in the Market" Versus "Timing the Market," 1963-1993
University of Michigan
In the 1990's the
New York Stock Exchange-where the stocks of about 3,000 companies are
traded among investors each day- had its longest "bull market" (a
period of rising stock prices) in its history. The NASDAQ-where the
stocks of approximately 3,300 companies are traded- also experienced
record performance. Following a
sustained period of rapid stocks/shares value growth, it takes
time during the downturn for memories of disappearing paper profits and high profile corporate failures, to
fade. So the scenario for the foreseeable future is unspectacular average equity returns growth compared with
successive years in the 1990s of double-digit
growth. However, some sectors and regions will continue
to outperform others. In a long period down/bear market,
there are always periods of growth. So the timing of
stock market investment is important. The last protracted
bear market (period of falling prices) in US equities started in February 1966 and
lasted until August 1982. The Dow Jones index value in
February 1966 was 995 and 16 years later it stood at 777.
So any investor who stayed fully invested in an average
portfolio of shares in this period lost 22%. Yet over
this time span there were four periods in which equities
experienced strong rallies which boosted the Dow by 32%,
66%, 76% and 38% respectively.
According to a
University of Michigan study, an investor who stayed in the US stock market
during the entire 30-year period from 1963 to 1993-7,802 trading days-would
have had an average annual return of 11.83 %. However, if the investor missed
the 90 best days while trying to time the market, the average return
would have fallen to 3.28% per annum.
to Dr. Bryan Taylor of Global Financial Data, analysis of US bull
and bear markets in the past has always used the S&P Composite Price
Index, not the Total Return Index. Since
most investors have their money in funds that reinvest their dividends, using
a price index to determine the movement of markets does not reflect the
results that investors receive. Over
time, price indices produce dramatically different results from return
indices. The 1920s bull market peaked on September 7, 1929.
If someone had invested their money in the stock market on September 7,
1929, it would have taken until September 1954 to break even using the price
index benchmark but on
a total return basis (allowing for dividends), the investor would have broken
years earlier, in 1945. Total returns reduce the size of the falls in a bear
market and increase the returns in a bull market.
Investment Returns Yearbook (originally
known as The Millennium Book) was launched in 2000. It is produced by
London Business School experts Elroy Dimson, Paul Marsh and Mike Staunton in
conjunction with ABN AMRO. ABN AMRO distributes the Yearbook to
investment professionals and London Business School makes it available to
other users (for
more information, contact: Adrian Rimmer Tel: +44 (0) 20 7678 4050 Email: firstname.lastname@example.org
The core of the Yearbook
is provided by a long-run study covering 106 years of investment since
1900 in all the main asset categories in Australia, Belgium, Canada, Denmark,
France, Germany, Ireland, Italy, Japan, the Netherlands, Norway, South Africa,
Spain, Sweden, Switzerland, the United Kingdom, and the United States. These
markets today make up over 92% of world equity market capitalisation. With the
unrivalled quality and breadth of its database, the Yearbook has
established itself as the global authority on long-run stock, bond, bill and
foreign exchange performance.
The paradigm that equity markets supported by strong
currencies provide superior returns compared to equities in
weak-currency markets has been rejected by the authors of the
2006 ABN AMRO Global Investment
The Yearbook, published annually in partnership with
Professors Dimson, Marsh, and Staunton of London Business School, is the
most comprehensive and authoritative work of its kind and examines total
returns since 1900 for stocks, bonds, cash and foreign exchange in 17
major markets, covering North America, Asia, Europe and Africa.
This year’s study takes a close look at the role of
currency exposure in portfolio management and challenges the widely held
view that equity markets supported by strong currencies will produce
Using data since 1900 for all 17 countries and also for
a broader sample of 53 countries, the authors show that instead, equity
markets experiencing currency weakness are more likely to outperform.
Chart 1 ranks countries by their exchange-rate change
over the preceding 5 years, assigning each country to quintile
portfolios. The portfolio comprising the weakest-currency markets
performed best over 106 years and (using a larger sample of countries)
over the last 34 years.
Professors Elroy Dimson, Paul Marsh and Mike Staunton of
London Business School, said:
“Our preliminary long-term evidence shows that over the
long haul, equity returns have not been bolstered by currency strength.
Historically, avoiding weak currencies might have been justifiable to
control risk, but not to enhance performance”.
The Yearbook also shows that while currency
fluctuations, such as the dollar’s strength in 2005 or its substantial
fall over 2000−02, can seriously impact short-run equity performance,
exchange rate movements have mattered much less to long-term investors.
This is because, over the long haul, parity changes have
largely tracked relative inflation rates. Over more than a century, real
exchange rates, after adjusting for differences in inflation rates, have
changed at most by a mere fraction of one percent per year.
The Yearbook also shows the impact of currency
volatility on the total risk of investing in overseas equities, and
quantifies the gains from hedging.
Professors Dimson, Marsh and Staunton explain:
“A key strategic issue for global investors is whether
to hedge their foreign-exchange exposure. Our analysis shows that while
hedging reduces risk, the gains from risk reduction have declined over
time and are now modest compared with the gains available from
diversifying equity portfolios internationally”.
The Yearbook also looks more broadly at investment
returns in 2005 as well as long-term trends.
- 2005 proved an excellent year for equities, with
positive returns in all countries except China.
The US disappointed with a mere 6.3% return, compared to
the majority of markets that exceeded 20% returns
- UK and Japanese equities posted their best performance
since 1999 with respective returns of 21.3% and 45%. Germany’s recovery
is starting to translate into equity performance, returning 28% in 2005
- Mid-cap stocks outperformed their large and small
counterparts in 2005. The mid-cap FTSE 250 index posted a 30.2% return,
versus 20.8% for the FTSE 100 and 28.6% for the Hoare Govett Smaller
Companies Index. In the US, the S&P 400 Mid-cap index returned 12.6%
compared to 4.9% for the large-cap S&P 500 and 7.7% for the S&P 600
- Since 2000, small-cap stocks and value stocks have
outperformed large-caps and growth stocks by a substantial margin in
- Despite strong equity returns in 2005, and
cumulatively, since the bottom of the 2000-03 bear market in March 2003,
world equities still show the scars from the bear market. The annualised
equity returns over the 21 st
century to date (2000-05) remain negative in 7 out of the 17 Yearbook
countries, including the UK (-1.3%), the US (-2.7%), Germany (-4.1%),
the Netherlands (-5.4%), France (-1.6%) and Sweden (-0.7%). The return
on the world index was -1.2% p.a.
- Equities have outperformed government bonds and
Treasury bills in all 17 stock markets, over the long term (chart 2).
ABN AMRO’s Head of European Equity Strategy, Rolf Elgeti,
discusses the practical implications of the Yearbook’s findings for
equity investors in a forward-looking chapter. He sees two opposing
forces when analysing the effect currencies have on equity markets.
First, a weak domestic currency is generally assumed to
increase corporate earnings in that country as export opportunities
improve as a result of increased competitiveness. However, this effect
has been much weaker than many people believe. Export-driven German
equities for example have experienced good returns, despite the strength
of the Euro, returning 28% in 2005.
Second, a depreciating currency tends to increase
inflation and, more importantly, inflation expectations. This can
translate into negative effects on a company’s stock-market rating,
however the lower PE multiples that tend to follow weaker domestic
currencies have historically been more than compensated for by higher
earnings generated by currency depreciation.
Rather than taking a macro approach toward equity market
investment, Mr Elgeti believes the best opportunities lie at the stock
and sector level.
“While a weak currency tends to lead to higher domestic
earnings for export-sensitive equity markets, the effect on earnings for
closed economies, such as the US, is more muted. The negative effect of
a weak currency on overall market valuation and the positive effect on
earnings may also broadly cancel each other out. We therefore believe
that investors concerned about earnings should look at currencies as a
factor for particular sectors and stocks, but not when looking at the
whole market,” he said.
Dow Jones Industrials Average is based on 30 stocks of leading companies and represents about 25% of the New York Stock Exchange market capitalisation. The S&P Composite represents about 75% of the market’s