Typical returns data is focused on the United States because it typically has the best and most extensively studied returns. The data below clearly indicates that the US was an outlier over the last 150 years compared to the rest of the world.
The US is now roughly 60% of the worlds free-float market capitalization. Did the US have a unique system of government, a unique commitment to capitalism, or a uniquely independent central bank that prevented high inflation? Perhaps, or maybe US outperformance was a right tail event that we should not expect to happen again.
I’m not sure what the right answer is, but I am certain that we shouldn’t rely on only one country to form our expectation for market returns. The Jordà-Schularick-Taylor Macrohistory Database provides data for 16 countries around the world, mostly going back to 1871. Using this data, supplemented by a few other sources, we can form better expectations for market returns moving forward.
Global Stock Market Returns
Here are stock market returns for each country, inflation adjusted in local currency and sorted from best to worst:
The US has the highest Annual Returns but is ranked near the middle according to standard deviation. We also see that the US market had high excess kurtosis, indicative of fatter tails in the distribution. The highest risk adjusted returns came from Australia, which had both high returns and low variance.
Finland had the highest standard deviation of returns, with Germany, Italy and Japan following close behind. Significant drawdowns tended to accompany high volatility. Finland saw an 85% drawdown during World War 1. Germany suffered two 90+% drawdowns, once during the hyperinflation of the 1920’s and another after World War 2 price controls were lifted. Italy and Japan also had severe (>85%) stock market drawdowns around World War 2.
Global Intermediate Term Government Bond Returns
The US also stands out as an outlier when considering bond returns. Here are summary results for intermediate government bonds returns, inflation adjusted in local currency:
The US annual return of 3.0% is ranked second highest among the 16 country sample, with only Denmark having a higher annual return. We also see that Sweden, the Netherlands, Norway and Switzerland also had high bond returns. The US also had one of the lowest standard deviations and was near the top in risk adjusted returns.
Germany had the lowest annual returns, reflecting a total loss of capital during the hyperinflation of the 1920’s. It is interesting to compare this to Germany’s high equity returns over the full sample period.
Global Inflation
Inflation is very important to consider as well as it affects the returns to both stocks and bonds. Here are real returns from holding uninvested currency in each country:
The US stands out when it comes to inflation as well, having one of the lowest inflation rates historically. The only country with lower inflation than the US was Switzerland. It is no wonder why Swiss currency is so highly regarded for such a small country.
Inflation was a menace during and between the two world wars and again in the 1970’s energy crisis. Italy experienced a near total drawdown of its currency during World War 2. Portugal experienced double digit inflation starting in 1915, experiencing a 96% decline in real purchasing power. German hyperinflation in 1923 caused a complete loss of real purchasing power. France experienced an 85% drop in purchasing power from 1944 – 1949. Around the same period as France, Japan experienced a 98% decline in purchasing power. Finland experienced a nearly 90% drop in purchasing power over a three year period beginning in 1916.
It’s also interesting to see that inflation rates exhibit negative skewness and high kurtosis. Historically the distribution of returns were fat tailed and tended to show up as severe losses in purchasing power.
Inflation More Directly Affects Bond Returns than Stock Returns
You can clearly see the relationship between bond returns and inflation in the tables above.
The six countries with the best bond returns also show up as the six countries with the lowest inflation rates. Likewise, the six countries with the worst bond returns are all ranked within the worst eight countries by inflation. This is to be expected as the interest rates on bonds are typically priced in nominal terms; if there is unexpected inflation this directly eats into real returns for bondholders.
Stocks, in contrast, are valued based on the future earnings of companies and are better able to adjust to inflation, at least in the long term. We see this in the charts above. Germany was one of the best performing stock markets historically in spite of its horrendous historical inflation of more than 5% annually. Likewise Finland was a top stock market performer despite inflation ranking in the bottom half of countries. Of course, inflation is still bad for stock performance as well. The worst three stock markets, Italy, France, and Portugal, were all ranked in the bottom four for inflation performance.
The historical record clearly indicates that investors should care about and be worried by high inflation. High inflation directly deteriorates the returns of bondholders and less directly deteriorates the returns of stock holders.
Volatility and Fat Tail Surprises
Real stock returns were highly volatile across all countries. Volatility, as measured by the standard deviation of annual returns, averaged 20% in local currency terms but ranged from 15% to 27%. Far riskier than bonds, stock returns also exhibited fat tails but were slightly positively skewed. Historically stock investors were surprised often, but more commonly to the upside.
Real bond returns exhibited roughly half the volatility of equity returns, averaging an 11% standard deviation (volatility) from the mean across the sixteen country sample. Switzerland had the lowest volatility in bond returns, only 7%, while Germany experienced the highest at nearly 19%. Although bond returns were less volatile than stock returns, the distribution of those returns was fatter (higher excess kurtosis) and were slightly negatively skewed. Historically bond investors were surprised often, but more commonly to the downside.
Inflation has persistently eaten away at the purchasing power of uninvested cash since 1871. Even while most of the world was on the gold standard inflation was the enemy of investors. The only two periods of global deflation occurred in the mid 1880’s and the early 1930’s. Inflation was slightly less volatile than real stock and bond returns, but has very fat tails and highly negative skewness. When inflation surprises, it almost always surprises to the downside. In other words, most of the time inflation is not an issue, but occasionally it pops up and severely debases a currency decimating investor returns in the process.
More Realistic Expectations
The evidence suggests that the US market has been remarkably successful, having a combination of high stock returns, high bond returns, and low inflation. No other country comes close to this combination historically. Denmark or Australia could be considered but neither compare to the US experience.
It would be prudent for investors to adjust their expectations. Rather than expecting US returns, globally minded investors might instead look to the UK which had middling stock and bond returns as well as inflation.
Using the historical record as a guideline, in the long-term investors should expect highly volatile stock returns of 6-7%, bond returns of roughly 2%, and inflation of 3-4%.