2017 Stocks, Bonds, Bills, and Inflation (SBBI) Yearbook

Acknowledgements xiv

Introduction xvi

Chapter 1: Results of U.S. Capital Markets in 2016 and in the Past Decade 1-1

A Graphic View of the Decade 1-2

The Decade in Perspective 1-3

Market Results for 2007—2016 1-6

Chapter 2: The Long-Run Perspective 2-1

Stocks, Bonds, Bills, and Inflation: Historical Returns 2-1

Logarithmic Scale Used on the Index Graphs 2-2

Large-Cap Stocks 2-4

Small-Cap Stocks 2-4

Long-term Corporate Bonds 2-4

Long-term Government Bonds 2-4

Intermediate-term Government Bonds 2-4

Treasury Bills 2-4

Inflation 2-5

Summary Statistics of Total Returns 2-5

Appreciation, Income, and Reinvestment Returns 2-7

Annual Total Returns 2-10

Rolling-Period Returns 2-10

Real Estate Investment Trusts (REITs) 2-26

Historical Returns on Equity REITs 2-28

Income Returns on Equity REITs 2-29

Correlation of U.S. REITs Compared to Other U.S. Asset Classes 2-30

Summary Statistics for Equity REITs and Basic Series 2-32

Chapter 3: Description of the Basic Series 3-1

Large-Cap Stocks 3-1

Small-Cap Stocks 3-2

Long-term Corporate Bonds 3-4

Long-term Government Bonds 3-4

Intermediate-term Government Bonds 3-9

U.S. Treasury Bills 3-11

Inflation 3-13

Bond Capital Appreciation Despite Rising Yields 3-13

Chapter 4: Description of the Derived Series 4-1

Derived Series Calculated Using Geometric Differences 4-1

Definitions of the Derived Series 4-1

Equity Risk Premium 4-2

Small-Stock Premium 4-3

Bond Default Premium 4-3

Bond Horizon Premium 4-4

Large-Cap Stock Real Returns 4-5

Small-Cap Stock Real Returns 4-7

Long-term Corporate Bond Real Returns 4-8

Long-term Government Bond Real Returns 4-9

Intermediate-term Government Bond Real Returns 4-11

Real Riskless Rates of Return (U.S. T-Bill Real Returns) 4-12

Chapter 5: Annual Returns and Indexes 5-1

Annual and Monthly Returns 5-2

Calculation of Returns From Index Values 5-3

Calculation of Annual Income Returns 5-4

Index Values 5-5

Inflation-Adjusted Returns and Indexes 5-7

Chapter 6: Statistical Analysis of Returns 6-1

Calculating Arithmetic Mean Return 6-1

Calculating Geometric Mean Return 6-1

Geometric Mean Versus Arithmetic Mean 6-2

Calculating Standard Deviation 6-3

Limitations of Standard Deviation 6-4

Semivariance and Semistandard Deviation 6-5

Issues Regarding Semivariance 6-6

Volatility of the Markets 6-7

Changes in the Risk of Assets Over Time 6-9

Correlation Coefficients: Serial and Cross-Correlations 6-13

Is Serial Correlation in the Derived Series Random? 6-16

Basic Series Summary Statistics 6-17

Inflation-Adjusted Series Summary Statistics 6-18

Rolling-Period Standard Deviations 6-18

Rolling-Period Correlations 6-20

The True Impact of Asset Allocation on Return 6-21

Chapter 7: Company Size and Return 7-1

Construction of the CRSP Size Decile Portfolios 7-2

Presentation of the Decile Data 7-5

Aspects of the Company Size Effect 7-12

The Size Effect: Empirical Evidence 7-12

Long-term Returns in Excess of Systematic Risk 7-15

Serial Correlation in Small-Cap Stock Returns 7-17

Seasonality 7-21

Chapter 8: Growth and Value Investing 8-1

Fama-French Growth and Value Series 8-1

Historical Returns of the Fama-French Series 8-3

Summary Statistics for the Fama-French Series 8-4

Presentation of Annual Fama-French Returns 8-5

Conclusion 8-5

Chapter 9: Liquidity Investing 9-1

What Is Liquidity? 9-1

Valuation as Present Value of Cash Flows 9-1

The Liquidity Premium 9-2

Liquidity and Stock Returns 9-3

Liquidity as an Investment Style 9-4

20 17 SBBI Yearbook xiii

Conclusion 9-7

What’s Next? 9-7

Chapter 10: Using Historical Data in Wealth Forecasting and Portfolio Optimization 10-1

Probabilistic Forecasts 10-1

Mean-Variance Optimization 10-4

Estimating Returns, Risks, and Correlations 10-5

Using Inputs to Form Other Portfolios 10-9

Enhancements to Mean-Variance Optimization 10-11

Markowitz 1.0 10-13

Markowitz 2.0 10-14

Approaches to Calculating the Equity Risk Premium 10-19

The Historical Equity Risk Premium 10-20

The Supply-Side Model 10-27

Chapter 11: Stock Market Returns From 1815–2016 11-1

1815–1925 Data Series Sources and Collection Methods 11-1

Price Index Estimation 11-3

146 Years of Stock Market Drawdowns 11-9

Reaching Back Beyond 1926 11-13

The Origin of Market Bubbles 11-13

Chapter 12: International Equity Investing 12-1

Construction of the International Indexes 12-1

Benefits of Investing Internationally 12-2

Risks Typically Associated With International Investment 12-8

International and Domestic Series Summary Data 12-14

Conclusion 12-16

Appendix A – Monthly and Annual Returns of Basic Series

Appendix B – Cumulative Wealth Indexes of Basic Series

Appendix C – Rates of Return for All Yearly Holding Periods 1926–2016