Change? What Change?

I have, for about 15 years, tried to understand why investment returns tend to be the way they are. I have noticed that over long periods the stock market moves in a very narrow growth trough. In my view there must be an attractor that makes the rate the one we see.

This is background.  It is insufficient to act upon as an investor.

I am reasonably convinced there is an attractor and for the Toronto Stock Exchange it is about 9 and 7/8%. This graphic shows how the total return index (Actual) has behaved from 1950 to now. Click for a larger image.

TSE attractor

The outside bands are the growth from 1920 at 9 7/8% plus or minus 3/8%. The graph is logarithmic.

There seems to be limits so that if the high band is exceeded, then the future actual return tends to be sharply lower and if outside or near the low band, it tends to bounce back. Something draws it back from excesses on either side.

It returns to some standard and that stand must make sense or it would not be so persistent. What makes it up?

I do not know with certainty but I have some candidate ideas.

  1. Since the stock index is in dollars, inflation will contribute some of the growth. Using the Bank of Canada records, that is 3.69% over the 1950 to 2013 period. Be careful with this one though, there are many ways to assess inflation and there is not a consistent set of principals used throughout the period.
  2. Productivity adds value. It is harder to know what that might be but it is likely about 2%.
  3. The size of the market matters. Population growth tends to create customers and thus business value. In 1950 there were 13.7 million of us and now there are 34.9 million. Average growth rate about 1.5%.
  4. Average wealth matters too because the stock market counts economic wealth alone. Real GDP per person has about tripled in the last 65 years. About 1.7% annually.

Total to here. 8.9%

The other could be things like:

  • Access to markets. The internet turns a local business into a global business for some products.
  • Cost reductions. Computers have replaced a lot of clerks. How many operators does Bell employ? Not many. What has happened to draftsmen? Some of these changes are picked up in productivity changes.
  • Competition because capital is not as crucial as it once was. It is possible to start a world class business and get it to the proof of concept level with much less capital than was needed to start old businesses like the car companies and the steel mills.
  • The rise of service industries is important too. Their margins per dollar sales is much higher than retail or manufacturing.
  • Better service and banking structures and better infrastructure
  • Longer lives.

Regardless of what makes it up, it seems to be a persistent number.

As an investor, it is not usually in your best interest to bet against the market long term without a very good reason. By that belief, it would be not so clever to expect yields over long times to be more than 10% less fees and costs to earn it. Call that 7% to 8%.

By the same token if you have a 40 year or longer time frame, then betting much lower may sound smarter, but you will shortchange the present. You cannot take the kids to DisneyWorld when they are 32.

There is always the systemic risk that some government or other will do something to make the attractor rate be much less. I suppose they could make it be much more but I will need to see evidence for that one. I already have evidence for the former.

Be wise. The world behaves in semi-predictable ways. Try to notice what drives it.  Notice the number, but pay attention to how that affects your meaning.


Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.