How much should the stock market earn each year?

As one of the largest financial markets in the world, the stock market has always been the top choice for investors. So what should the average return of the stock market reach? How significant are the differences between different markets?

The Xun Yugen team at Haitong Securities released a research report on November 28 titled "What is the Reasonable Rate of Return for the Stock Market?" stating that global stock market returns are higher than other assets, with an annualized return of around 8-10%. Considering dividends, the return of the Chinese stock market is also relatively high, with the annualized return of different stock indices ranging from 6% to 10%. However, in the short term, the stock market is quite volatile, and if investors invest for the long term, they can expect to enjoy the effects of compound interest.

What factors determine stock market returns? The Xun Yugen team believes that stock market returns are directly related to fundamental conditions, and specifically, in different countries, they are positively correlated with GDP growth rates, mainly consisting of corporate profits and dividend payouts.

If one wants to participate in the stock market better, are there other options besides direct investment? The Xun Yugen team stated that compared to actively managed funds, both the US and A-share markets show a trend of passive index funds gradually dominating.

High Returns in the Chinese Stock Market, with Annualized Returns for All A Shares Ranging from 6% to 10%

The Xun Yugen team indicated that if the perspective is extended to 20 years or even 100 years, the nominal return of global stock markets is around 8-10%, with US stocks having the highest returns, averaging around 10%, and even performing better during certain periods. Considering dividends, the return of the Chinese stock market is also relatively high, with the nominal annualized return of different indices ranging from 6% to 10%, outperforming other asset classes:

From 2005 to 2023, the annualized return of the Wind All A Index (considering dividends) was 9.8%, ranking first among all asset classes; the annualized return of the CSI 300 Index (considering dividends) reached 8.6%, and the annualized return of the Shanghai Composite Index (considering dividends) was 6.1%; in terms of Hong Kong stocks, the annualized return of the Hang Seng Index from 1964 to 2023 was 10.1%.

The annualized increase in housing prices calculated by dividing the national new housing sales by the sales area was 7.3%, and if considering a rental annualized return of 2.2%, the annualized return of real estate was 9.5%; the annualized return of bonds measured by the China Bond Total Index was 4.3%; the annualized return of commodities represented by the CRB Spot Index was 3.0%.

However, from a short-term perspective, it can be found that the stock market exhibits higher volatility compared to other major asset classes. Compared to the more mature US market, the A-share and Hong Kong stock markets are more volatile, with significant differences in returns during bull and bear markets:

In the US stock market, from 1927 to 2023, the annualized increase of the S&P 500 Index was 6.0%, with an average annualized increase of 12.5% during bull markets and an average annualized decrease of -11.2% during bear markets

In terms of A-shares, from 1990 to 2023, the Chinese A-share market has shown greater volatility, with the Shanghai Composite Index having an annualized growth rate of 10.0%. During bull markets, the average annualized growth rate is 49.4%, while in bear markets, the average annualized decline is -20.7%. For Hong Kong stocks, from 1964 to 2023, the annualized growth rate of the Hang Seng Index is 9.1%, with an average annualized growth rate of 34.9% during bull markets and an average annualized decline of -23.0% during bear markets.

If one wants to combat volatility, a better approach is to rely on time and extend the investment duration to enjoy the effects of compound interest:

According to our calculations, the probability of obtaining positive returns from stocks generally increases with the length of the holding period at any month-end point. Within a 3-year holding period, the probability of positive returns for each index is not high, averaging around 65%.

However, if the holding period is extended to 5 years, the probability of positive returns for each index significantly increases to 80% or more. If held for 7 years, the probability of positive returns rises to over 85%. If the holding period approaches 10 years, the probability of positive returns for each index increases to over 90%.

Stock Market Returns Depend on Fundamentals

The Xun Yugen team believes that at the macro level, the returns on stock assets in various countries are closely related to the level of economic growth. The specific level of stock market returns is directly related to the fundamentals, and in different countries, it is positively correlated with GDP growth, mainly consisting of corporate profits and dividend payouts.

Firstly, the returns on stock assets in various countries are closely related to the level of economic growth. The faster the economic growth of a country, the higher its stock market returns:

For example, countries and regions with rapid economic growth, such as mainland China (since 1991), Taiwan (since 1967), and South Korea (since 1980), have annualized growth rates of their stock market indices of 10%, 10%, and 8%, respectively, which closely match their nominal GDP annualized growth rates of 9%, 10%, and 11%.

In contrast, countries with lower economic growth, such as Japan (since 1981) and the UK (since 1983), have annualized growth rates of their stock market indices of 4% and 5%, corresponding to GDP growth rates of 2% and 6%. Some countries or economies, such as Germany and Hong Kong, show certain discrepancies between stock market performance and GDP growth, which may stem from factors such as the economic structure and the stage of capital market development in each country.

In addition, whether in the A-share or US stock market, the stock market's returns are mainly contributed by the earnings and dividends of listed companies:

According to data analysis from 2005 to 2023, the annualized growth rate of the CSI 300 Index is 9.6%, with the annualized growth rate of corporate earnings reaching 9.4% and a dividend yield of 2.0%. Compared to the mature US stock market, the earnings growth in the A-share market is more volatile (averaging 11.1%, ranging from -15.7% to 85.4%), and speculative returns are also more extreme (ranging from -59.6% to 72.2%).

More specifically, we further analyzed the daily data of the cumulative return of the CSI 300. As of the end of 2023, the cumulative return of the CSI 300 was 404.5%, with contributions from earnings and dividends being 403.8% and 153.8%, respectively, indicating that the historical returns of the CSI 300 are mainly contributed by earnings and dividends.

How to Share Stock Market Returns? Passive Index Funds Are Receiving More Attention

Comparing stock funds in the US and A-share markets, there has been a growing trend of passive index funds gaining dominance in recent years. In the A-share market, the scale of passive equity funds is gradually approaching that of actively managed equity mutual funds during the same period:

In recent years, the US stock market has shown a trend of passive investment strategies gaining dominance, which primarily stems from the general difficulty of active funds to outperform passive products over the past decade. The dominance of institutional investors in the US stock market is a significant reason why active funds struggle to beat the market.

Another source of the performance gap between active and passive funds is the difference in fees; high fees and trading costs are the main reasons for the lower returns of US active funds compared to benchmark indices, often reaching 2% or more annually.

Active management funds in the A-share market have outperformed the index in the past, but this advantage may gradually narrow in the future.

The institutionalization ratio of A-shares from 2004 to 2023 still needs time to rise, but this trend is already quite evident. Data shows that the proportion of institutional investors in the A-share market has increased from 33.5% at the end of 2019 to 41.3% in the third quarter of 2024, while the proportion of retail investors has correspondingly decreased from 42.7% to 32.5%.

From the perspective of fund structure, passive funds in the A-share market have rapidly developed. As of the third quarter of 2024, the scale of passive equity funds in China's A-share market has grown from 2.23 trillion yuan in Q4 2023 to 3.69 trillion yuan, which is not far from the scale of actively managed equity mutual funds at 3.75 trillion yuan during the same period. The above content is excerpted from Haitong Securities' "What is the Reasonable Rate of Return in the Stock Market?", authors: Xun Yugen (S0850511040006), Wu Xinkun (S0850521070001), Wang Zhenghe (S0850523060001)