Understanding the historical context of financial markets is crucial for investment professionals seeking to make informed decisions in today’s complex landscape. This exploration of historical data stretching back more than 230 years reveals how markets have evolved and how continuity and change shape investment opportunities.
From the dominance of railroads in the 19th century to the emergence of multi-sector indexes, this historical lens offers invaluable insights for analysts working with older data. By integrating this knowledge into modern strategies, professionals can better navigate market cycles, understand long-term trends, and refine their investment approaches.
This post – part II of a three-part series – is intended for investment analysts who plan to work with older data and need to know more about the historical context. My first post dated and defined the fully modern era and then traced the roots of the modern era to the 1920s. This post pushes the history back further. The audience again is the analyst who plans to work with this older data and needs to know more about the historical context.
Continuity and Change
Only a few elements of today’s financial markets can be shown to be continually present from the 1790s:
The joint stock limited liability company — as a legal structure with reasonable liquidity for buying and selling — has been available to US investors from that time. And a stockholder has always been a remainder man, junior in the capital structure, and last in line to be paid in the event of firm dissolution.
A government bond market, sometimes with only sub-sovereign issues (state and city bonds) has also been in continuous operation since the 1790s.
In short, a US stock and bond return series can be constructed that extends more than 230 years back in time. I do have to acknowledge that despite decades of effort, these data are still not as good as post-1925 data. Nonetheless, I believe the record is good enough for many purposes.
To trace how the stock and bond markets of the 1790s evolved toward their modern form, it will again be desirable to work backward.
From the Civil War to World War I
If you read enough historical analyses produced on Wall Street, you will encounter such phrases as “since 1871 stocks have …” or “this was the best [worst] return seen over the past 150 years.” Admittedly, these phrases appear less often than you hear “since 1926,” but you will find them.
What happened in 1871? Nothing. Like 1926, it is once again an arbitrary date set by the needs and preferences of later data compilers and not any real historical juncture.
The true point of beginning for the early modern period was the end of the Civil War. In addition to being a notable hinge point in history, from 1865 we have in hand the equivalent of the Wall Street Journal and a Moody’s manual, with contemporaneous publication of stock prices, share counts, dividends, and earnings, and information on bond prices, coupons, issue amounts, maturities and terms. That source, the Commercial & Financial Chronicle, has been made available online by the St. Louis branch of the Federal Reserve.
Stocks
Statements anchored in 1871 typically use data from Robert Shiller’s web site. Shiller reproduces the price, dividend, and earnings data compiled by Alfred Cowles in the 1930s. Cowles had data from 1917 forward already compiled by Standard Statistics, the predecessor of Standard & Poor’s. His unique contribution was to push the stock record back by five decades.
What did Cowles find, there at the beginning of his data in 1871?
The New York Stock Exchange had already achieved national predominance. Cowles felt he could safely ignore stocks trading on regional exchanges or over the counter (in those days described as trading “on the curb”). He found 80% or more of market cap on the NYSE—about the same proportion of total US market cap as represented by the S&P 500 in our day.
There was one key difference, however. A single sector dominated the NYSE of this era: railroads, which accounted for about 90% of NYSE cap at the outset, and still almost 75% by 1900.
Only in the 1880s did gas and electric utilities begin to appear in Cowles’ record, and only after 1890 were there industrials — one reason why the Dow Jones Industrial Average dates only to 1896.
In fact, that’s why Cowles postponed his start date to 1871. He was committed to constructing a multi-sector index, as had become possible for Standard Statistics from 1917. Only by 1871 could he scrounge a few stocks which he could deem “utilities,” which in his case included canals and “industrials,” which meant coal mines and shipping services.
The analyst today should not be fooled: for all intents and purposes, the Shiller-Cowles stock index is a single sector index of railroads until after 1900, when sectors did begin to proliferate, approaching modern levels of diversity by World War I.
Of course, business enterprises from diverse sectors long predate 1900, but these businesses either did not have traded stock or did not trade on the NYSE.
In fact, banks and financial services firms had ceased to trade on the NYSE from even before the Civil War. This sector is absent from Cowles’ indexes throughout.
The final point of difference concerns the number of stocks available: just under 50 stocks were in Cowles’ index at the outset. There were not 100 stocks until 1899 and a count of 200 was not achieved until World War I.
Nonetheless, setting aside counts and sector concentration, the differences between the US stock market in the 1870s, relative to the market in the 1920s, are not substantially greater than the differences that separate the 1920s from 1970s. There is meaningful continuity.
With these caveats in mind, the analyst can append the Cowles-Shiller data to post-1925 data to construct a monthly series of stock returns that spans over 150 years. Price return can be distinguished from total return, dividend yields and price earnings ratios can be calculated, returns are value-weighted, and Shiller provides an inflation measure for calculating real returns.
Bonds
It’s complicated.
You cannot construct a 150-year continuous record of Treasury returns parallel to what can be done for stocks. Or rather, you can do that—there are Treasuries with a trading record throughout the period between the Civil War and World War I—but the account will be false in multiple respects, and likely to be misinterpreted.
And you should not place much faith in any 150-year chart of bond returns that you encounter, unless the report contains copious footnotes.
That caution holds also for historical accounts of the 60/40 blend and other balanced stock/bond mixes, reports which proliferated after the annus horribilis of 2022. The bond component in any balanced portfolio analysis that extends back beyond World War I is suspect.*
*If it consists exclusively of long corporate bonds, the record is good back to the Civil War. It is the government bond record that is problematic before World War I.
In fact, I cannot fit a description of the 19th century US bond market into this series of posts. I’ll point you to my recent paper, “Introducing a New Monthly Series of U.S. Government Bond Returns 1793 -2023,” which gives a bond market history from 1793 to 1925, and a thorough discussion of what kind of government bond series could be constructed.
I’ll reiterate and emphasize what did NOT exist in the bond market before World War I.
There was no Treasury bill and no risk-free rate. There is a record for short-term paper back to about 1830, but it was not issued by the Treasury and certainly is not a proxy for a risk-free instrument. Thus, “bills” in Jeremy Siegel’s historical record represent rates on paper issued by “department and men’s furnishing stores, jobbers of dry goods, hardware, shoes, groceries, floor coverings, etc., the manufacturers of cotton, silk and woolen goods.” (Frederick Macaulay, pp. A340-341).
There was nothing but long Treasury bonds, issued with maturities of 20 to 30 years, with the supply steadily shrinking after about 1877, as the government ran large surpluses.
By 1900, there was not much liquidity in the Treasury market, with individual bonds no longer trading even every month. Bonds got locked up in the Treasury to secure the circulation of national bank notes. See my paper for an explanation. Only after the Liberty bonds were floated beginning in 1917 did the modern Treasury market dawn: a deep, liquid market of instruments guaranteed by the world hegemon, able to serve as the anchor for the fixed income space.
In conclusion, here are two rather more pointed assertions about the available bond record prior to World War I:
Do not accept Jeremy Siegel’s bond returns from 1871 to 1920.
Do not use Robert Shiller’s “GS-10” series for this period.
Both these return series have the same source: a yield series compiled by Sidney Homer in his 1963 book History of Interest Rates. Unbeknownst to Siegel or Shiller, and probably Homer as well, the source for that series is deeply problematic, to the point of being fictional, as further explained in my paper.
Don’t go there.
The next and concluding post in this series will look at US markets before the Civil War.
Sources
The Commercial and Financial Chronicle is at FRASER [https://fraser.stlouisfed.org/title/commercial-financial-chronicle-1339?browse=1860s]. Free, online, and searchable (within the limits of OCR).
The Shiller data is at [http://www.econ.yale.edu/~shiller/data.htm]. Monthly values are the average of the four or five weeks in a month, again constraining volatility.
Cowles’ book describing his data collection and index construction efforts is available online at [https://som.yale.edu/centers/international-center-for-finance/data/historical-financial-research-data/cowlesdata]
READ PART I
READ PART III
