The Perception Problem With “Returns”

Jun 7 2011 | 10:19am ET

By Charles J. Gradante, Managing Principal, Hennessee Group – Rarely do equity market pundits focus on real performance returns (nominal returns less core inflation). Reporting nominal returns, rather than real returns, is the standard of measurement for the media. However, it can be misleading to the average investor who may assume that a +12% nominal return is better than a +9% nominal return since they do not consider the "core inflation rate". 

A +12% nominal return with +7% core inflation is actually worse than a +9% nominal return with +2% core inflation. The real return of the first period is +5%, while the real return for the second period is +7%.  While the concept of nominal versus real returns is common knowledge for professionals, it is not for most investors. Furthermore, it is not a standard of measurement routinely discussed when pundits analyze market returns in the media.

Hennessee Group LLC, an adviser to hedge fund investors, analyzed the historical relationship between inflation and equity prices dating back to the 1970’s.  According to Hennessee Group’s research, the equity market, represented by the S&P 500 TR, has generated a return of over +700 basis points above inflation on an annualized basis since the 1970’s. 

In 2009 and 2010, real returns were +23.8% and +13.6%, respectively, and +18.5% annualized.  However, despite the great performance of equity markets since the credit crisis ended, the markets still generated a negative real return of -3.48% from 2000 to 2009, the worst decade in the last 40 years.  This was 200 basis points worse than the 1970’s decade, which is remembered for periods of hyper inflation and a -40% correction from 1973 to 1974.

Investors should be encouraged by the above average real return the equity markets have provided during the past two years.  Equity markets have stabilized, generating double digit returns for investors in two consecutive years while inflation has averaged only +2%.  Through May, the S&P 500 is up over +7% this year relative to a core inflation reading of below +2%, generating a real return in line with historical averages. 

The Hennessee Group believes this recent performance is part of a long term reversion to the mean in the spread between inflation and the equity markets and expects further improvement in 2011.  With reasonable year-over-year earnings growth for S&P 500 of +17%, an improving global economy, an accommodative Fed, and muted inflationary pressures at the core level, the Hennessee Group believes the outlook for real returns above +7% remains favorable through the election in 2012.  Beyond that point, pundits are polarized with some predicting inflation and others deflation depending on job creation, velocity of money and housing (to name a few). 


In the Hennessee Group’s opinion, the investment community should discuss real returns, which are hardly, if ever, a topic of coverage in the media.  A chart showing the direction of real returns, albeit sometimes frustrating in light of headline inflation (especially related to commodities), would offer the investor another dimension to their understanding of the real value added or lost in the equity markets.  The media and pundits should discuss and debate both nominal performance and the real return above inflation.  Lower inflation coupled with lower performance does not necessarily translate to lower purchasing power.  This research paper is intended to shed light in a corner often ignored and encourage a more in depth and consistent discussion of real returns over nominal returns by the media and market pundits.  The Hennessee Group purposely avoided incorporating QE2, headline inflation, taxes and pension liabilities in order to make a general point about real returns without inordinate complexity. 

Charles J. Gradante is a Managing Principal at Hennessee Group LLC. Mr. Gradante focuses on research, market analysis, risk management and portfolio design. In 1995, following a twenty-five year financial industry career, he joined the Hennessee Hedge Fund Advisory Group as co-director while it was a division of Weiss, Peck & Greer. He co-founded the Hennessee Group LLC with Ms. Hennessee in 1997.

In Depth

Q&A: Neil Azous Talks Global Macro Investing

Nov 24 2014 | 12:41pm ET

Neil Azous is the founder and managing member of Rareview Macro, an advisory firm...


Hedge Fund Managers Among Top Tory Donors

Nov 14 2014 | 5:34am ET

Three hedge fund managers are among 32 people paying for the privilege of dining...

Guest Contributor

Why The Big Money Is Going To Europe

Nov 14 2014 | 6:03am ET

Peer-to-peer lending was invented with the individual investor in mind. But despite...


Sponsored Content

    For Hedge Funds, Mastering Data Is Key To Success

    Nov 4 2014 | 9:45am ET

    Data management is important to every business, but for hedge funds, it is critical. FINalternatives recently asked Peter Sanchez, CEO of Northern Trust Hedge Fund Services, how fund managers can deal with the demands of managing data while at the same time remain transparent and abide by operational best practices. Read more…

Editor's Note

    Guidelines for Guest Articles

    Oct 22 2014 | 9:46am ET

    We are always looking for guest articles from hedge fund managers and buy-side firms.

    If you are interested in submitting a contributed piece for possible publication on FINalternatives, please take a look at the specs. Read more…


Futures Magazine

November 2014 Cover

Building a better market

Reg NMS created a huge bifurcation in equity markets and while much of what has followed has been positive, in terms of lower fees and greater liquidity, many traders would like to see the market come...

The Alpha Pages

TAP July/August 2014 Cover

The Alpha Pages Interview: Senator Rand Paul

Senator Paul sat down in the debut series of the Alpha Pages Interview to discuss the broken tax code, regulation surrounding Bitcoin, and his plans for the 2016 Presidential election.