What If the Stock Market Was an Inflation-Protected Bond?

Who’s up for a very off-the-wall post? Good, you’re at the right place.
As I mentioned yesterday, I just got the new Ibbotson Yearbook which is a great resource for historical stock market data.
A few years ago, I took the historical performance data of the stock market and wanted to see what it would look like if the stock market were a bond. In order words, what if a bond performed exactly the same way the stock market had? What would its yield-to-maturity look like through the decades?
I took all of the monthly return data going back to the 1920s and assumed we had a bond of infinite maturity that paid a fixed coupon each month.
Let me stress that even though this bond is complete make-believe, the results are what the stock market actually did. I ran this scenario again but this time I changed the bond to an inflation-protected bond. Here’s what it looks like:
There were three major troughs; 1929 around 2.7%, 1968 at 3.3% and 2000 at 3.5%.
The highest peak came in 1932 at 15%. There were other peaks in 1949 at 12.5%, 1982 at 12.9% and last year at 13%. At the end of 2009, the yield-to-maturity stood 9.3%. Thanks to the rally, that’s come down some since.
There’s one hitch with this study. 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.
Based on trial and error, I used 6.76% as a starting point. That made the graph symmetrical with an historical average yield of 6.79%.

Posted by on March 30th, 2010 at 11:40 am

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