More Stock-Market Analysis

I ended “Shiller’s Folly” with the Danish proverb, it is difficult to make predictions, especially about the future.

Here’s more in that vein. Shiller uses a broad market index, the S&P Composite (S&P), which he has reconstructed back to January 1871. I keep a record of the Wilshire 5000 Full-Cap Total-Return Index (WLX), which dates back to December 1970. When dividends for stocks in the S&P index are reinvested, its performance since December 1970 is almost identical to that of the WLX:

It is a reasonable assumption that if the WLX extended back to January 1871 its track record would nearly match that of the S&P. Therefore, one might assume that past returns on the WLX are a good indicator of future returns. In fact, the relationship between successive 15-year periods is rather strong:

But that seemingly strong relationship is an artifact of the relative brevity of the track record of the WLX.  Compare the relationship in the preceding graph with the analogous one for the S&P, which goes back an additional 100 years:

The equations are almost identical — and they predict almost the same real returns for the next 15 years: about 6 percent a year. But the graph immediately above should temper one’s feeling of certainty about the long-run rate of return on a broad market index fund or a well-diversified portfolio of stocks.

Related posts:
Stocks for the Long Run?
Stocks for the Long Run? (Part II)
Bonds for the Long Run?
Much Ado about the Price-Earnings Ratio
Whither the Stock Market?
Shiller’s Folly

8 thoughts on “More Stock-Market Analysis

  1. Index funds typically match the S&P, but I’m not satisfied with a meager 6% — less after fees. I follow Buffett’s strategy — buy and hold sectors. My portfolio is up 27% this year (+32% before recent volatility).


  2. Past performance should certainly not be expected in the short term due to market fluctuations and volatility, but those who go long reap the rewards. The $10,000 I invested in Fidelity’s Contrafund way back when is now worth $250,000. That included the crash of ’87, the 2001 dot-com bust and 2008 Great Recession.

    Retail investors are especially schizophrenic. They ignore market fundamentals, panic on the headlines and cause undue volatility when they are forced to sell in order to cover their short stake. If only they would ignore the news, stay calm or stuff their cash in a mattress.


  3. You are right about retail investors. And your experience with Contrafund illustrates the virtue of buy-and-hold — it gets you through the rough spots. Your inflation-adjusted, annualized rate of return on Contrafund (as of now) is 6 to 7 percent (6.7, assuming a 35-year holding period). That’s a real, long-run return that most retail investors never remotely approach.


  4. Investors typically lose money because they buy high and sell low. They didn’t buy Amazon when it was $18 per share in 1997, but paid $2000 when the stock was frothy, and have realized a $400 loss due to recent volatility. Afraid that the stock will go even lower they sell to avoid further loss. They have no patience and act on fear. The market is not for the timid.

    A long term strategy can buffer the volatility. A time horizon of 3, 5 or 10 years will dictate a more conservative or aggressive allocation. If I needed the money in six months I would not be in the market, but CD’s.


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