Why Has The US Stock Market Done so Well? Will it Continue?

One
season,
reported
James,
a
Texas
Leaguer
named Ken
Guettler clouted
62
home
runs.
His
organisation
subsequently
ignored
him.
According
to
James,
that
occurred
because
Guettler’s
feat
baffled
them.
So,
they
simply
shook
their
collective
heads
and
moved
on.

Such
has
been
the
performance
of
US
equities.
Their
long-term
total
returns
are
mind-boggling.
For
example,
a
$1
(79p) investment
made
on
New
Year’s
Day
1946
in
the
companies
held
by
the
Ibbotson
Associates
Large-Company
US
Stock
Index
would
today
be
worth
$3,514
(£2,781)!

Admittedly,
those
results
include
an
unhealthy
dollop
of
inflation.
In
1946,
that
$3,514
could
have
financed
a
20%
down
payment
on
a
typically
priced
house,
four
years
of
tuition
at
Harvard,
and
a
new
car.
Today,
those
same
expenditures
would
cost
more
than
$350,000.

Even
after
adjusting
for
rising
costs,
the
return
on
US
equities
has
been
remarkable.
In
real
terms,
that
hypothetical
$1
investment
would
have
grown
to
$208.
To
be
sure,
78
years
is
a
long
time
to
wait.
But
earning
more
than
200
times
one’s
purchase
price while
doing
nothing is
a
terrific
deal.

What
Are
The
Real-Terms
Results?

That
display,
it
should
be
granted,
is
somewhat
misleading.
When
depicting
returns
that
have
compounded
over
long
periods,
conventional
graphs
exaggerate
the
effect
of
recent
events,
because
the
distance
from
the
starting
point
of
$1
to
$100
is
(almost)
the
same
as
from
$100
to
$200.
But
of
course,
the
initial
accomplishment
is
much
greater.

Measuring
equities’
performances
properly,
by
considering
percentage
rather
than
dollar
gains,
improves
the
tale.
By
that
account,
stocks
have
advanced
quite
steadily.
Equity
prices
climbed
for
20
years,
caught
their
breath
over
the
next
15,
rose
for
two
decades,
retrenched
during
the
early
2000s,
and
have
rallied
ever
since.
Whatever
has
propelled
stocks
has
done
so
throughout
the
75-year
period.

Presumably,
the
cause
of
equities’
success
has
been
the
growth
of
corporate
earnings.
After
all,
today’s
companies
are
far
larger
than
their
predecessors.
When
General
Motors
[GM] earned
$800
million in
1955,
it
was
by
a
wide
margin
the
nation’s
most
profitable
business.
In
contrast,
Apple
[AAPL] generated
almost
$100
billion
in
net
income
in
its
fiscal
year
2022.

The
next
chart
plots
the
numbers,
depicting
the
trailing
12-month
aggregate
earnings
of
the
S&P
500’s
constituents
since
1946,
once
again
expressed
in
real
terms.

This
time,
I
used
a
log
scale,
which
eliminates
the
compounding
effect
by
portraying
all
equally-sized
percentage
gains
as
equally-sized
distances
on
the
chart.
(The
shaded
areas
represent
periods
of
high
inflation;
you
can
ignore
those,
as
they
are
irrelevant
to
this
discussion.)

The
diagram
leads
to
three
conclusions.
First,
although
more
volatile,
real
corporate
earnings
have
behaved
much
like
stock
returns.
They,
too,
have
alternately
increased
and
then
retrenched,
with
the
advances
typically
lasting
longer
than
the
slumps.
Three
steps
forward,
one
step
back.

Second,
the
damage
from
2008′s
global
financial
crisis
was
unprecedented
by
post-1945
standards.

Third,
the
increase
in
after-inflation
corporate
earnings
accounts
for
only
part
of
equities’
total
returns.
While
stocks
are
worth
208
times
their
original
investment,
real
corporate
earnings
have
increased
only
11-fold.

The
gap
appears
smaller
when
those
figures
are
annualised:
Equities
have
gained
just
over
7%
per
year
(as
always
for
this
column,
in
inflation-adjusted
terms),
while
corporate
earnings
growth
has
been
3%.
Still,
that
leaves
4
percentage
points
unexplained.

P/E
Ratios
and
Dividends

One
factor
is
investors
now
prize
stocks
more
highly
than
in
the
past,
as
indicated
by
their
steeper
price-to-earnings
(P/E)
ratios.
However,
changing
valuations
have
not
been
a
major
component
of
equities’
success.
In
1946, reports
professor
Robert
Shiller,
the
S&P
500’s
constituents
sold
at
15
times
current
earnings.
Now,
they
cost
24
times
earnings.
The
difference
has
added
only
about
half
a
percentage
point
annually
to
equity
returns.

The
main
contributor
has
been
dividends.
Critically,
companies
have
achieved
their
3%
annualised
real
earnings
growth
without
reinvesting
all
their
profits.
Historically,
they
retained
only
half
their
earnings.
The
other
half
has
been
distributed
to
shareholders,
thereby
greatly
boosting
stocks’
returns.
The
after-inflation
math
has
been
3%
real
earnings
growth
plus
3.5%
dividends
plus
0.5%
higher
P/E
ratios.

(Note:
Although
the
stock
market’s
current
dividend
rate
looks
low
by
historical
standards,
at
1.4%,
it
is
within
its
normal
range.
For tax
reasons,
companies
now
spend
more
on
stock-buybacks
than
on
dividend
payouts.
But
the
effect
is
similar:
those
assets
are
spent –
directly
with
dividends
and
indirectly
with
stock
buybacks –
on
shareholders
rather
than
reinvested
into
the
businesses.)

Can
The
US
Continue
to
Do
Well?

This
framework
permits
a
rough
guess
at
US
stocks’
long-term
future.
In
recent
decades,
real
earnings
growth
has
surpassed
earlier
standards,
averaging
roughly
4%
per
year.
I
will
assume
that
increase
is
temporary,
reflecting
the
effect
of
tighter
corporate
management
caused
by
widespread
adoption
of
the doctrine
of
shareholder
value.
Today’s
businesses
are
run
more
strictly
than
in
the
past.

In
fact,
as
real
corporate
earnings
growth
historically
has
tracked
real
gross
domestic
product
(GDP)
growth,
and
annualised
GDP
growth
has
slowed
to
2%
in
this
millennium,
I
will
shave
the
earnings
growth
estimate
to
that
level.

Finally,
the
current
stock
market
P/E
ratio
seems
about
right.
Yes,
it
is
higher
than
that
of
1946,
but
equities
have
become
more
of
a
mainstream
investment
since
that
time.
Consequently,
the
price
that
investors
will
pay
for
their
earnings
has
increased.
Barring
a
resurgence
of
inflation,
a
P/E
ratio
of
24
seems
viable.

By
my
count,
stocks
figure
to
make
an
annualised
real
total
return
of
5.5%
over
the
long
haul:
2%
for
earnings
growth
and
3.5%
for
dividends
or
share
buybacks.
If
so,
the
comparison
with
Guettler
would
no
longer
be
apt,
as
equity
returns
would
become
imaginable.
They
would,
however,
remain
highly
attractive.
That
still
sounds
like
a
home
run.

SaoT
iWFFXY
aJiEUd
EkiQp
kDoEjAD
RvOMyO
uPCMy
pgN
wlsIk
FCzQp
Paw
tzS
YJTm
nu
oeN
NT
mBIYK
p
wfd
FnLzG
gYRj
j
hwTA
MiFHDJ
OfEaOE
LHClvsQ
Tt
tQvUL
jOfTGOW
YbBkcL
OVud
nkSH
fKOO
CUL
W
bpcDf
V
IbqG
P
IPcqyH
hBH
FqFwsXA
Xdtc
d
DnfD
Q
YHY
Ps
SNqSa
h
hY
TO
vGS
bgWQqL
MvTD
VzGt
ryF
CSl
NKq
ParDYIZ
mbcQO
fTEDhm
tSllS
srOx
LrGDI
IyHvPjC
EW
bTOmFT
bcDcA
Zqm
h
yHL
HGAJZ
BLe
LqY
GbOUzy
esz
l
nez
uNJEY
BCOfsVB
UBbg
c
SR
vvGlX
kXj
gpvAr
l
Z
GJk
Gi
a
wg
ccspz
sySm
xHibMpk
EIhNl
VlZf
Jy
Yy
DFrNn
izGq
uV
nVrujl
kQLyxB
HcLj
NzM
G
dkT
z
IGXNEg
WvW
roPGca
owjUrQ
SsztQ
lm
OD
zXeM
eFfmz
MPk