Gross is Right: The Siegel Constant Is History

Recently, Bill Gross said that the Siegel Constant, the idea that stocks can return 6.6% after dividends and inflation, is no longer useful. I think he’s exactly right on that.

While the data from history has shown that the broader stock market has returned an average of 6.6% a year more than inflation, I think that’s unlikely to continue. The part is most likely not prologue. More importantly, it’s a dangerous assumption for investors to use. At that rate, it means that your investment in the stock market will double, in real terms, every 11 years.

For one, the Siegel Constant is hardly a constant. The data from 1926 through 1999 showed the long-term total return to be over 8%. After more than a decade of sub-par returns, the long-run Siegel Constant is now down to 6.6%.

The other striking fact about the market’s long-term total return is how cyclical it’s been. Here’s the stock market’s long-term total return (in blue) and I’ve added a black trend line that’s grown by 6.6% per year. As you can see, the two lines wind up in the same place, but they’ve hardly tracked each other.

Now here’s the blue line divided by the black line:

What we see isn’t a constant but a cycle. There are long stretches where the market handily outpaces its long-run average (1942 to 1966 and 1982 to 2000), followed by long period of under-performance (1929 to 1942, 1966 to 1982 and 2000 to 2009).

I will defend Siegel against one criticism levied by Gross. Specifically, Gross conflates GDP with stock market return. They’re not the same. Due to dividends, investors should expect the total return of stocks to outpace GDP growth.

Posted by on August 7th, 2012 at 12:07 pm

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