riding on the analysts. I'm glad this symbiotic equilibrium hasn't been perturbed much yet.
The takedown of Stocks for the Long Run is astounding, but I wonder if what people were buying in the early 1800's was even remotely similar to what we buy today. There was no SEC to protect you from lying conmen, no FDIC to protect the banks, no guarantees against dilution schemes, no ratings agencies, no legal system mature enough to protect your claim or adequately handle a default, and not really even a market within which to transact in a legitimate way. If there were not standardized contracts, just as there was not the concept of interchangeable parts, then how can we even compare interest rates? Payment in gold coin for treasuries???
Until the modern era, most investors went to talk to some guy in a smokey office and handed him a suitcase of cash in exchange for a written note that a railroad you can only hope he actually represents will pay you coupons. In a sense, it was more akin to today's "wild west" crypto market. It's hard to say how much brokers earned, but as recently as the 1970s $1,500 was not an unusual trade commission for one stock trade.
In terms of record keeping, when a bank or railroad went belly-up, people just wadded up their bond papers and lit a fire with them. The money and the data would literally go poof. The accounting records of defunct businesses were not likely to survive, considering that lots of relevant documents didn't survive either! I suspect there is survivorship bias even in the article's work.
Maybe we should say "Of course bonds performed as well as stocks. Either was a wild gamble with higher risks than, say, leasing farmland, doing hard money loans to farmers, or running tenement houses." Another close analogy would be the sketchiest markets in the world's poorest countries. Imagine loaning cash to people or buying shares of businesses in an open-air market in Mozambique or Nicaragua or Iraq. It would have to be relationship-based or you wouldn't do it, and buying a bond might be the most speculative edge of your investing activities.
@chris-b I don't think things were quite as bleak in the early 19th century as you may imagine. Contract law had long underpinned trade. The Amsterdam stock market had been in business since 1602 and remains in business (likewise the London Stock Exchange from 1698). The recently independent and then emerging market of the USA penned the Buttonwood Agreement in 1792 establishing rules for the trading of stocks.
Far from trades being done in smoky back rooms, in London from 1823 to 1870 all trades had to be traded by law on the floor of the exchange. Sure there were scandals and regulatory issues and Acts of Parliament passed to improve regulation but it is worth remembering that the Imperial Age was founded on trade and with it came contract law, accountancy, and regulation in all it's forms.
I don't disagree that digitization has produced much more data and this may give future historians better records (or worse depending on what we do with this planet) and that we have better data on more recent market events than past but this gives us a lot of recency bias which we are hard wired to lap up.
Ultimately the old data gives us a view, perhaps an impressionistic one, of how markets performed before our modern age.
Personally I think the older data is a good reminder that things in the future will be different again and that the immediate future can be dramatically different to the recent past we just grow complacent as it usually isn't (i.e. momentum).
It remains logical to assume that the risks of holding equities will be better rewarded in the long term than holding bonds although in the long term we are all dead. That's why diversification is valuable, but only when the tide goes out.
My problem is psychological in that I like bonds in theory but find them unattractive in practice.
I don't trust the early 1800s stock data that much. But post-1871, there's a clear pattern: equities outperform in the long run, while bonds can have long stretches of poor returns:
See here: https://earlyretirementnow.com/2016/05/19/bond-vs-stock-risk/
Especially this chart:
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