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Stock Prices and Future Returns

Wednesday, 01 January 2014 08:35

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 (4)Add Comment
Liberation Theology?
written by Jeffrey Stewart, January 01, 2014 7:51
“How can it be that it is not a news item when an elderly homeless person dies of exposure, but it is news when the stock market loses two points?” -Pope Francis
written by Kat, January 02, 2014 8:15
They're running out of workers to lay off.
written by Sirius_TheStarDog, January 02, 2014 10:04
NPR's ATC this afternoon pondered obtusely why the middle and working classes continue to struggle given the surging strength of the national economy, you know, the 2013 stock market boom.


And to think, people actually donate money to hear this clap-trap.
written by jim, January 04, 2014 1:24
Teaching the Wall Street Journal About Pensions and Stock Returns

in this article you argued for 9.5% returns. now your saying 5. based on what you used in last article it should still be 8ish

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.