Australian shares: The best in the world over a century

Just a few months ago researchers at London Business School (LBS) set about working on an ambitious exercise: On the centenary of the outbreak of the First World War they wanted to find out which stock market has performed best since that time.

Moreover, they also examined which countries managed to recover fastest from the trauma of the ‘Great War’ and other traumas such as wartime or economic depression.

Though the focus was very much on the economies of Europe and North America, the answer was … Australia. To be precise, Australia tied for top place with South Africa, but it must be pointed out that our performance over the last decade was superior to South Africa.

All up Australia managed a powerful return on a ‘price only’ basis (i.e. share price appreciation without dividends being included). In fact, Australia managed a 6.9% is average annual real (after inflation) rise in shares values between 1914 and 2012. At first glance this does not sound especially impressive, but in reality a return of 6.9% above inflation, before taking into account the value of dividends, is a very strong return. As you can see from the chart below, Australia was also among the fastest markets to recover if you had been unlucky enough to invest at the worst times over the last century.

Indeed, Australia has consistently managed world-leading returns. Over the same period the US share market provided an average after inflation price return of 6.3% per annum, the UK 5.7% and New Zealand 5.3%. From a global perspective the figures also showed how deeply war – particularly losing a war – can negatively affect a market. The survey showed that Germany, so often put forward as a model for a strong economy, could only manage an average return per annum of just 3.3% over the same time.

Another way to look at the price-only returns is to view it as a bar graph, which I have created here.

But what would the picture look like if we include dividends? Unfortunately, the London Business School did not provide a parallel exercise including dividends. However, there is a recent study also by the London Business School  which does exactly that. Working this time in conjunction with Credit Suisse (the 1914-2014 study was done in conjunction with investment bankers O’Shaughnessy and Company), the study looked at accumulated returns over the slightly longer period of 1900-2013.

This is a period which includes world wars, the depression, various recessions, the cold war and share market crashes, including the 1987 crash. A $1 invested in the Australian share market in 1900 had turned into $3,332 by 2013, assuming that dividends were reinvested and after taking into account inflation. It is no surprise that the authors refer to Australia as the ‘Lucky Country’.

Over this period of time, this equates to a real return (after inflation) of 7.4% per annum including dividends but not allowing for franking. Interestingly, we tied exactly with South Africa again at this 7.4% accumulated returns figure, though of course on an after-tax basis the Australian investor would win overall thanks to the positive effects of franked dividends.

What does this mean for investors?

First of all, it means the Australian share market has shown itself to be remarkably strong and resilient on a per annum basis over a very long period of time. Of course, historic returns are not a reliable pointer to future returns but it does offer a counterbalance to the enthusiasm for overseas investing we are witnessing this year as overseas markets look much more promising. To read more on this issue see Kerr Neilson’s article in Eureka Report earlier this week.

It’s really worth looking again at the ‘price only’ returns between 1914 and 2014. There were some striking negative price movements on a per annum basis, such as Italy (-1.7%), France (-2.7%), Spain (-3.2%) and Japan (-3.3%).

The question is – how sure can we be that the superior investment returns in Australia will continue?

What if, in the next 40 or 50 years, Australian returns are some of the lagging returns? The answer would seem to suggest that some international exposure makes sense – as a way of diversifying away from the possible impact of a poor period of Australian returns. After all, this is a situation that has clearly happened in other share markets around the world, even over long periods of time.

Conclusion

Past returns have limited predictive power; however, it allows us to think about what has happened historically, and how we could have reacted to this. Looking at historical returns Australia has returned exceptionally well – there is every reason to believe it will continue to be one of the world’s best markets, but we may also be facing a period where our overseas counterparts are going to have their ‘good years’ and on that basis there is a continuing argument for overseas diversification.