Sunday, 27 January 2013

The Bulls Eye View ( Housing & Stocks )

100-Year Housing Price Index History

This post illustrates the increase in U.S. housing prices since 1900. However, considering price alone is a misleading way to evaluate the performance of residential real estate. Investors who fail to do additional analysis are likely to overestimate the attractiveness of housing as an investment.

100-Year Housing Price Index Graph

100-year history of U.S. real estate/housing prices
U.S. Housing Price Index (1900 - 2012)

The above chart (click to expand) shows a 100-year history of residential real estate prices in the U.S. The graph is based on Robert Shiller's historical housing index, which I have summarized to yearly data. As he readily admits, his data is
imperfect. However, it's the best source of long-term housing data that I am aware of.

Note that he has attempted to adjust for the significant increase in the size and quality of homes over the past 100 years. In effect, he has attempted to estimate the price of houses of constant size and quality; otherwise, we'd be comparing apples and oranges.

In addition, note that this is an index, not actual prices. The index values are relative to the year 2000, which has been assigned an index value of 100. Using the index values, we can convert a price from any year to any other year. For example, we can calculate that a house that cost $100,000 in 2000 would have cost a little over $10,000 in 1950, and approximately $125,000 in 2012.


100 Years of Stock Market History (log graph thru 2012)

In times of turmoil, such as a financial crisis, I look for one of those big charts with an arrow that says, “You are here.” It is in that spirit that I offer the following long-term log graph summarizing over 100 years of DJIA (Dow Jones Industrial Average) performance / history. I will defer most of my analysis until later, and for this post rely mainly on what one of my statistics professors used to call “interocular trauma.”

Dow Jones 100-Year Stock Market History Chart

stock market history chart year-end 2012 (Dow Index closing prices since 1900 log graph)
Dow Index 100-Year History Chart

Stock Market Performance Since 1900 Has Alternated Between Excitement and Disinterest

Above is a graph of stock market (Dow Jones) performance since 1900 (click on image to enlarge it). It shows year-end closing prices through 2012. (See Yearly Returns for a bar chart of the returns each year.) While some describe this history as
a steady long-term upward trend, to me it appears to show alternating periods of excitement and disinterest. For example, the periods from ’33 to ’65, and from ’82 to ’99 were periods of excitement. From ’33 to ’65 the average return was about 7% per year, plus dividends -- for a total of approximately 10%. From ’82 to ’99 the average return was about 15% per year, again plus dividends – though dividends in recent decades were significantly smaller than they were in earlier decades.

The Long Flat Periods

On the other hand, the 1905 close of 96 was not permanently eclipsed until 28 years later -- 1933; the 1965 close of 969 was not permanently eclipsed until 17 years later -- 1982. I use the word “disinterest” to characterize these long flat periods. (Note: This is a log graph. If you are not familiar with them, see About Stock Market Log Graphs.)

In the long term, you would expect that stock market performance should approximate the performance of the underlying businesses. Therefore, an obvious interpretation of the chart is that the stock market periodically gets ahead of itself by increasing faster than the underlying businesses, and then has to wait for the “real” value of the underlying businesses to catch up during the long, flat periods of “disinterest.” If that is the case, we could well be in another one of those periods of “disinterest” -- though when you’re actually in one of those periods, you may find other words more descriptive….

Note: The above chart and discussion ignores the impact of inflation. To see the long flat periods adjusted for inflation, see 100 Years of Inflation-Adjusted Stock Market History. Warning: not for the faint of heart!

The Monthly Update, & Adding the 25-Year Moving Average as a Support Level

The December 2012 Stock Market Performance post includes a recap of the most recent month and year-to-date, plus comparisons to important milestones such as all-time highs and crash lows. In addition, it includes the most recent projection of 10-year market returns. The 25-year moving average can be a useful addition to the above graph. As discussed in Dow 25-Year Moving Average History, the market has very rarely fallen below its 25-year moving average. That is, historically this moving average has been a reliable support level during secular bear markets. That graph is updated infrequently, as appropriate.


Average Stock Market (Dow) Returns

The average return starts at 11.8% for the one-year returns, drops rather sharply to 10.6% for the two-year periods, and then declines gradually to 9.9% for the 100-year periods. Historically, the longer the holding period the less likely it was to end with the investor losing money, and, the closer the return has been to the long-term average of around 10%. In fact, the maximum, minimum and average returns are all converging toward the long-term average return.

Based on this history, it appears that readers who are planning to buy and hold for 100 years or more are "assured" of performance very close to the long-term average return of around 10% per year -- regardless of when they buy. For those of us holding for shorter periods, there is a significant difference between the minimum and maximum annual rates of return that gets smaller the longer we hold. 

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