01. Over a century of historical data backtesting

In the future, will the stock market or the real estate market have more investment value?

In the future, will conservative financial management methods such as bonds and bank wealth management be able to outpace inflation?

Last week, in the article analyzing "Why the yield of Yu'e Bao fell below 1.5%," I suggested that everyone should learn about some mainstream financial tools. As a result, many people asked me, what is the best way to manage finances?

The answer to this question varies from person to person. However, most people's judgments are generally summarized from past investment experiences. But the Chinese stock market is only 30 years old, the real estate market has been fully opened for only 20 years, funds have been in the public eye for 20 years, and money market funds, financial products, and various "treasures" have a history of no more than 10 years...

But the economy is cyclical, and it takes 50 to 60 years to complete a full Kondratiev cycle. In the nearly twenty years that Chinese people have been aware of financial management, the economy has been transitioning from high-speed growth to the "new economic normal" of an L-shaped pattern, and not a single cycle has been completed. The experience gained from this is inevitably one-sided.

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Is there more comprehensive and longer foreign data available?

Recently, I read a macroeconomic research report from Haitong Securities, which mainly used data from the JST Macrohistory Database to analyze the changes in global major asset prices over the past two hundred years. The database collects historical data on the economy, finance, and asset prices of major countries from 1870 to 2016, which is very valuable for reference.This report categorizes assets into two types: one is stable income assets such as bonds, gold, and rent (the rental return part of real estate), and the other is risky assets such as stocks and real estate (the asset appreciation part of real estate).

The core conclusion of the report is that the returns of various assets over the past two hundred years have shown completely different performances before and after the 1930s. Before the 1930s, stable income assets like bonds, gold, and rent (the rental return part of real estate) outperformed risky assets such as stocks and real estate, while from the 1930s to the present, risky assets have outperformed stable assets.

Why is that the case? Which stage will China be more similar to in the future?

02. Asset Performance in the Gold Standard Era

Since the 1930s serve as a dividing line, the first question is, what significant change occurred for asset prices in the 1930s?

The answer is: the gold standard was replaced by "fiat money."

The so-called "gold standard" refers to a system where each unit of currency has a legally defined gold content, and currency can be freely exchanged for gold, known as "unlimited legal tender."

It is estimated that readers have not seen the era of the "gold standard," where anyone could exchange currency for gold according to the legal gold content. This means that for a country to issue currency, it must have a certain proportion of gold as a reserve, otherwise, it is easy to face a lack of payment capacity, leading to a loss of confidence among currency holders and accelerating the outflow of gold.

Thanks to the constraint of gold reserves, countries issued currency "according to their means." From 1870 to 1931, the average annual real economic growth rate in the UK was 1.4%, while the circulation of money grew at 2.1%; the average annual real economic growth rate in the US was 3%, with the circulation of money growing at 3.9%, and the average annual increase in gold reserves was 5.4%. The economic growth and currency issuance of both countries were limited by the production of gold.

The result of not over-issuing currency was no inflation. During this period, the average annual inflation rate in the UK was 0.56%. The US was even lower, at 0.04%.No inflation sounds like paradise, but for those holding different assets, the feeling is entirely different.

Firstly, gold is definitely not going up — after all, it's based on the gold standard.

Secondly, most commodities don't rise much, including housing prices. During this period, the average annual increase in UK housing prices is 1.6%, slightly higher than the economic growth rate of 1.4%, while the average annual increase in US housing prices is 1.2%, far below the economic growth rate of 3%.

Thirdly, in an era of low inflation, the best assets are debt instruments, mainly bonds. The average annual interest income from holding UK short-term and long-term government bonds is 3.1% and 3.15%, respectively, while for US short-term and long-term government bonds, it is 5.3% and 4.75%, respectively.

Although housing prices do not rise, rental income is quite good. The average annual return on UK rental property is 3.6%, and in the US, it is 5.5%. Rent is equivalent to the "interest" generated by treating a house as money lent to others, and it also belongs to debt instruments.

Why do debt instruments offer the highest returns? It is precisely because there is no inflation.

Suppose the inflation rate is 3%, and you deposit 10,000 dollars in a bank at a fixed interest rate of 3%. After one year, the bank pays you back 10,300 dollars, including principal and interest (excluding interest tax). Due to the 3% devaluation of the currency, the actual purchasing power of this 10,300 dollars is equivalent to 10,000 dollars a year ago, meaning the bank has used your money for free for a year.

It is evident that inflation is unfavorable to creditors, so zero inflation is unfavorable to debtors, and in economic activities, the largest debtor is the corporation.

Thus, in the end, the worst-performing asset is stocks. The average annual increase in the UK stock index and the US S&P 500 index is 1.4%, which is similar to the economic growth rate and housing price increase, and it cannot be compared with the current booming NASDAQ.

However, stock indices do not include annual dividends, and the average annual dividend yield of the UK and US stock markets during the same period is 3.9% and 5.4%, respectively, which is similar to rental income.Considering the risks associated with equity investments, this return is somewhat disappointing.

Thus, in summary, under the gold standard, since governments of various countries could not overissue currency, leading to long-term zero inflation, the best investment options were bonds, followed by real estate (due to high rents), with stocks being relatively poor, and commodities such as gold being the worst.

All of this changed dramatically with the advent of the credit money era in the 1930s.

03. Asset Performance in the Credit Money Era

The US dollar and British pound before the 1930s, and after, are essentially two different things.

In the gold standard era, the essence of money was gold; in the credit money era, the essence of money is national credit.

The production of gold is limited, so money is limited, and national credit... isn't that just government debt? Of course, it can be unlimited.

So you see, governments do not perceive themselves as overissuing money, but due to various needs such as national defense, technology, medical education, social welfare, social governance, infrastructure, epidemic prevention, and disaster relief, they have to expand the issuance of government debt year by year. Once the additional government debt enters the circulation field, the central bank needs to provide additional money. In this way, with the "two monks carrying water to drink" scenario, the Ministry of Finance and the central bank work together, and all countries are overissuing money without realizing it.

The most direct result of overissuing money is inflation. From 1932 to 2019, the average annual inflation rates in the UK and the US were 5% and 3.53%, respectively, whereas in the gold standard era, they were only 0.6% and 0.04%.

Although the collapse of the gold standard gave the green light to government overissuance of money, the loosening of the money supply also brought vitality to the economy. Therefore, against the backdrop of inflation, the returns on various assets have undergone fundamental changes:Unshackled from the constraints of the gold standard, gold prices have also taken flight. In the era of fiat money, the average annual increase of gold against the British pound is 6.5%, and against the US dollar, it is 4.9%. However, the demand for gold has also declined, overall only slightly outpacing inflation.

As mentioned earlier, deflation is beneficial to creditors, so inflation is detrimental to them. The safest debt assets that yielded the best returns in the gold standard era have now become the worst performers. From 1932 to 2019, the average annual interest income of short-term and long-term British government bonds was 4.7% and 5.6% (inflation rate of 5%), while in the United States, it was 3.5% and 5.6% (inflation rate of 3.53%), with short-term bonds losing to inflation and long-term bonds performing similarly to gold.

Being unfavorable to creditors means being favorable to debtors. Besides nations, the biggest borrowers are companies, which is why the performance of stocks has become the top performer.

During the same period, the average return rate of the stock market (stock index increase + dividend yield) for the UK and the US (S&P 500 Index) was as high as 10.7% and 10.5%, respectively.

So, what's the second place? Real estate.

During the same period, the average annual increase in house prices in the UK and the US was 6.4% and 4.3%, respectively, which may not seem high, but when added to the rental yield of 4% and 5.2%, the average annual return rate reaches 10.4% and 9.5%.

Moreover, most houses are mortgaged, which is equivalent to using leverage. Of course, considering the various taxes and fees associated with owning real estate in Europe and America, even if they balance out, they can only be secondary to stock returns.

A side note must be made here: many people do not calculate the rental yield when calculating the return on investment for owner-occupied properties, which is incorrect. If you don't buy a house, you have to rent, increasing your living costs. Therefore, even for owner-occupied homes, the rental yield should be included when assessing investment returns.

(The above data refers to the research report "How to Beat the Printing Press—Observations from a Century of Monetary History! (Haitong Macro Jiang Chao)" published by Haitong Securities)

Having seen so much foreign data, I can now share my long-term advice on financial management for the future.04. The Different Performances of Major Asset Classes in Various Periods

Although there is a wide array of financial products on the market, most of them are underpinned by three types of assets:

1. Steady-yield debt assets, such as bonds and rents (the rental component of real estate);

2. Risk assets, such as stocks and real estate (the appreciation part of real estate);

3. Commodity assets like gold and oil.

The performance of these three types of assets varies across different periods.

1. The worse the economy, the less suitable it is to hold cash and steady assets.

When the economy is not doing well, Chinese people tend to be conservative with their savings. However, it is precisely because of the economic downturn that the country engages in large-scale monetary easing. The result of such easing is a double-edged sword: on one hand, currency devaluation occurs, and on the other hand, asset prices rise.

Therefore, after the holidays, the stock market begins to soar. Even with the severe pandemic and riots in the United States, the stock market still reaches new highs, all due to the massive influx of liquidity.

Conversely, short-term debt instruments like money market funds (such as Yu'e Bao) and bonds are seeing a decline in returns, and some bank-issued financial products have even incurred losses.So many economists do not advocate using monetary easing to counteract economic recessions because easing benefits the wealthy with high leverage, and government social security only helps the poorest of the poor, while currency devaluation is equivalent to "taxing" the vast middle and lower-middle classes.

At this time, the best assets are actually risky ones like stocks and real estate. This might seem counterintuitive—how can stocks do well when the economy is not doing well?

However, in reality, the "80/20 divide" within the same industry intensifies, with most industry leaders taking the opportunity to expand their market share.

So to be precise: during economic recessions, the best assets are stocks of leading companies (including stock funds invested in leading companies) and real estate in first and second-tier cities.

What about during economic booms, which assets are the best?

I'm sorry to say, it's still stocks and real estate.

2. In the long run, stocks are the best investment channel, followed by real estate.

During economic prosperity, corporate profits improve, people's incomes rise, and demand for real estate also increases. Although at this time, the returns on debt assets also rise, it is still stocks and real estate that yield higher returns.

There is only one period when stocks and real estate briefly lag in returns, which is during an economic overheating when the state withdraws excess liquidity (such as in 2011-2012), often compounded by rising raw material prices, increased operating costs for businesses, and declining efficiency.

So at this time, the best-performing investment options are industrial raw materials and commodities, but most of these assets are leveraged financial derivatives, which ordinary people lack the professional knowledge to invest in (such as the Bank of China's "Crude Oil Treasure").There is an idiom called "water spilled cannot be retrieved," and the same can be said for currency. It is easy to release it into circulation, but when it comes to reeling it back in, economic entities and residents will experience various forms of pain, making it difficult for the government to take action. Consider Federal Reserve Chairman Powell's reluctance to lower interest rates, which led to relentless criticism from Trump; or recall our "deleveraging" in 2018, where a string of corporate debt chains broke, metaphorically described as "surgery without anesthesia."

Therefore, whether domestically or internationally, loose monetary policy will become the norm, and the contraction of money supply is only a temporary phase. This is precisely why, in the era of credit currency, stocks and real estate have long-term returns that outpace others.

In the long run, stocks are the best investment channel. The securities market has a mechanism for survival of the fittest, with the NASDAQ index increasing sixfold over ten years, yet 70% of stocks have fallen, and only 7% of companies have outperformed the index. Since 2017, the A-share market has also been dominated by blue-chip stocks, and the ongoing "delisting mechanism for junk stocks" will inevitably concentrate capital more on leading stocks, further "Americanizing" the A-share market.

Thus, for the average person, stock investing is, after all, too specialized. In the future, index funds, actively managed stock funds, and private equity funds that focus on growth stocks and blue-chip stocks will be the mainstream.

The return on real estate comes next. After all, it is still a consumer good, and with the future decline in population, the overall demand for housing will decrease, limiting investment opportunities to first- and second-tier cities. (A reminder again, real estate investment returns include rental income.)

Wealth management tools such as bank wealth management, money market funds, and bond funds are all based on various types of debt as their underlying assets, and they cannot change the long-term trend of low interest rates, only offering short-term high returns during localized "money shortages" caused by monetary contraction. Investing entirely in debt-based assets over the long term is difficult to outpace inflation.

(Interest declaration: As a professional investor, I may have biases that reflect my own interests, so everyone should still decide their financial direction based on their own abilities and understanding.)