Christopher Joye and I have been disagreeing lately in the AFR about whether Australian Super funds are too heavily invested in stocks. Chris is the founder of Rismark, a successful residential real estate data company and a director of Mark Bouris’s financial advisory firm Yellow Brick Road. Chris is a good guy, and I don’t want to embarrass him too much in front of all of the Australian finance community, so I will continue the discussion here on Core Economics instead of the AFR.
Chris makes a big deal about the total return on Treasury bonds in Australia being higher than the total return on Australian stocks over the 30 years since 1982. My response to that is yes, but why don’t we go back to 1900? Over the 112 years since Federation Australian stocks have outperformed Australian Treasury bonds by 5.80%, repeat 5.80%, per year. And that is 5.80% in geometric means not arithmetic means, which makes the difference all the more profound. Moreover, I point out that Chris’s choice of 1982 as the starting point for the comparison of bond and stock returns in Australia is not just arbitrary — it is crudest form of data mining. 1982 is chosen because, as everyone knows, that is the start of the “great bond rally”. Treasury yields peaked in Australia in 1982 at 16.4% and have fallen by nearly 13 percent since then (they are now about 3.5%). That fall of 13% cannot be repeated over the next 30 years unless we are to suffer a catastrophic generation of disinflation. Therefore, bond returns cannot be as high over the next 30 years as they were over the past 30 years. I apologise for having to point out the obvious.
Anyway, so far so good. But then Chris says no, 1982 is not an arbitrary choice. Rather, it is the year before which stock returns indices suffer from ‘survivorship bias’ and apparently that is well known. Let me quote Chris from the AFR. “The ‘losers’ tend to disappear from stock market indices. As a result, returns get biased up.” What? Bunkum and balderdash I say. How can that possibly be true? What is Chris talking about? Total return indices are ‘chain linked’. They just connect the daily returns on stock markets (with dividends reinvested) joined together over many years. Yes, stocks come and go from the index — so what?
Chris also seems to really believe that bond returns are higher than stock returns in the long run equilibrium. That is very odd. Stocks are by construction riskier than bonds — Treasury bonds are the risk free asset in the economy and corporate bonds are senior to stocks. So, Chris’s belief can only be true if aggregate risk aversion in the economy is negative. Imagine what other things would be true if aggregate risk aversion where negative.
Unfortunately, Chris does not seem to have much regard for economists, which is why Core Economics is a good place to excoriate his views. Here is a quote from an article of his in the AFR on the question of super fund investments in which Chris discusses the equity premium puzzle. “Reviewing the literature on the puzzle reveals a common asymmetry. Academics are evaluating apples with oranges. Specifically, they contrast the yield-to-maturity interest rates on government bonds with the holding period “total returns” (ie, dividends plus capital changes) supplied by shares. They ignore changes in the capital values of bonds, which can be a vital part of the asset’s total return.” He must think that academic economists are fools, even those of the highest calibre such as Mehra and Prescott who first framed the equity premium puzzle.