150+ Years of Long-Term Earnings and Stock Returns of the ‘Conglomerate’ of Collective S&P 500 Index Companies

Readers of this newsletter might be familiar with our preferred way of thinking of a stock index as a ‘conglomerate’ of the collective businesses in the index (with weights from the index, of course). We have pointed out in several past newsletters that the ‘conglomerate’ of the S&P 500 index companies has been a fantastic business throughout its 150-plus years (see, for example, April 1, 2019: S&P 500 As A Business. In this newsletter, we delve into how this business and its stock returns have performed since 1871, covering a history of more than 150 years.

A fantastic business that never lost money in any single month

Nobel Prize laureate and Yale professor Robert Shiller has maintained one of the highest quality historical S&P 500 index datasets (see this). His data spans from 1871, covering more than 150 years. Here is what we have found:

From 1871 to present:

• The Consumer Price Index (CPI) has an annualized growth rate of 2.14%. This implies a long-term inflation rate of 2%, which, not coincidentally, aligns with the comfortable inflation target set by the Federal Reserve.
• The annualized growth rate of real earnings per share (after inflation adjustment) for S&P 500 companies is 6.36%.
• The S&P 500 index’s real return (including price appreciation and dividend reinvestment, after inflation adjustment) has grown at an annualized rate of 6.95%, closely tracking the real earnings growth rate.
• The real dividends of the S&P 500 have grown at an annualized rate of 3.75%.

If we zoom in to the monthly earnings for our ‘conglomerate’, we find that:

• The minimum monthly real earnings were $5.27 in December 1921. Note that in Shiller’s data, he extrapolated monthly earnings from the available quarterly earnings data. For yearly data, you can refer to the following chart, which shows that 1921 was perhaps the worst year in terms of earnings. Nevertheless, the key takeaway is that this ‘company’ never lost any money in any single month!

Here is the up-to-date historical S&P 500 real earnings by year:

Compared with the data we showed in 2019, we can say that this ‘business’ has done quite well recently.

The significance here is that our ‘company’ has grown at an annual rate of nearly 9% in nominal terms, or more importantly, after adjusting for inflation, its profit has grown by more than 6%. This fundamental is particularly noteworthy for business owners, as achieving sustained inflation-beating growth for over 150+ years is a rare feat indeed!

A fantastic business that generates compounding wealth

The other important data from above shows that this business’s stock real returns (including price and dividend reinvestment, adjusted for inflation) are fantastic for compounding wealth. Just to give you an idea:

• A dollar invested in 1871, after 153 years, is now roughly equivalent to $28,800 in 1871 dollars (28,800 times) or $736,000 in today’s dollars!
• Alternatively, if you started investing $1 in 1974, it would have grown to $36 in 1974 dollars or $100 in today’s dollars over the past 50 years.

Moreover, for those needing to withdraw money for expenses (such as retirees), these data strongly support the 4% retirement spending strategy. This strategy suggests that, if managed correctly, one can safely withdraw 4% annually, adjusted for inflation, and still maintain or even grow their wealth. Intuitively, this approach indicates that there may still be a 3% real return annually to further increase wealth or savings, even after withdrawals.

In reality and practice, things are more complex than the straightforward arithmetic calculations mentioned above, as one must consider the significant fluctuations in S&P 500 stock prices. For retirement-type spending withdrawals, we advocate maintaining a balanced portfolio, such as 60% in stocks and 40% in bonds. Additionally, if feasible, it is advisable to implement specific tactical strategies like Tactical Asset Allocation(TAA) from MyPlanIQ to mitigate volatility and improve returns.

Rolling returns of S&P 500 real returns and a long-term moving average strategy

A natural question to ask is how the S&P 500 real returns appear in rolling returns. Below, we utilize Shiller’s data to compute its 10-year rolling returns. Additionally, we implement a portfolio strategy based on a 10-month moving average, which invests in the S&P 500 when its real return price exceeds its moving average or remains in cash otherwise. Note that we do not calculate the cash return and assume it maintains its value, resulting in a somewhat underestimated calculation for this portfolio.

Here are the findings:

• The annualized real return from 1871 of the 10-Month moving average based portfolio for the S&P 500 is 7.9%, approximately 1% higher than the S&P 500’s annualized real returns over the same period.
• The minimum 10-year rolling return (annualized) for the S&P 500’s 10-year rolling return series is -5.9%, occurring from March 1999 to March 2009 during the tech bubble burst and the Great Financial Recession.
• In contrast, the minimum 10-year rolling return (annualized) for the 10-month moving average portfolio is 0.14%, observed from August 1972 to August 1982, a period marked by high inflation. This is significant as it indicates that the 10-month moving average portfolio never incurred a loss over a 10-year period since 1871, unlike the (buy and hold) S&P 500, which experienced several such periods as illustrated in the chart following this text.

The following chart displays the 150-year 10-year rolling return for both the S&P 500 and the portfolio:

So the S&P 500 experienced real 10-year losses during the Great Depression era, the World War II period, the high inflation of the 1970s-80s, and the Great Financial Recession of 2008! In contrast, the 10-year rolling return (annualized) of the moving average portfolio never fell below 0 over the entire 150+ years!

We also note that there were many periods when the blue line (S&P 500 rolling returns) was above the red line (the moving average portfolio’s real returns). This indicates that there were many 10-year periods when the S&P 500 outperformed the portfolio. However, patience certainly paid off for those who adopted such a strategy over the long term!

Finally, let’s not forget that the additional 1% annual return would have resulted in roughly 4 times more terminal wealth for the 10-month moving average portfolio compared to the S&P 500 buy-and-hold strategy! So not only would you have slept better, but you would also have accumulated more wealth.

There are many additional studies that can be conducted, such as studies on different rolling return periods (like 5-year, 15-year, 20-year, etc.) and empirical results of the 4% retirement spending withdrawal strategy, among others. We plan to develop a tool/calculator in the future to support these studies.

In summary, the garden variety S&P 500 index is not ordinary at all: it represents a fantastic business that has been a wealth compounding machine for long-term investors. Furthermore, one can adopt a more active tactical strategy in a tax-deferred account to enhance such compounding.

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