In their 2001 masterpiece, Triumph
of the Optimists, London Business School professors Elroy Dimson, Paul
Marsh and Mike Staunton document the returns in the major global stock markets
during the 20th century. Since reading the book, we have been
engaging in a spirited debate with the professors over whether the 21st
century’s returns will be comparably great. We say yes; they say no. Their
latest thinking appears in a forthcoming article on equity premiums for the Journal
of Applied Corporate Finance.
Dimson wrote us: “We cannot
unthinkingly extrapolate expected total return from the past total return
(something you imply in your email but do not, I suspect, believe). That is the
substance of our piece in JACF. Implicitly, however, you are observing that
some “low-future-expected-return: adherents derive their views from the
historical record of real dividend growth (which is quite a low rate of
growth). You are correct to imply that we should not unthinkingly extrapolate
expected future dividend growth from past dividend growth. That would be
the same "sin" as Shiller et al criticize. So people who use a
forward-looking interpretation of the Gordon model should use forward-looking
growth forecasts. But where would the latter come from?”
We took the liberty of
showing the new Dimson/Marsh/Staunton article to Will Goetzmann, an eminent
market historian at Yale. His comment: “A major problem with all studies of the
equity premium is that there in no riskless asset, and there is no theory
about whether risky government bonds should have a higher or lower expected
return than stocks. In some countries, equity is clearly less risky
because government default or hyperinflation is more likely than equity market
collapse. So the spread between stocks and bonds is little more than a
curiosity. Jorion addressed this by comparing equity returns with
inflation (i.e., a basket of goods) and also against the U.S. dollar, although
this was an ex post benchmark.
"Missing from
DMS: St. Petersburg, Shanghai, Teheran and most of South America."