Jack W. Wilson

An Analysis of the S&P 500 Index and Cowles's Extensions: Price Indexes and Stock Returns, 1870-1999

This article provides a consistent monthly stock price index from January 1871 through 1999. The broadly defined S&P Weekly Index is reconstructed from 1918 and carried forward as the S&P 500 Composite Index to the present. Cowless monthly index is improved in order to provide month-end estimates from February 1885. Cowless estimates of dividends and earnings for this index from 1871 are reevaluated and are carried forward until spliced to the S&P daily estimates that began in 1957. The result is a monthly index of prices, dividends, and earnings based on consistent definitions over a period of 130 years.

A Comparison of Annual Common Stock Returns: 1871-1925 with 1926-85

Lawrence Fisher and James H. Lorie, and Roger G. Ibbotson and Rex A. Sinquefield have documented annual returns on common stocks since 1926. Prior to 1926, due to the work of the Cowles Commission, annual returns can be extended back to January 1871. This study utilizes Alfred Cowless reconstruction of common stock returns to provide a comparison between the periods 1871-1925 and 1926-85. A comparable series of annual returns over the complete 115-year period is developed in both nominal and inflation-adjusted terms. The comparison of the two periods suggests that the inflation-adjusted return averages 6.6 percent with similar variability between the two periods. Copyright 1987 by the University of Chicago.

The Changing Nature of Stock and Bond Volatility

This article examines the changing nature of U.S. stock and bond risk from 1871 through 2000 and the implications for asset allocation. Using geometric means and standard deviations, we examine nominal and inflation-adjusted monthly returns over nonoverlapping 5-year periods, as well as annual returns over periods of approximately 25 years, and we document how stock and bond volatility changed over the period. Our analysis suggests that the relative change in the volatility of stocks and volatility of bonds over the past 50 years has increased the importance of stocks in asset allocation. The change is even more pronounced when inflation is considered. This article examines the changing nature of stock and bond risk from 1871 through 2000 and the implications for asset allocation. Using geometric means and standard deviations, we examine nominal and inflation-adjusted monthly returns over five-year periods, as well as annual returns over periods of approximately 25 years, and document how stock and bond volatility changed over the sample period. Our analysis suggests that the change in the relative volatility of stocks and bonds over the past 50 years has increased the attractiveness of stocks in asset allocation, and the change is even more pronounced when inflation is considered. Since about 1940, stock volatility has fluctuated in a narrow range, and both low and high mean stock returns have been associated with similar levels of volatility. But bond volatility increased during the last 35 years of the series. The best 5-year nominal mean returns on bonds occurred during a 10-year period when bond volatility was at its highest level in history. The geometric mean nominal returns of stocks exceeded those of bonds in 18 of the 26 nonoverlapping five-year periods. Inflation-adjusted geometric mean stock returns were negative in only 3 of the 26 periods, but for bonds, they were negative in 10 of the 26 periods. The inflation-adjusted geometric standard deviation of bonds was 30 percent higher than the nominal standard geometric deviation for the 1871–2000 period. For stocks in this period, however, there was little difference between inflation-adjusted and nominal geometric standard deviations. The relative riskiness of stocks and bonds has undergone a long-term change. Until roughly 1950, the ratio of the two variances (stocks to bonds) was much greater than it has been subsequently except for a single five-year period. An examination of five-year standard deviations indicates that bond risk has increased since the 1960s whereas stock risk has remained relatively steady. The correlation between bond returns and stock returns, although fluctuating, has been increasing. Combined with the increase in bond volatility relative to stock volatility, this rising correlation has important implications for asset allocation. Our analysis of the nominal risk–return trade-off available to investors shows that the situation changed after World War II. For the later two 25-year periods examined here, a 100 percent bond portfolio, or a portfolio invested primarily in bonds, compared unfavorably on a return–risk basis with several portfolios that had larger stock allocations. This outcome was most pronounced in the last period, 1974–2000, when a 70/30 stock/bond allocation had less risk and a much larger return than did a 100 percent bond portfolio. Clearly, during the last half of the 20th century, the changes in relative stock and bond volatility increased the attractiveness of stocks relative to bonds. On an inflation-adjusted basis, the case for portfolios heavily invested in bonds is even weaker than it is on a nominal basis. Bonds are affected more severely when adjusted for the increased risk caused by the covariance of nominal bond returns and inflation.

Estimating Stock Returns

How do we quantify the level of return that an investor can expect in the future? An examination of the historical distribution of total returns reveals declines in dividend yields and new likely lower boundaries for price appreciation. It is often asserted that low dividend yields brought about by higher earnings retention should be followed by greater price appreciation as a firm invests retained earnings into new projects. The available recent evidence refutes this assertion. Barring some significant reversal of current conditions, short-term and possibly intermediate-term returns from stocks will be lower than what many investors may be anticipating.

Asset Allocation Decisions Making the Choice Between Stocks and Bonds

Given renewed interest in bonds, this article considers asset allocation decisions in the context of realized returns for bonds and stocks. The study is based on new and improved data on bond returns covering long periods of time as well as calculations of the probabilities associated with stock bond returns. An analysis of these probabilities using inflation-adjusted returns suggests that the probability of earning sizable compound rates of return with bonds is not only small, but also declines over time. Therefore, despite recent strong performance by bonds, our results suggest investors should be cautious in making asset allocation decisions.

The Equity Risk Premium Controversy

The equity risk premium controversy is a puzzle with implications for investors and money managers. Whatever the arguments about a high equity risk premium in the past, there has been a substantial premium over time on average, although typically not as great a realized premium to investors. There is similarly credible evidence that an equivalent or only slightly lower premium may continue into the future.

Long-Term Returns and Risk for Bonds

CHARLES P. JONES is GLU professor of 6nance at the College of Management of North Carolina State University in Raleigh (NC 27695). D espite the vast amount of information available about bond yields and returns, there are differences in the data series involving this important asset class. A good example is seen in the Treasury bond data for 1994. For long-term Treasuries for 1994, Ibbotson Associates reports the yield increasing from 6.54% to 8.09%, for a total return of -7.77%. In contrast, the Lehman Brothers long-term Treasury index shows yields rising from 6.42% to 7.98%, for a total return of -6.94%, a substantial difference in reported results. Some vendors of bond data complain about the validIty and usefulness of competing sources of data supplied to users. There are also gaps in bond data when compared to common stocks, for which we have reconstructed the SP Schwert [1990] has extended market data even farther back. Meanwhde, the experience of bondholders over the years provides strong evidence that bonds are a risky asset for whch reliable, long-term information is needed. This article provides an independent estimate of monthly yields and returns for both government and corporate bonds over a very long period of time. These data are consistent and reliable, and can easily be updated by users of such data on a real-time basis with the methodology outhned here. This data series provides additional insights into the long-term returns and risks from bonds; furthermore, the data are realistic estimates of the actual

Stocks, bonds, paper, and inflation: 1870–1985

m 10 data covering the returns on major financial assets common stocks, government and corporate bonds, Treasury bills and inflation begin in 1926 and are updated on an annual, quarterly, and monthly basis, the entire record of the returns of financial assets dates back nearly sixty years farther. We can almost double the history of returns for major asset classes, resulting in a ”complete” record of 115 years covering the period 1871-1985. The construction of such a recoid can offer new insights into the wealth accumulation power of equity securities as well as information on a consistently constructed corporate bond series. Furthermore, we can provide a look at the long-term performance of shortterm interest rates in an alternative form to the IS Treasury bill data. After all, the first Treasury bills were issued only in December 1929 and were used sparingly until World War 11. Finally, if heretofore unavailable data on the Consumer Price Index can be constructed and analyzed, we can evaluate the complete record described above on both a nominal and an inflation-adjusted basis. This article presents the entire 115-year performance record December 31, 1970 December 31, 1985 for a composite index of common stock returns, a corporate bond series, and commercial paper. We also construct and present new CPI data for the earlier period in order to be able to examine for the first time inflation-adjusted returns similar to those that IS provide. The additional information of this complete record should be helpful in analyzing long-term price cycles and movements, andl in documenting the well-known power of compounding over very long periods of time. Comparisons between the early period and the IS period two periods of roughly equal length -are useful in substantiating both the absolute and relative relationships found in the IS data.

Sinking funds as credible commitments: Two centuries of US national-debt experience

Abstract For much of US history, the federal government employed sinking funds as devices to support the market for its debt. The policy was inaugurated by Hamilton in 1790 as a method of enhancing public credit by committing the government to redeem its debt. We interpret the commitment, as others have interpreted the gold standard, as a way of achieving time consistency of government policy. Although steeped in controversies about the utility of sinking funds, subsequent US history did reflect that commitment – until the 1930s. Since the 1930s, the view of Hamiltons opponents, namely Jefferson and Madison, that the governments hands should not be tied by commitments such as sinking funds have prevailed, just as the gold standard itself was abandoned.

The Impact of Inflation Measures on the Real Returns and Risk of U.S. Stocks

Using different inflation measures produces economically significant differences in both the inflation record and inflation-adjusted stock returns. We introduce a more consistent measure of the monthly Consumer Price Index (CPI) inflation rate to better measure real returns over 1913-2004, for which the official CPI exists. We also extend the series backward to 1871 on a monthly basis, an important addition to the data series. We analyze the impact of inflation on the real standard deviation of stock returns and find that, in contrast to the results for geometric mean returns, inflation adjustments have little impact on estimates of return variability. Copyright 2006 by the Eastern Finance Association.