Does the Stock Market Really Return 7% Per Year?

I want to revisit the Ibbotson data again to look at the often-cited claim that the stock market has historically returned (capital gains and dividends) 7% per year greater than inflation. This claim has been repeated so much by Jeremy Siegel that some have called it Siegel’s Constant.

Here’s the long-term real return in blue, with a 6.9% trendline in black.

image1327

I think this is a dangerous idea for several reason. For one, the long-term real return of stocks is no longer 7%. Thanks to two giant market crashes in less than a decade, the long-term number has fallen to 6.67% (that’s since 1925). Furthermore, much of that gained comes from the post-war boom. Over that last 50 years, that real return has been a much more reasonable 5.45%.

Another problem is that this data series is highly volatile. Too volatile to call the results a constant. There have been long periods when investors haven’t made a dime from the stock market in real terms.

Looking at the data, there seem to be periods of 15 to 20 years when stocks boom, or when they bust. Notice how the blue line runs above or below the black line for long periods at a time. Still, I would say that we don’t have enough data to make the claim that the stock market does this regularly.

Here’s how the market has done versus its long-term trend. The chart below is the same as the chart above but it shows the blue line divided by the black line. When the line is rising, stocks are outperforming their long-term average. When it’s falling, stocks are trailing their long-term average. I chose a 6.9% trend line because that seems to sync up the three major peaks.

image1328

What’s interesting is that the chart above appears to be similar (though not exact) to a long-term chart of price/earnings ratios. This shouldn’t be a surprise since long-term growth in corporate profits doesn’t vary very much.

Posted by on April 11th, 2013 at 9:31 am


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.