Long Run Stock Returns
By Arnold Kling
Because the stock market figures into most Social Security privatization plans, the Social Security Administration commissioned economists to estimate long-run returns from stocks. This analysis is three years old, but since I’ve brought up the issue on several occasions it seems worth a mention.
Keep in mind that when the economists were writing the market had fallen from its Internet Bubble peak, but the ratio of stock prices to earnings and to dividends was still high relative to historical averages.
John Campbell wrote,
the unadjusted dividend-price ratio has declined by 3.3 percentage points from the historical average. Even adjusting for share repurchases, the decline is at least 2.3 percentage points. Assuming constant long-term growth of the economy, this would imply that the geometric average return on equity is no longer 7%, but 3.7% or at most 4.7%
Peter Diamond wrote,
the 7 percent assumption [for annual stock market returns] throughout the next 75 years is not plausible in that it requires a rise in stock values to GDP that is implausible. The level of implausibility is not quite as high as two years ago, but it is still implausible.
John B. Shoven wrote,
My own estimate for the long-run real return to equities looking forward is 6 to 6.5 percent. I come to that using roughly the parameters chosen above. If the P-E ratio fluctuates around 20, the cash payouts to shareholders should range from 3 to 3.5 percent. I am relatively optimistic about the possible steady-state growth rate of GDP and would choose 3 percent for that number.
I share Shoven’s optimism about long-run GDP growth, but I think that getting there will involve an acceleration of Schumpeterian competition, which might mean that stock portfolios invested in incumbent companies could perform less well than what otherwise might be expected.
For Discussion. Do you think that profits of major corporations as a share of GDP will increase, decrease, or remain about the same over the next decade?