What If the Stock Market Was a Bond?

Here’s an unusual post. But it’s my blog, so deal.
I was curious what the historical stock market performance would look like if the stock market was a bond.
Strange? Let me take a step back and explain.
I have the monthly total return figures (including dividends) for the stock market going back to the 1920s. I wanted to take those same monthly changes, apply them to an imaginary bond and see what the yield would have been through the years.
I assumed that it’s a bond of infinite maturity and pays a fixed coupon each month. Actually, the amount of the coupon doesn’t matter, as long as it’s the same each month.
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.
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. If I start with 6.6%, the market’s yield gets
out of control by the 1970s. If I start with 6.5%, the yield goes to rock bottom levels by today. By my judgment, the best looking line starts with 6.538%.
Here’s what it looks like:

I have to stress that even though this “bond” is complete make believe, this reflects what the actual stock market really did for the past eighty-two 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 February 2007, it stood at 8.3%. Seven years ago, it got down to 5% (by comparison, long-term Treasuries were going for 6.5%).

Posted by Eddy Elfenbein on March 14th, 2007 at 2:55 pm

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.