2016 Stocks, Bonds, Bills, and Inflation

®

(SBBI®) Yearbook Market Results Through December 31, 2015 Duff & Phelps In this document: Table of Contents

“Stocks, Bonds, Bills, and Inflation” and “SBBI” are registered trademarks of Morningstar, Inc. All rights reserved. Used with permission.

The definitive study of the historical returns of capital markets in the United States from 1926 to present – now available from Wiley. Morningstar, Inc. announced in February 2016 that it will no longer publish the Ibbotson® Stocks Bonds, Bills, and Inflation (SBBI) Yearbook.1 Starting with the 2016 edition, the Stocks Bonds, Bills, and Inflation (SBBI) Yearbook (“SBBI Yearbook”) is now produced by Duff & Phelps, and published by John Wiley & Sons (Hoboken, NJ). The 2016 SBBI Yearbook includes data through December 31, 2015. This book is updated annually.

What’s Inside The SBBI Yearbook includes total returns, index values, and statistical analyses of U.S. large company stocks, small company stocks, long-term corporate bonds, long-term government bonds, intermediate-term government bonds, U.S. Treasury bills, and inflation from January 1926 through December 2015 (monthly). The SBBI Yearbook includes also provides historical returns for the U.S. equity risk premium, the small stock premium, the default premium, and the horizon premium from 1926 through 2015. Note: Some Chapters and Sections Previously Reported Have Been Discontinued The 2016 SBBI Yearbook includes as much of the critical data and information reported in previous editions of the book as possible. Some chapters and sections within chapters presented in last year’s 2015 SBBI Yearbook are not included in the 2016 SBBI Yearbook. Note: To facilitate getting the 2016 book’s critical year-end data and information out to users as soon as possible, all purchasers who “pre-order” the 2016 SBBI Yearbook will be emailed a PDF document that includes key year-end SBBI data (through December 31, 2015) from the hardcover book. The hardcover 2016 book will follow, with a delivery data in late July/early August 2015. Next year’s 2017 SBBI Yearbook will be back on a “regular” schedule of shipping in March 2017. Draft Table of Contents In order to enable the Reader to quickly understand what is included (and what is not included) in this year’s 2016 SBBI Yearbook (as compared to previous editions), the table of contents presented herein is the table of contents from last year’s 2015 SBBI Yearbook. All topics with a red strikethrough in them were included in the 2015 book, but do not appear in the 2016 book (subject to change).                                                              1

The Ibbotson Stocks Bonds, Bills, and Inflation (SBBI) Classic Yearbook (as it was previously named when published by Morningstar from 2006 to 2015, and Ibbotson Associates in prior years) has been published for over 30 years. Starting with the 2016 SBBI Yearbook (this book), the word “Classic” has been removed from the name.

Table of Contents

Acknowledgements

vi

Introduction

1

References

6

Chapter 1 Highlights of the 2013 Markets and the Past Decade

13

Events of 2014

13

Economic Overview

13

U.S. News Stories

18

Global News Stories

22

2014 Currency Matrix

26

2014 Commodity Price Changes

26

Global Currencies

27

Commodities

27

Sector Highlights

27

Results of 2014 Capital Markets

32

A Graphic View of the Decade

33

The Decade in Perspective

33

Table of Market Results for 2005–2014

34

Morningstar Style Indexes

34

Chapter 2 The Long-Run Perspective

37

Stocks, Bonds, Bills, and Inflation: Historical Returns

37

Logarithmic Scale on the Index Graphs

38

Large-Cap Stocks

38

Small Company Stocks

38

Long-Term Corporate Bonds

38

Long-Term Government Bonds

39

Intermediate-Term Government Bonds

39

Treasury Bills

39

Inflation

39

Summary Statistics of Total Returns

39

Appreciation, Income, and Reinvestment Returns

40

Annual Total Returns

43

Rolling-Period Returns

43

Real Estate Investment Trusts

51

Equity REIT Index Construction Methodology

53

Diversification

54

Summary Statistics for Equity REITs and Basic Series

54

NOTE: In order to enable the Reader to quickly understand what is included (and what is not included) in this year’s 2016 SBBI Yearbook (as compared to previous editions), the table of contents presented herein is the table of contents from last year’s 2015 SBBI Yearbook. All topics with a red strikethrough in them were included in the 2015 book, but do not appear in the 2016 book (subject to change).

i

Chapter 2 The Long-Run Perspective (Continued)

Commodities Overview

55

Commodities as a Hedge Against Inflation

56

Chapter 3 Description of the Basic Series

57

Large-Cap Stocks

57

Small-Cap Stocks

57

Long-Term Corporate Bonds

58

Long-Term Government Bonds

59

Intermediate-Term Government Bonds

60

U.S. Treasury Bills

61

Inflation

63

Bond Capital Appreciation Despite Rising Yields

63

Chapter 4 Description of the Derived Series

67

Derived Series Calculated Using Geometric Differences

67

Definitions of the Derived Series

67

Equity Risk Premium

68

Small-Stock Premium

68

Bond Default Premium

68

Bond Horizon Premium

68

Large-Cap Stock Real Returns

69

Small-Cap Stock Real Returns

70

Long-Term Corporate Bond Real Returns

70

Long-Term Government Bond Real Returns

71

Intermediate-Term Government Bond Real Returns

71

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

71

Chapter 5 Annual Returns and Indexes

75

Annual and Monthly Returns

75

Calculation of Returns From Index Values

76

Calculation of Annual Income Returns

76

Index Values

77

Using Index Values for Performance Measurement

77

Computing Returns for Non-Calendar Periods

77

Chapter 6 Statistical Analysis of Returns

83

Calculating Arithmetic Mean Return

83

Calculating Geometric Mean Return

83

Geometric Mean Versus Arithmetic Mean

83

NOTE: In order to enable the Reader to quickly understand what is included (and what is not included) in this year’s 2016 SBBI Yearbook (as compared to previous editions), the table of contents presented herein is the table of contents from last year’s 2015 SBBI Yearbook. All topics with a red strikethrough in them were included in the 2015 book, but do not appear in the 2016 book (subject to change).

ii

Chapter 6 Statistical Analysis of Returns (Continued)

Calculating Standard Deviation

84

Limitations of Standard Deviation

85

Semivariance and Semistandard Deviation

85

Issues Regarding Semivariance

85

Volatility of the Markets

86

Changes in the Risk of Assets Over Time

86

Correlation Coefficients: Serial and Cross-Correlations

90

Is Serial Correlation in the Derived Series Random?

91

Basic and Inflation-Adjusted Series Summary Data

91

Rolling-Period Standard Deviations

92

Rolling-Period Correlations

93

The True Impact of Asset Allocation on Returns

93

Chapter 7 Company Size and Return

99

Construction of the Decile Portfolios

99

Aspects of the Company Size Effect

99

Presentation of the Decile Data

100

Size of the Deciles

107

Long-Term Returns in Excess of Systematic Risk

108

Serial Correlation in Small-Cap Stock Returns

109

Seasonality

111

Small-Cap Returns are Unpredictable

112

Chapter 8 Growth and Value Investing

115

Different Ways of Measuring Growth and Value

115

Morningstar Growth and Value Series

115

The Morningstar Style Box

116

The Morningstar Market Barometer

116

Fama-French Growth and Value Series

117

Historical Returns of the Fama-French Series

119

Summary Statistics of the Fama-French Series

119

Presentation of Annual Fama-French Returns

120

Conclusion

120

NOTE: In order to enable the Reader to quickly understand what is included (and what is not included) in this year’s 2016 SBBI Yearbook (as compared to previous editions), the table of contents presented herein is the table of contents from last year’s 2015 SBBI Yearbook. All topics with a red strikethrough in them were included in the 2015 book, but do not appear in the 2016 book (subject to change).

iii

Chapter 9 Liquidity Investing

123

What is Liquidity?

123

Valuation as Present Value of Cash Flows

123

The Liquidity Premium

123

Liquidity and Stock Returns

124

Liquidity as an Investment Style

124

The Liquidity Style of Mutual Funds

126

International Liquidity Premiums

127

Liquidity or Popularity?

127

Conclusion

127

Chapter 10 Alternative Investments

129

The Birth of Liquid Alternatives

130

Alternative Investments, Deconstructed

130

Historical Returns and Risk Exposures of Alternatives

131

Morningstar Risk-Adjusted Returns

133

Incorporating Alternative Investments in a Portfolio

135

Chapter 11 Using Historical Data in Forecasting and Optimization

139

Probabilistic Forecasts

139

Mean-Variance Optimization

140

Estimating Returns, Risks, and Correlations

141

Generating Probabilistic Forecasts

142

Constructing Efficient Portfolios

144

Using Inputs to Form Other Portfolios

144

Enhancements to Mean-Variance Optimization

145

Markowitz 1.0

147

Markowitz 2.0

147

Approaches to Calculating the Equity Risk Premium

151

The Historical Equity Risk Premium

151

The Supply-Side Model

155

Long-Term Market Predictions

158

Chapter 12 Wealth Forecasting With Monte Carlo Simulation

159

Why Use Monte Carlo Simulation?

159

Types of Monte Carlo Simulation

159

Wealth Forecasting

160

Steps in Monte Carlo Simulation

161

Case Study: Establishing Returns and Wealth Values

161

NOTE: In order to enable the Reader to quickly understand what is included (and what is not included) in this year’s 2016 SBBI Yearbook (as compared to previous editions), the table of contents presented herein is the table of contents from last year’s 2015 SBBI Yearbook. All topics with a red strikethrough in them were included in the 2015 book, but do not appear in the 2016 book (subject to change).

iv

Chapter 12 Wealth Forecasting With Monte Carlo Simulation (Continued)

Case Study: Asset-Class Forecasts

162

Case Study: Stock and Bond Portfolio Forecasts

163

Case Study: Savings Rate Guidelines for Individuals

164

Limitations of Monte Carlo Simulation

165

Conclusion

166

Chapter 13 Stock Market Returns from 1815 to 2014

167

1815-1925 Data Series Sources and Collection Methods

167

Price Index Estimation

168

A Look at the Historical Results

168

144 Years of Stock Market Drawdowns

170

Reaching Back Beyond 1926

173

The Origin of Market Bubbles

173

Chapter 14 International Equity Investing

177

Construction of the International Indexes

177

Benefits of Investing Internationally

177

Risk Associated With International Investing

180

International and Domestic Series Summary Data

183

Conclusion

184

Chapter 15 Lifecycle Investing

185

Challenges in Lifecycle Investing

185

Evaluating Lifecycle Investing Methodologies

185

Ibbotson’s Lifetime Asset Allocation Methodology

187

Appendices

Appendix A: Monthly and Annual Returns of Basic Series (Jan. 1926 to Dec. 2014) 195 Appendix B: Cumulative Wealth Indexes of Basic Series (Dec. 1925 to Dec. 2014) 231 Appendix C: Rates of Return for all Yearly Holding Periods (1926–2014)

255

Glossary

301

Index

311

Investment Tools and Resources

322

NOTE: In order to enable the Reader to quickly understand what is included (and what is not included) in this year’s 2016 SBBI Yearbook (as compared to previous editions), the table of contents presented herein is the table of contents from last year’s 2015 SBBI Yearbook. All topics with a red strikethrough in them were included in the 2015 book, but do not appear in the 2016 book (subject to change).

v