300 years of the Equity-Risk Premium

The equity-risk premium (ERP) is one of the most important variables in finance. In theory, riskier stocks should provide a higher return than risk-free government bonds, but unfortunately, this is not always true. Different factors drive return to stocks and bonds.  Bond returns are driven by inflation; stock returns are driven by corporate cash flows.  The two will vary independently of one another.  It is not risk alone that determines the equity-risk premium. Any review of the equity-risk premium shows that its value is not constant, and even if you average returns over 10 or 20 years, the premium can vary dramatically. Using GFD’s data, analysis of the evolution of the equity-risk premium over the past 300 years is possible. .  Information on the Equity Risk Premium in 20 countries can be found in the GFD Guide to Global Stock Markets.

The US Takes a Wild Ride on the ERP


Figure 1.  10-year Returns to Stocks and Bonds in the United States, 1792 to 2023

              The 10-year return to stocks and bonds in the United States is illustrated in Figure 1.  The black line represents the return to stocks, and the green line, the return to bonds.  The 10-year return to stocks between from 2012 to 2022 was 12.45%.  An investment in bonds returned 0.20% during the same time period and the equity premium would have been 12.25%.

              As Figure 1 illustrates, the return to stocks is more volatile than the return to bonds.  The 10-year return to stocks fell from 19.87% in 1999 to -2.34% in 2009.  During that same period the return to government bonds fell from 7.98% to 6.40%. The return to stocks greatly influences the equity-risk premium as can be seen by the volatile returns in Figure 1 relative to the slower change in the return to bonds.

              There is a strong correlation between the current yield on government bonds and the total return over the subsequent 10 years.  Few people realize that you can use the yield to predict the future return on government bonds. The market would predict that investors will receive about a 4% return on government bonds between 2023 and 2033.

The black line shows the yield in 2022 and the green line shows the return to bonds between 2012 and 2022.  As bond yields declined between 1981 and 2019, fixed-income investors received capital gains that largely offset the decline in bond yields.  Although yields fluctuate up and down from year to year, bond yields can trend up or down for decades. Bond yields generally declined from 1920 until 1945, rose until 1981 and declined until 2021. They have increased from a low of 0.5% in 2020 to over 4% now.


Figure 2.  United States 10-year Government Bond Yield and Returns, 1920 to 2023

Now Trending 100 Years

              Unfortunately, there is no similar indicator to predict future returns to stocks. Dividend yields don’t change very much, but the price of stocks do.  Nevertheless, using a 10-year average return shows that the return to stocks does trend over time; however, the trends are shorter than the trends in risk-free bonds.  During the past 100 years, 10-year peaks in the return to stocks occurred in 1928, 1958 and 1999.  Peaks in the return to bonds occurred in 1930 and 1991.  10-year bottoms occurred in stocks in 1938, 1974 and 2009 and in bonds in 1959 and 2018.  There have basically been three market cycles in stocks over the past 100 years and two in bonds. Currently, the return to stocks is in an uptrend that began in 2009 while bonds are trading in a downtrend that began in 1991. Both of these trends should reverse soon, but the 10-year ERP will probably remain positive for the rest of the decade because it will take time for these two trends to once again converge.