Why should stocks go up over the long term?
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Why should stocks go up over the long term?
Hi guys
This is my first post on Bogleheads, however, I'm very familiar with Vanguard's offering and indexing in general.
My question is, what is the underlying reason why stocks go up over the long term? Of course it is economic growth but what essentially drives this?
This is quite an interest graph and I'm sure you've seen similar before on the net:
What's to say that this long term growth of stocks will continue going forward? Couldn't we have hit the "peak" and it no longer grow from here?
This is my first post on Bogleheads, however, I'm very familiar with Vanguard's offering and indexing in general.
My question is, what is the underlying reason why stocks go up over the long term? Of course it is economic growth but what essentially drives this?
This is quite an interest graph and I'm sure you've seen similar before on the net:
What's to say that this long term growth of stocks will continue going forward? Couldn't we have hit the "peak" and it no longer grow from here?
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Re: Why should stocks go up over the long term?
Stock market prices grow in relation to corporate profits. Sentiment swings distort this profit growth--higher prices for a dollar of earnings sometimes, lower prices other times--but eventually markets always come back to earnings which tend to grow over time. What makes earnings grow? Population growth increases aggregate demand for goods and services and drives employment gains. Worker productivity and efficiency per hour of labor increases over time due to technological innovations and other factors. So the combination of population growth and worker productivity growth drive both demand for and supply of goods and services which in turn drives corporate profit growth. Corporate profits and stock prices do not move up in steady straight lines, however, sometimes more like a roller coaster, but over very long periods of time corporate profits and therefore stock prices tend to increase especially in the US.
Garland Whizzer
Garland Whizzer
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Re: Why should stocks go up over the long term?
FIrst, be careful. That chart is misleading because it a "nominal" return chart; that is, it is not corrected for inflation. The inflation-corrected chart is impressive, too, but it has some awkward places like a level section for 17 years from 1966 and 1982. I cannot think of any good reason at all for ignoring inflation except to give a misleading visual picture of the steadiness of the rise of stocks. Also, quality of the data before 1926 is questionable and the quality of the data before 1870 is very very questionable.
Second, the U.S. has done better than the world as a whole. For a more global view, download and look through the Credit Suisse Global Returns Yearbook 2014, where you will see about twenty-odd charts like the one you posted--for each of twenty countries, as well as the world as a whole, and the world "ex-US." The message is still the same--over sufficiently long periods of time in the past, stocks have beaten everything else.
Third, the reason is, as you say, economic growth. I believe that companies actually do create value. They start with raw materials hidden in the ground that are no particular use to humankind. I buy stocks, that gives capital to companies, they buy machines and hire workers to bring stuff to the surface and turn it into steel and oil and plastic and assemble it into cars. From the point of view of human value there is now more value in the world than there was before. Since people are willing to pay money to get cars, company earns a profit and gives some of it to the stockholders in the form of dividends (and uses some of it to expand the company). Because our stock entitles us to receive those dividends, it really is worth more than we paid for it--it is worth the value of all those future dividends.
Or something like that.
Can it go on forever? Who knows? If the "Limits to Growth" studies of the 1970s had been correct it would have already stopped by now. But I think humankind will muddle through and economies and stocks will keep growing.
From that Credit Suisse report, here's the United States, i.e. the same chart you posted but corrected for inflation. Sensational performance but not quite as steadily upward as yours.
Here's a country that didn't do as well as the United States: Austria.
Here's "the world ex-US," often called "international," i.e. all the stocks except the United States.
Second, the U.S. has done better than the world as a whole. For a more global view, download and look through the Credit Suisse Global Returns Yearbook 2014, where you will see about twenty-odd charts like the one you posted--for each of twenty countries, as well as the world as a whole, and the world "ex-US." The message is still the same--over sufficiently long periods of time in the past, stocks have beaten everything else.
Third, the reason is, as you say, economic growth. I believe that companies actually do create value. They start with raw materials hidden in the ground that are no particular use to humankind. I buy stocks, that gives capital to companies, they buy machines and hire workers to bring stuff to the surface and turn it into steel and oil and plastic and assemble it into cars. From the point of view of human value there is now more value in the world than there was before. Since people are willing to pay money to get cars, company earns a profit and gives some of it to the stockholders in the form of dividends (and uses some of it to expand the company). Because our stock entitles us to receive those dividends, it really is worth more than we paid for it--it is worth the value of all those future dividends.
Or something like that.
Can it go on forever? Who knows? If the "Limits to Growth" studies of the 1970s had been correct it would have already stopped by now. But I think humankind will muddle through and economies and stocks will keep growing.
From that Credit Suisse report, here's the United States, i.e. the same chart you posted but corrected for inflation. Sensational performance but not quite as steadily upward as yours.
Here's a country that didn't do as well as the United States: Austria.
Here's "the world ex-US," often called "international," i.e. all the stocks except the United States.
Last edited by nisiprius on Mon Jul 28, 2014 5:41 pm, edited 2 times in total.
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Re: Why should stocks go up over the long term?
Another way of asking the question is - why is Widget Co. probably going to make more money in 20 years that it is today? First, it's probably going to make more $ per widget due to productivity growth. Second, it's going to sell more widgets, due to population growth, and once again productivity growth, which makes customers wealthier and allows them to buy more widgets. It's also going to make more $ in nominal terms due to inflation.
Re: Why should stocks go up over the long term?
There is also growth (from a shareholder perspective) due to corporations returning cash to their shareholders, via stocks and cash buybacks. In 2013, that added up to a bit over 4% of the market cap of the S&P 500. Just that part was larger then the interest paid on T-Bills of any maturation in 2013. Add in inflation of 2% or so, we get a nominal return of 6% without an iota of growth in either the underlying companies or valuations. Of course, we had both, so the return in 2013 was quite a bit higher then 6%.
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Re: Why should stocks go up over the long term?
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Re: Why should stocks go up over the long term?
Thanks for the responses guys
It seems to have been mentioned more than once that population growth is a considerable driver behind equities growing over the long term.
If this is the case, then surely property and/or natural resources are the way forward and could be preferential to equities?
It seems to have been mentioned more than once that population growth is a considerable driver behind equities growing over the long term.
If this is the case, then surely property and/or natural resources are the way forward and could be preferential to equities?
Re: Why should stocks go up over the long term?
If you buy some land and sell it 10, 20, whatever years later, you might reasonably expect to receive a similar amount in inflation adjusted terms as what you bought it for.Index Reflex wrote:What's to say that this long term growth of stocks will continue going forward? Couldn't we have hit the "peak" and it no longer grow from here?
What if during the time of owing that land you grow/sell something using that land, trees or crops, and use that to buy more land and/or provide a income.
What if instead of buying the land outright yourself, you split the cost 100 ways and get others to buy a share in that deal - perhaps calling the group 'Grow Trees' with a abbreviation of GT. To simplify some individuals wanting to sell their share(s) - others buying, you approach the New York Stock Exchange to list your shares - but they say sorry, you can't use GT as that's already been used by another company (Goodyear Tires) so you'll have to use another abbreviation for your listing.
Shareholders own a part of a business that owns assets (land, machinery, workers, trade or intellectual rights) and that uses those assets to generate cash (profits). Some of those profits might be retained to upgrade the assets and/or expand the business, some of the profits might be paid as cash to the shareholders (dividends) - and if a shareholder uses those dividends to buy more shares then the investor accumulates more..
All the time there is inflation share (land) prices might broadly rise with inflation, whilst the value of the products/sales might also grow with inflation (a present day $5 plank of wood sawed from a tree might cost $10 in 25 years time due to 2.8% yearly inflation). But that's highly subjective. Some companies might expand, others contract, creating volatility (of share price) that's subject to the particular period across which the stock is held.
Last edited by Clive on Mon Jul 28, 2014 6:44 pm, edited 1 time in total.
Re: Why should stocks go up over the long term?
+1 ,,,,Well said Garlandgarlandwhizzer wrote:Stock market prices grow in relation to corporate profits. Sentiment swings distort this profit growth--higher prices for a dollar of earnings sometimes, lower prices other times--but eventually markets always come back to earnings which tend to grow over time. What makes earnings grow? Population growth increases aggregate demand for goods and services and drives employment gains. Worker productivity and efficiency per hour of labor increases over time due to technological innovations and other factors. So the combination of population growth and worker productivity growth drive both demand for and supply of goods and services which in turn drives corporate profit growth. Corporate profits and stock prices do not move up in steady straight lines, however, sometimes more like a roller coaster, but over very long periods of time corporate profits and therefore stock prices tend to increase especially in the US.
Garland Whizzer
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Re: Why should stocks go up over the long term?
There's no guarantee that population growth will increase the value of the commodity or piece of real estate you choose. Japanese real estate or, say, coal, might go out of favor. Stocks offer a little more assurance there, since a company can always change its products. Plus you get the productivity bonus.Index Reflex wrote:It seems to have been mentioned more than once that population growth is a considerable driver behind equities growing over the long term.
If this is the case, then surely property and/or natural resources are the way forward and could be preferential to equities?
Re: Why should stocks go up over the long term?
Stocks of particular companies do not for the most part go up over the long-term. Stocks that are growing in value change over time because economies are dynamic. Many of the biggest US stocks today were tiny or non-existent in 1980. Many of the biggest stocks in 2050 are undoubtedly tiny or non-existent today.
BobK
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The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.
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Re: Why should stocks go up over the long term?
True. This reminds me of when I helped a Japanese consumer finance company design a risk management system in the early 90s. Their four business lines were credit cards, real estate loans, stock loans and golf club membership loans (which were being traded like equities). I hope the implemented the design which called for, in effect, margin calls on price drops for the more illiquid 'assets' based on tracking their value somewhat independently. The golf investors argued that surely their ownership share/stake in beautiful land, earning high revenues due to ever increasing demand would never decline in value requiring collateral for the debt!steve_14 wrote:There's no guarantee that population growth will increase the value of the commodity or piece of real estate you choose. Japanese real estate or, say, coal, might go out of favor. Stocks offer a little more assurance there, since a company can always change its products. Plus you get the productivity bonus.Index Reflex wrote:It seems to have been mentioned more than once that population growth is a considerable driver behind equities growing over the long term.
If this is the case, then surely property and/or natural resources are the way forward and could be preferential to equities?
Re: Why should stocks go up over the long term?
Diversifying reduces single stock risk.bobcat2 wrote:Stocks of particular companies do not for the most part go up over the long-term. Stocks that are growing in value change over time because economies are dynamic. Many of the biggest US stocks today were tiny or non-existent in 1980. Many of the biggest stocks in 2050 are undoubtedly tiny or non-existent today.
BobK
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Re: Why should stocks go up over the long term?
If OP is asking about the reason for economic growth, then the following is the simplest growth theory.
http://en.wikipedia.org/wiki/Exogenous_growth_model
http://en.wikipedia.org/wiki/Exogenous_growth_model
The Solow–Swan model is an exogenous growth model, an economic model of long-run economic growth set within the framework of neoclassical economics. It attempts to explain long-run economic growth by looking at capital accumulation, labor or population growth, and increases in productivity, commonly referred to as technological progress. At its core is a neoclassical aggregate production function, usually of a Cobb–Douglas type, which enables the model “to make contact with microeconomics”.
Re: Why should stocks go up over the long term?
I think this is pretty close. The economics articles I've read seem to place the credit for economic growth on improving technology that drives increasing productivity and on population growth. Other factors are zero sum or unimportant to the gross economy.Pizzasteve510 wrote:I had a very interesting conversation with one of my senior exec friends about this topic on an airplane flight. After several drinks we concluded that most real returns for corporations have been driven by either some form of labor or commodity arbitrage ('hunters' carving up a felled beast...mostly a zero sum game) or by productivity gains or value creation from technology driven innovation. We concluded (based on some liquid fact enhancement), that 'management' did a good job if it could sustain 0 pct real earnings growth.
While I have a great deal of belief that technology can continue to improve for quite a while yet, the fact is that population growth, especially in developing countries is slowing, or even going negative. This makes me believe that we are likely to see lower economic growth in the future. When of course is the rub.
Re: Why should stocks go up over the long term?
People save, lend and otherwise risk their money on profit-seeking ventures. When done wisely, production - what we call the "economy," grows. Businesses make up the productive capacity of the country (and world). So, unless you think saving will cease, or that businesses will invest that savings foolishly, the economy should grow. As it does, the valuations of companies will grow along with it (eventually).
There's no law that says the stock market will continue to grow and thus the economy will continue to grow, but the evidence is so strong that it will that you need a pretty much airtight theory as to why it won't continue to do so to put the assumption into question.
JT
There's no law that says the stock market will continue to grow and thus the economy will continue to grow, but the evidence is so strong that it will that you need a pretty much airtight theory as to why it won't continue to do so to put the assumption into question.
JT
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Re: Why should stocks go up over the long term?
People generally start a company when they think that they can make money. If they are correct, and the company does make money, either the money will be distributed (investors will hope for dividends, but salaries or taxes might be other uses for the money) or the money will be reinvested to add value to the business and the stock might grow in value. Of course, there will probably be a combination of uses for the money, possibly even dividends and growth.
If you are investing for retirement, you have an even more important concern than the company growing in value, and that is using the stock as a store of value. Once you are no longer able to work and earn a living, you still want to eat. So you are looking for a way to use what you are earning today to pay your bills tomorrow. Almost all investment for retirement is about finding a way to ensure that you can pay your bills tomorrow by putting aside something today. Hopefully, stocks will turn out to be a better store of value than most other alternatives, such as collecting beer cans or antique toys. One reason that jewelry became desirable was that it served as a store of value, however poorly it did the job.
If you are investing for retirement, you have an even more important concern than the company growing in value, and that is using the stock as a store of value. Once you are no longer able to work and earn a living, you still want to eat. So you are looking for a way to use what you are earning today to pay your bills tomorrow. Almost all investment for retirement is about finding a way to ensure that you can pay your bills tomorrow by putting aside something today. Hopefully, stocks will turn out to be a better store of value than most other alternatives, such as collecting beer cans or antique toys. One reason that jewelry became desirable was that it served as a store of value, however poorly it did the job.
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Re: Why should stocks go up over the long term?
Don't worry about 0 or negative population growth. Population growth is just one factor in the economic growth. For example, even with 0 population growth, human capital can increase due to better education. This will drive economic growth.Ged wrote: While I have a great deal of belief that technology can continue to improve for quite a while yet, the fact is that population growth, especially in developing countries is slowing, or even going negative. This makes me believe that we are likely to see lower economic growth in the future. When of course is the rub.
Re: Why should stocks go up over the long term?
Au contraire, I think that the growth of productive population is faster than ever. Think about it.Ged wrote:While I have a great deal of belief that technology can continue to improve for quite a while yet, the fact is that population growth, especially in developing countries is slowing, or even going negative. This makes me believe that we are likely to see lower economic growth in the future. When of course is the rub.
Hundreds of millions of subsistence farmers means little to the world economy, until they are given modern machinery or knowledge and start making something.
Re: Why should stocks go up over the long term?
In one of Bogle's books, I remember he makes the point that the return from stocks ultimately must equal the return to business. There is speculative short-term return as well, but that can't deviate from the underlying returns too greatly or for too long. I don't think he discussed economic growth but I think that would be the driver of the overall return to business, or at least be closely related to it.
Now, will the economic growth that we have enjoyed since the industrial revolution persist? I hope so, and I think in general the Boglehead philosophy is one of general optimism regarding the US economy. On the other hand, though, exponential economic growth is actually a very modern phenomenon. Economists estimate that economic growth was basically zero up until about 1800. Is the current period of exponential growth just how things are in the modern economy, or is the post-industrial experience a blip in history soon to be followed by a return to centuries of zero growth? I think the most likely scenario is continued growth, though perhaps not quite has high as it has been.
Now, will the economic growth that we have enjoyed since the industrial revolution persist? I hope so, and I think in general the Boglehead philosophy is one of general optimism regarding the US economy. On the other hand, though, exponential economic growth is actually a very modern phenomenon. Economists estimate that economic growth was basically zero up until about 1800. Is the current period of exponential growth just how things are in the modern economy, or is the post-industrial experience a blip in history soon to be followed by a return to centuries of zero growth? I think the most likely scenario is continued growth, though perhaps not quite has high as it has been.
Re: Why should stocks go up over the long term?
Here is the inflation-adjusted version of Siegel's chart.nisiprius wrote:FIrst, be careful. That chart is misleading because it a "nominal" return chart; that is, it is not corrected for inflation. The inflation-corrected chart is impressive, too, but it has some awkward places like a level section for 17 years from 1966 and 1982. I cannot think of any good reason at all for ignoring inflation except to give a misleading visual picture of the steadiness of the rise of stocks.
To my eye, the rise of stocks looks just as steady. It also becomes clear that bond investors made no money at all for 65 years between 1915 and 1980. This is also before taxes. After paying taxes, bond investors would have had to wait even longer to make any money.
Last edited by berntson on Mon Jul 28, 2014 7:53 pm, edited 1 time in total.
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Re: Why should stocks go up over the long term?
This is a nice theory, but it doesn't explain real world data. The Dimson-Marsh data set, which covers 114 years, shows that while the correlation between stock returns and population growth is positive, the correlation between stock returns and real per capita gdp growth is negative. If anything, productivity gains seem to have a negative impact on market returns.garlandwhizzer wrote:What makes earnings grow? Population growth increases aggregate demand for goods and services and drives employment gains. Worker productivity and efficiency per hour of labor increases over time due to technological innovations and other factors. So the combination of population growth and worker productivity growth drive both demand for and supply of goods and services which in turn drives corporate profit growth. Corporate profits and stock prices do not move up in steady straight lines, however, sometimes more like a roller coaster, but over very long periods of time corporate profits and therefore stock prices tend to increase especially in the US.
Garland Whizzer
Re: Why should stocks go up over the long term?
I think you're drawing generalizations and conclusions from the DMS data (and one unique century of world events generally) far in excess of what it deserves. The data includes a specific set of events (wars, shifts from ancient to modern societies, etc) that are in no way guaranteed to repeat. To use a notional example, supposed Country A had a fast growth rate, then was taken over by the Nazis in 1937, causing its stock market to drop to zero. This doesn't mean we should expect high growth countries to be taken over by Nazis going forward. One simply can't generalize history, since it's so unique and ever changing.cowboysFan wrote:This is a nice theory, but it doesn't explain real world data. The Dimson-Marsh data set, which covers 114 years, shows that while the correlation between stock returns and population growth is positive, the correlation between stock returns and real per capita gdp growth is negative. If anything, productivity gains seem to have a negative impact on market returns.garlandwhizzer wrote:What makes earnings grow? Population growth increases aggregate demand for goods and services and drives employment gains. Worker productivity and efficiency per hour of labor increases over time due to technological innovations and other factors. So the combination of population growth and worker productivity growth drive both demand for and supply of goods and services which in turn drives corporate profit growth. Corporate profits and stock prices do not move up in steady straight lines, however, sometimes more like a roller coaster, but over very long periods of time corporate profits and therefore stock prices tend to increase especially in the US.
Garland Whizzer
Re: Why should stocks go up over the long term?
Consider two investments A and B. A gives a return of 3 % for 10 years. It is fully backed by Uncle Sam and there is no risk. B also gives same 3% return in 10 years but there is no guarantee. Also it may lose value but overall return us around 3. Most folks will choose A. This will mean B will lose value and expected return will rise. Some persons may get interested. It may fall further and there will be a greater expected return. In general because of risk element, B has to provide better return than A.
Re: Why should stocks go up over the long term?
If I remember right, what's true is that past high growth rates in GDP are not correlated with higher returns, but future high growth rates are. In other words, if you knew which countries would grow fastest in the future, you could get higher returns by investing in them. The problem is that past high growth rates do not predict future high growth rates.cowboysFan wrote: This is a nice theory, but it doesn't explain real world data. The Dimson-Marsh data set, which covers 114 years, shows that while the correlation between stock returns and population growth is positive, the correlation between stock returns and real per capita gdp growth is negative. If anything, productivity gains seem to have a negative impact on market returns.
Re: Why should stocks go up over the long term?
I will cut to the chase give you the short answer: It is from technological improvements. Without it, there would be diminishing returns from any investments and eventually growth would come to a halt.Index Reflex wrote:Hi guys
This is my first post on Bogleheads, however, I'm very familiar with Vanguard's offering and indexing in general.
My question is, what is the underlying reason why stocks go up over the long term? Of course it is economic growth but what essentially drives this?
This is quite an interest graph and I'm sure you've seen similar before on the net:
What's to say that this long term growth of stocks will continue going forward? Couldn't we have hit the "peak" and it no longer grow from here?
I can prove this with a few simple equations and some logical thinking, but don't have time right now.
Re: Why should stocks go up over the long term?
grayfox wrote: I will cut to the chase give you the short answer: It is from technological improvements. Without it, there would be diminishing returns from any investments and eventually growth would come to a halt.
I can prove this with a few simple equations and some logical thinking, but don't have time right now.
Technically, your statement is not 100% accurate.
Technological progress is important but is not the only factor for economic growth. I can also show using several (but not so simple) equations to show economic growth without technological progress. I'll have to brush my learning from growth theory 15 years ago.
Or, google "economic growth without technological progress."
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Re: Why should stocks go up over the long term?
Not quite.Ged wrote:I think this is pretty close. The economics articles I've read seem to place the credit for economic growth on improving technology that drives increasing productivity and on population growth. Other factors are zero sum or unimportant to the gross economy.Pizzasteve510 wrote:I had a very interesting conversation with one of my senior exec friends about this topic on an airplane flight. After several drinks we concluded that most real returns for corporations have been driven by either some form of labor or commodity arbitrage ('hunters' carving up a felled beast...mostly a zero sum game) or by productivity gains or value creation from technology driven innovation. We concluded (based on some liquid fact enhancement), that 'management' did a good job if it could sustain 0 pct real earnings growth.
There is capital accumulation.
Solow's famous estimate was that (from memory) something like 2/3rds of growth is 'other' which means basically returns from higher productivity resulting from 'being smarter' about how we make and do things.
But that still leaves the growth in the fixed capital of a society:
- you don't technological change without adoption. It's not that the High Speed train exists in a lab, it's that France has a network of over 1000 km of them. Ditto Japan.
It's not that the Internet exists, it is that it has 1 billion daily users
- think about all the really long term fixed capital in the USA: the Washington Monument. The Interstate Highway System. The Intra Coastal Waterway. The Erie Canal. The borough of Manhattan- -replacement cost of the Empire State Building alone in the billions. Bridges. O'Hare Airport. etc.
- then you get the educational and social capital. The US knows how to 'do things smart' and that's why it has such high productivity. Yale University is 300 years old? And Harvard older?
Yes but no but yes but no.While I have a great deal of belief that technology can continue to improve for quite a while yet, the fact is that population growth, especially in developing countries is slowing, or even going negative. This makes me believe that we are likely to see lower economic growth in the future. When of course is the rub.
If we have slower population growth, then we can have the same (or higher) GDP growth *per capita*.
The downside is consumer product demand growth (houses, cars etc.) will be lower. The upside is 1). people living longer have higher demands for healthcare, travel etc. 2).
There are also still rising populations in many Emerging Markets (Africa and Middle East especially). Bringing those people up from say $100-2000 per capita GDP to say $10k (Mexico and Latin America) will be an enormous task. There are real questions about the environmental and resource affordability of that. But those people will want cars, homes, air conditioners, hair shampoo, beer, high schools and universities etc.
But taking 1 billion Africans up to $10k per capita is like taking 250 million American up by 20% (say US GDP per capita is c. $40k).
Personally I welcome lower population growth because it reduces the resource and pollution strains on the planet, and makes the goal of achieving a reasonable standard of living on this planet more achievable.
I have some concerns about the effects on economic growth, particularly in Europe, but conversely the opportunities amongst emerging consumers are so huge that this offsets this in the long run.
Re: Why should stocks go up over the long term?
Retained earnings are the biggest force behind long-term stock appreciation. Acme Widgets has ten factories making identical widgets. Every year, they make a profit on those widgets. After a few years, they use their profits to build an eleventh widget factory. Their total assets are now 10% more valuable. They can also produce 10% more widgets now that they have another factory. So the stock price for Acme Widgets goes up about 10%.
Notice that this process can work without any technological progress (Acme has same machines and make the same widgets), without population growth (as long as there is sufficient demand for widgets), and without increased worker productivity. Those things also contribute to stock appreciation too, but retained earnings are the main show.
[Obviously, this is a gross simplification of how things actually work. For example, by the time they build a new factory, Acme's old factories will have depreciated. But we can assume that they have enough profits to both pay for the depreciation and build the new factory. Acme may also have to cut the price of widgets a bit to sell the widgets from the new factory. And so on.]
Notice that this process can work without any technological progress (Acme has same machines and make the same widgets), without population growth (as long as there is sufficient demand for widgets), and without increased worker productivity. Those things also contribute to stock appreciation too, but retained earnings are the main show.
[Obviously, this is a gross simplification of how things actually work. For example, by the time they build a new factory, Acme's old factories will have depreciated. But we can assume that they have enough profits to both pay for the depreciation and build the new factory. Acme may also have to cut the price of widgets a bit to sell the widgets from the new factory. And so on.]
Re: Why should stocks go up over the long term?
There are at least 3 ways to answer this question
1. They go up because of fundamentals - productivity increases, earnings reinvestment etc.
2. They go up because they are riskier, and investors demand higher returns for riskier assets
3. They don't - the data presented is just a statistical fluke
I don't fully buy #1 - if it were so certain that stocks would go up, then the market would bring their returns closer to riskless assets. I think #2 is closer to the truth, the risk just hasn't shown up clearly. I hope for all our sakes it's not #3.
1. They go up because of fundamentals - productivity increases, earnings reinvestment etc.
2. They go up because they are riskier, and investors demand higher returns for riskier assets
3. They don't - the data presented is just a statistical fluke
I don't fully buy #1 - if it were so certain that stocks would go up, then the market would bring their returns closer to riskless assets. I think #2 is closer to the truth, the risk just hasn't shown up clearly. I hope for all our sakes it's not #3.
Re: Why should stocks go up over the long term?
This is really odd isn't it? What needs to be explained is the existence of the risk premium in the presence of the asymptotic proposition that real growth = real return. Assuming risk-free assets give 0 real return at the least, then the real return gap between a risk asset and a risk-free asset -- the putative risk premium -- is small when real growth is slow. It can even be negative in negative real growth environments. This is clearly uneconomical, which means risk-free assets must not be really risk-free, in that they don't truly exist. In high growth environments, the risk-free asset has to move up in real return to capture any market (government needs to pay real return to borrow), and in negative growth environments, the risk-free asset has to give negative real return or else everybody will be in that asset (which government can't repay from tax receipts that track negative growth). This is sort of what we see playing out, that nothing can be risk-free and over the very long term there is no economic reason (though some financial reasons) to invest in so-called risk-free assets. The only reason they have a market is likely because of finite investment horizon and liability matching needs.Chan_va wrote:There are at least 3 ways to answer this question
1. They go up because of fundamentals - productivity increases, earnings reinvestment etc.
2. They go up because they are riskier, and investors demand higher returns for riskier assets
3. They don't - the data presented is just a statistical fluke
I don't fully buy #1 - if it were so certain that stocks would go up, then the market would bring their returns closer to riskless assets. I think #2 is closer to the truth, the risk just hasn't shown up clearly. I hope for all our sakes it's not #3.
So back on topic, it appears correct that #1 gives stock returns, not #2, though other assets set their returns relative to stocks via downward spreads based on risk. Sort of an inverted view of the usual case where you build spreads upward from the "risk-free" asset.
Re: Why should stocks go up over the long term?
Also occurs to me the formula real growth = real equity returns requires the public market to be well representative of the economy as a whole, i.e. private equity does not siphon off the most valuable parts of the economy. Not guaranteed at all.
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Re: Why should stocks go up over the long term?
The DM data shows that gdp per capita growth (real) is negatively correlated with stock returns over the same time frame. Future higher gdp per capita growth rates correlate slightly negative with stock returns. If in 1900, you could have predicted the gdp per capita growth rate for every country over the next century, it would not have helped you to get higher investing returns.berntson wrote:If I remember right, what's true is that past high growth rates in GDP are not correlated with higher returns, but future high growth rates are. In other words, if you knew which countries would grow fastest in the future, you could get higher returns by investing in them. The problem is that past high growth rates do not predict future high growth rates.cowboysFan wrote: This is a nice theory, but it doesn't explain real world data. The Dimson-Marsh data set, which covers 114 years, shows that while the correlation between stock returns and population growth is positive, the correlation between stock returns and real per capita gdp growth is negative. If anything, productivity gains seem to have a negative impact on market returns.
Re: Why should stocks go up over the long term?
That's not what I take this chart to show (from the 2014 yearbook).cowboysFan wrote:The DM data shows that gdp per capita growth (real) is negatively correlated with stock returns over the same time frame. Future higher gdp per capita growth rates correlate slightly negative with stock returns. If in 1900, you could have predicted the gdp per capita growth rate for every country over the next century, it would not have helped you to get higher investing returns.berntson wrote:If I remember right, what's true is that past high growth rates in GDP are not correlated with higher returns, but future high growth rates are. In other words, if you knew which countries would grow fastest in the future, you could get higher returns by investing in them. The problem is that past high growth rates do not predict future high growth rates.cowboysFan wrote: This is a nice theory, but it doesn't explain real world data. The Dimson-Marsh data set, which covers 114 years, shows that while the correlation between stock returns and population growth is positive, the correlation between stock returns and real per capita gdp growth is negative. If anything, productivity gains seem to have a negative impact on market returns.
The blue bars are portfolios formed on the basis of past growth rates. The red bars are portfolios formed on the basis of future growth rates. The chart illustrates a clear relationship between high future growth and high market returns. There is no apparent relationship between past growth and future returns.
Now all we need is to visit the future and find out which countries grew the fastest.
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Re: Why should stocks go up over the long term?
I think this chart is more informative.berntson wrote:That's not what I take this chart to show (from the 2014 yearbook).cowboysFan wrote:The DM data shows that gdp per capita growth (real) is negatively correlated with stock returns over the same time frame. Future higher gdp per capita growth rates correlate slightly negative with stock returns. If in 1900, you could have predicted the gdp per capita growth rate for every country over the next century, it would not have helped you to get higher investing returns.berntson wrote:If I remember right, what's true is that past high growth rates in GDP are not correlated with higher returns, but future high growth rates are. In other words, if you knew which countries would grow fastest in the future, you could get higher returns by investing in them. The problem is that past high growth rates do not predict future high growth rates.cowboysFan wrote: This is a nice theory, but it doesn't explain real world data. The Dimson-Marsh data set, which covers 114 years, shows that while the correlation between stock returns and population growth is positive, the correlation between stock returns and real per capita gdp growth is negative. If anything, productivity gains seem to have a negative impact on market returns.
The blue bars are portfolios formed on the basis of past growth rates. The red bars are portfolios formed on the basis of future growth rates. The chart illustrates a clear relationship between high future growth and high market returns. There is no apparent relationship between past growth and future returns.
Now all we need is to visit the future and find out which countries grew the fastest.