January 01, 2014
The media were filled with euphoric accounts about the run-up in the stock market in 2013. This was certainly good news for the people who own lots of stock, less so for everyone else. (The generational warriors who yap about government debt hurting our kids would also be yelling about the stock market run-up transferring resources from young to old, if they were honest.)
Anyhow, it would be reasonable if this reporting included some discussion of the implications of higher stock prices for future returns. With the ratio of stock prices to trend corporate earnings now in the neighborhood of 20 to 1, the expected return for the future is around 5 percent annually in real terms. By contrast, the historic average for stocks in the United States is over 7 percent.
Unless future growth vastly exceeds anyone’s predictions, given its current value it is not possible for the market to sustain 7 percent real returns for any substantial period of time. This means that investors in stock must be willing to accept lower than historic rates of return.
Comments