London Indices Before the GFD UK-100
Before the introduction of the UK-100, there was no single index that covered the 327 years of London data the UK-100 covers. In fact, there was no British index that covered even 100 years of stock market history. Before the calculation of the UK-100, GFD chain-linked a number of different indices in order to create a continuous, long-term equity index for the UK; however, this index was limited in its scope and coverage and was not market-cap based.
Between 1692 and 1811, GFD used an equal-weighted average of the price of the Bank of England, East India Co. and South Sea Co. However, using an equal-weighted index underestimated the return to shareholders. During most of the 1700s, the Bank of England was two to three times the size of the East India Co. and the East India Co. was about four times the size of the South Sea Co. Figure 1 compares the relative performance of the old, equal-weighted index and the new, market cap-weighted index. As you can see, the market-cap weighted index provides a higher return than the equal-weighted Index since the largest component, the Bank of England outperformed the shares of the other two companies.
Beginning in 1811, GFD used Rostow’s index of shares which began in 1811 and ended in 1850. Hayek’s index of industrial shares, which excluded bank, insurance and bridge stocks, was used from 1850 to 1867 when the London and Cambridge Economic Service’s index of shares was employed and continued to be the index source until 1914. All three of these indices were equal-weighted monthly indices that used a limited number of shares. The L&CES Index included only 25 shares in 1867 and 75 shares by 1914 while GFD’s index used 100 companies during the same period of time. The Banker’s Magazine index of shares was used from 1914 until 1933. Although this index was broader in its coverage, including over 200 companies, the index just provided the total capitalization of the shares that were included. If new shares were issued, this increased the value of the index, but would have produced no change in a market-cap weighted index, so its use as an overall index of British shares was limited.
The first modern, real-time index that was used was the Actuaries General Index which began in 1933 and was published in The Economist. The index continued to be used until April 10, 1962 when the Financial Times-Actuaries All-Share Index was introduced. The All-Share index was cap-weighted and included over 98% of all shares that were listed in London.
Unfortunately, Rostow, Hayek and L&CES did not keep track of dividends that were paid out and only calculated price indices. Consequently, GFD’s return index for London only had access to dividend data going back to 1923. Data from 1693 to 1923 relied exclusively on the returns of three companies: the Bank of England, East India Co. and South Sea Co. So, prior to 1923, the price and return indices were not comparable in their components. Acheson, Hickson, Turner and Ye in their article, “Rule Britannia” put together an index of stocks that included dividends, but the index only covered the period from 1825 to 1870. Since 94% of the return to shareholders before World War I came from dividends, any attempt to measure the total return to shareholders on the London Stock Exchange simply did not exist.
GFD’s UK-100 index provides not only a price index of shares traded in London between 1692 and 2018, but it also provides a total return index that includes dividends from 1692 until 2018, a task that no one was able to achieve until now.
The Organization of GFD’s UK-100 Index
Global Financial Data has spent the past 10 years organizing data from the Course of the Exchange, The London Times, The Investor’s Monthly Manual and other publications to create a complete history of stocks that traded in London over the past 325 years.
The FTSE-100 index includes the top 100 stocks by capitalization that were listed on the London Stock Exchange between 1692 and 2018. The capitalization of the FTSE-100 is currently over £2 trillion with Royal Dutch Shell, HSBC Holdings, Unilever, BP and GlaxoSmithKline representing the 5 largest companies with over £600 billion in market capitalization between them. The FTSE-100 index represents about 85% of the total stock market capitalization of the London Stock Exchange.
GFD had several criteria for including stocks in the index.
1) There had to be at least 10 observations per year for each stock and there had to be at least two price changes during each year to warrant inclusion. Otherwise, the stock was excluded due to illiquidity.
2) Dividend data had to be available for each stock in order that both price and return indices could be calculated. A stock may not have paid a dividend during a particular year, but to be included, we had to know the company had passed on paying a dividend during that year. Any shares for which we were unable to find dividend information were excluded.
3) There had to be share outstanding information available so the stock could be included in a capitalization-weighted index
GFD used a simple process to create an index covering 300 years of stock market history. For each year from 1692 to 1985, we put together a list of all the British stocks that traded on the London Stock Exchange and ranked them by capitalization. Non-British companies that traded in London were excluded. We chose the 100 largest companies and tracked their behavior for the rest of the year. When January 1 rolled around, we repeated the process, tracked the behavior of those companies, then chain-linked that year’s index to the previous year’s index. By calculating annual indices and chain-linking them together, we were able to create the GFD UK-100 index.
During those 294 years, 847 British shares were included in the index. At least 100 stocks are included every year from 1865 until 1985. From 1817 until 1864, we lowered the number of components to 50 stocks and before 1817, we included as many companies as were available to maximize the liquidity of the index. The index begins in 1692 because that was the first year in which we had more than one company that we could include in the index. The three companies included in 1692 were the East India Company, the Royal Lustring Co. and the English Linen Co. (technically known as the Governor and Assistants of the King's and Queen's Corporation for Linen Manufacture in England). In 1694, the Bank of England was founded and became the stock with the longest history, staying in the index until its nationalization in 1946.
During most of the 1700s, there were only three stocks in the index, the Bank of England, the East India Co. and the South Sea Co.
The real expansion in components of the index began in 1806. Although we were able to collect periodic price data for canals before 1806, none of the data was consistent enough to include canal shares in the index. However, in 1806 a London broker, L. Wolfe began listing the prices of shares in several British magazines and in 1811, the Course of the Exchange began publishing the price of shares as well as Funds. The number of components in the index increased to 14 in 1806, 25 in 1808, 40 in 1813 and 50 in 1817.
To be included in the index, we needed three components: 1) the price and dates of trades in the shares, 2) dividends paid on the shares, and 3) the number of outstanding shares. With these three pieces of information, we could calculate cap-weighted price and return indices. Any shares that lacked any of these three components were excluded from the index. Any company that was incorporated outside of the United Kingdom or had its operations primarily in another country, such as the Canadian Pacific Railway was excluded from the Index. For each component, we kept track of the number of days the shares traded and the market cap of the company during that year.
The GFD UK-100 Index
Figure 2 provides a graph of the GFD UK-100 Index on a logarithmic scale from 1692 until 2018. Over those 327 years, the trend on the price Index has been upward with most of the increase coming after 1950, though this was primarily due to inflation.
As we have discussed in our blog, The Five Eras of Financial Markets, the history of equity markets over the past 400 years can be divided into four eras of Monopolies (1692-1805), Free Trade (1806-1914), the Great Reversal (1914-1974), and Globalization (1975-). For London, these four eras break down like this:
Between 1694 and 1805, three companies dominated the London Stock Exchange: the Bank of England, the East India Co. and the South Sea Co. Besides the “three sisters,” there was extensive trading in government bonds, particularly the consols, omnium and other fixed-income securities, but other than the “funds,” very little traded in London because the focus of investors was on owning securities with a fixed return.
The first non-fund securities began trading in London on a regular basis in the early 1800s. Although many canal stocks were issued in the 1790s, they mainly traded in the Midlands and there was no exchange that listed those securities. The London Stock Exchange was founded in 1801, Wolfe began advertising the price of shares in 1806, and the Course of the Exchange began listing canals and other securities in 1811. By 1825, the Course of the Exchange had expanded to two pages. The stock market continued to grow in size for the rest of the century with a second canal bubble in the 1810s, a Latin American bubble in the 1820s and railroad mania in the 1840s. London became the financial capital of the world and by 1914, over 1000 securities from dozens of countries were traded in London.
It is easy to make a case that one of the principle factors that has influenced the growth of the London stock market over the past 327 years has been the wars that Britain has fought. Wars forced the government to issue debt which crowded out capital that could have been reinvested in the economy. Britain fought a number of expensive wars in the 1700s and in the 1900s which withdrew capital from equity markets. The period from 1815 to 1914 was one of general peace and the period since the 1970s has been a period of relative peace. During each of these periods of peace, stock market capitalization increased, but grew slowly during the 1700s and 1900s.
The contrast between the size of British government debt and the capitalization of the stock market illustrates these changes. In 1689, Britain’s central government debt was £1.3 million and the market cap of its stock market was £2.27 million. Government debt peaked at £844 million in 1819 when stock market capitalization was only £80 million. By 1911, central government debt had shrunk to £733 million while the market cap of British shares had risen to £3.5 billion. A graph of Britain’s debt as a share of GDP is provide in Figure 3.
When World War I closed down the London stock exchange in 1914. Sixty years of government regulation began which limited the growth of the equity market. According to Michie, British government debt grew from 11.5% of London capitalization in 1913 to 34.6% in 1920 and 57% in 1950 while foreign debt fell from 32.9% in 1913 to 18.6% in 1920 and 3.4% in 1950. Foreign equities and debt were sold and repatriated to help pay the war debts which Britain incurred during World War I and World War II. Equities’ share of London capitalization fell from 55.6% in 1913 to 46.8% in 1920 and 39.6% in 1950. A comparison of the growth in central government debt and the stock market capitalization of British shares is provided in Figure 4.
At the end of World War II, Britain’s major industries were nationalized and by the 1950s, some members of Labour were questioning whether Britain even needed a stock exchange, but the gradual decline of the British economy in the 1970s made the importance of the private sector obvious. In 1975, Britain’s inflation rate hit 26%, 10-year bond yields rose to 17%, the stock market hit bottom after a 77% decline in real terms between 1972 and 1975, and Margaret Thatcher was elected the leader of the Conservative Party. She became Prime Minister in 1979 and played an important role in getting Britain back on track as the financial center of the European economy.
London’s Stock Market Capitalization
The changes in the London stock market are illustrated in Figure 4 which shows the capitalization of British stocks as a share of GDP. There was strong initial growth until 1720 when the Bubble Act was passed making it more difficult to incorporate companies in Britain. The growth in the capitalization of the stock market relative to GDP declined for the next 85 years. Beginning in the 1790s, the growth of canals and railroads as well as other industries led to a steady growth in the capitalization of the British market from 1790 to 1914. Market cap as a share of GDP grew from around 10% in 1805 to 150% by 1914. However, with the onset of World War I, the growth in London equity markets ground to a halt and there was a general decrease in the capitalization of the British stock market during the next 60 years. Stock market capitalization fell from around 150% of GDP in 1914 to 30% by 1974. After 1974, capitalization skyrocketed for the rest of the twentieth century, reaching 180% by 1999 as London regained its role as the financial center of Europe. The stock market, however, has failed to surpass the 1999 peak during the twenty-first century.
Since 1975, bond yields have declined from 17% to around 1%, inflation rates have declined from 26% to 3% and the FTSE-100 has risen in value from 139 to over 7000. As you can see in Figure 5, If you adjust for inflation, London’s stock market price index was only 6% higher in 1974 than it had been in 1692 when trading began. Of course, most returns occurred through the reinvestment of dividends, but these facts show how the Great Reversal of 1914 to 1974 cheated investors of decades of gains in the stock market as investors lost on average 0.74% per annum after inflation between 1914 and 1974.
Returns to Stocks Bonds and Cash
Analyzing the returns to investors in London for stocks, bonds and cash over the past 327 years provides interesting results. Table 1 analyzes the returns to stocks, bonds and bills between 1694 and 2018 breaking the past down into the four different eras discussed above and differentiates between returns before 1914 and after 1914. It also provides data on the dividend yield and equity premium.
|Era||Years||Price||Return||Dividend Yield||Bonds||Bills||Equity Premium|
Returns are from 1692 to 2018 for the UK-100, from 1694 to 2018 for bills and from 1700 to 2018 for consols and for 10-year bonds. Equity returns are for the GFD UK-100 index to 1983 and the FTSE-100 from 1984 to 2018. Bill yields exceed bond yields before 1914 because only non-risk-free proxies were available. The discount rate of the Bank of England was used from 1694 until 1718 and the private discount rate was used from 1718 until 1900 when data on government treasury bills becomes available. Bonds yielded about 1% more than bills between 1914 and 2018, so one could infer that before World War I, treasury bills would have yielded about 3% rather than the 4% paid by short-term private bills if treasury bills had existed. It should be remembered that British government annuities yielded 3% from 1729 to 1753, the consolidated bond yielded 3% from 1753 until 1888, 2.75% from 1889 until 1906 and 2.5% after 1906.
Between 1692 and 2018, equities increased in price by 1.87% per annum, but the average annual total return, including reinvested dividends, was 6.62%. The return from dividends averaged 4.66% during the past 327 years meaning that about 70% of the return to shareholders came from reinvested dividends. The equity premium, the difference between the return to stocks and bonds, averaged 2.29%. By contrast, the equity premium in the United States, using data from GFD’s US-100 index was 4.60% between 1791 and 2018. Fixed income returned 4.33% between 1692 and 2018 while bills yielded 4.29%.
If you break down the 327 years of data into different eras, you get quite different results. Between 1692 and 2018, most of the return to equity investors came from dividends rather than price appreciation. During the 1700s and 1800s, inflation was almost non-existent, declining 0.04% per annum between 1692 and 1914. Most investors sought a 5% rate of return on common stocks while consols paid a coupon of 3%. If a company raised its dividend, the price of the stock would rise to return the dividend yield to about 5%.
After 1914, increases in the inflation rate and increases in the personal income tax favored capital appreciation relative to dividends. Between 1692 and 1914, shares increased in price by 0.37% per annum, but between 1914 and 2018, shares increased 5.30% per annum. The average dividend yield fell from 4.83% to 4.22% between 1692/1914 and 1914/2018. This resulted in nominal total returns of 5.22% between 1692 and 1914 and 9.74% between 1914 and 2018; however, if you adjust for inflation, the differences disappear. The total return to equities was 5.12% before 1914 and 5.04% after 1914. Before 1914, 94% of the return came from reinvested dividends, but only 42% after 1914.
The equity premium rose over time, increasing from 1.41% between 1692 and 1914 to 3.78% between 1914 and 2018. The equity risk premium was 3.67% between 1914 and 1974, and increased to 6.09% after 1974. The worst returns to investors came during the Great Reversal between 1914 and 1974. After inflation, equities declined in value by 0.74% per annum and even after reinvesting dividends, shareholders earned only 3.78% per annum. Bond investors lost 1% per annum between 1914 and 1974 while holders of cash received only 0.10% per year. However, shareholders had their strongest returns of any era, receiving 7.46% after inflation on average between 1974 and 2018 while bondholders earned 6.41%.
If you adjust for inflation, most of the return to stocks is wiped out as Table 2 shows.
After inflation, equities have returned on average 5.04% per annum over the 327 years that are covered, bonds 2.85% and cash 2.81%. Nevertheless, there is a high variance in the returns, especially to fixed income. Bonds on average lost 1% per annum between 1914 and 1974 but returned 6.41% after 1974. Cash barely beat inflation between 1914 and 1974, returning only 0.10% annually during those 60 years.
The long-term relative returns to stocks, bonds and bills are compared in Figure 6.
Figure 7 contrasts the dividend yield with the yield on government consols until 1933 and the 10-year bond since then. For the most part, the dividend yield and government bond yield tracked each other from 1700 to 1820. Between 1820 and 1950, equities provided a higher return reflecting the greater risk of equities relative to government bonds. However, between 1955 and 2010, government bonds paid a higher return than equities, mainly because of the rise of inflation in the United Kingdom. After the 2008 financial crisis, the Bank of England pushed interest rates down below the yield on equities where it is today. The same pattern occurred in the United States with the dividend yield exceeding government bond yields until the mid-1950s when bond rates rose and stayed above the dividend yield until the 2010s.