return on stocks has been 6.9 percent per year. This is virtually identical
to the previous 125 years, which saw no overall inflation. This remark-
able stability is called the mean reversionof equity returns, which means
that returns can be very unstable in the short run but very stable in the
long run.
Mean reversion can also be seen by noting how the total real return
in stocks “cling” to the statistical trend line fitted through the 204 years
of stock market data in Figure 1-4. When the total real return on stocks
was substantially above the trend line, such as during the late 1960s and
1990s, the market was at risk for a correction, as forces of mean reversion
eventually worked to bring total returns down. Similarly, periods dur-
ing which the market fell below the trend line, such as during the early
1980s, pointed to promising future returns.
The long-term stability of stock returns is all the more surprising
when one reflects on the dramatic changes that have taken place in our
society during the last two centuries. The United States evolved from an
agricultural to an industrial economy and then to the postindustrial,
service- and technology-oriented economy it is today. The world shifted
from a gold-based standard to a paper money standard. And informa-
tion, which once took weeks to cross the country, can now be instanta-CHAPTER 1 Stock and Bond Returns Since 1802 13
TABLE 1–1
Annual Stock Market Returns, 1802 through December 2006