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Here’s an update of a post I did last year. I thought it would be interesting to see what the stock market’s historical performance would look like if the stock market were a bond.
Let me explain what I mean.

I took all of the monthly return data for the stock market going back to the 1920s. I then wanted to see what a bond would look like if we applied those exact same monthly changes to it.
I assumed that it’s a bond of infinite maturity and pays a fixed coupon each month.

There’s one hitch though. I have to choose a starting yield-to-maturity for December 1925. So this isn’t a completely kosher experiment because the starting point is based on my guess. If I choose a number that’s too high, then the historical performance won’t be able to keep up, and the yield-to-maturity would grow higher and higher and soon leave orbit. Conversely, if my starting YTM is too low, the yield would gradually get pushed down to microscopic levels.

Fortunately, the data makes my job easy. After eight decades, the window I have to work with is pretty narrow. If I start with 6.6%, that’s too high, and 6.5% is too low. After playing with the numbers, I settled on 6.538%.

Even though this “bond” is complete make-believe, it reflects what the actual stock market really did for the past 83 years.

Over the last eight decades, the yield has averaged about 10.2%, which is right in line with the market’s long-term total return. Through the end of May, it stood at 8.75%. Eight years ago, it got down to 4.9% (by comparison, long-term Treasuries were going for 6.5%).

Last year, I wrote:

I have to think that many investors would be better served if there were such an investment vehicle. If they knew that the market’s current yield was something like 7% or 8%, they might treat their investments very differently.

What’s interesting is that investing in the 19th century wasn’t too far from this. Many stocks traded at or near “par” which was often $100 a share. Every year, the company would pay out an annual dividend, say $5 or $8 a share, sometimes none, sometimes $10 or $15. They dividend was the game, and there wasn’t nearly as much emphasis on long-term capital gains.

Posted by edelfenbein at June 3, 2008 1:35 PM