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What Long-Run Returns Can Investors Expect From the Stock Market?
PR Newswire - October 30, 1997 10:37
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KANSAS CITY, Mo., Oct. 30 /PRNewswire/ -- Individual investors who expect
the 15 percent stock returns of the past decade to continue indefinitely ought
to pay closer attention to macroeconomic fundamentals. In fact, some analysts
believe returns could drop below their 1O percent historical average.
That's the message from a new study by John E. Golob, a senior economist
at the Federal Reserve Bank of Kansas City, and David G. Bishop, a former
research associate at the bank, and now a product specialist with Sprint.
Golob and Bishop examined the outlook for long-run stock returns. They report
their findings in the current issue of "Economic Review," the Fed's Quarterly
research journal. Their article, "What Long-Run Returns Can Investors Expect
from the Stock Market?" is also available on the Bank's website at
www.kc.frb.org.
The authors begin by comparing the stock market's recent strong
performance with its historical record, and then analyze how macroeconomic
fundamentals and high price-earnings (P/E) ratios will affect long-term
returns.
"Total returns on the S&P 500 index, which include the effects of price
increases and dividends, have averaged more than 17 percent per year since the
1982 lows," they write. "As a result. this index was recently more than nine
times higher than it was during the 1982 recession." In another measure of
stock market performance, they note, "Before 1974, stock prices usually
declined significantly about every five years. The steady uptrend since 1974,
however, with only one modest year-over-year decline in 1987, is unprecedented
in U.S. stock market history extending back to 1802."
With regard to fundamental measures of stock value such as book value,
dividends and P/E ratios, Golob and Bishop say all three show cause for
concern, leading many analysts to forecast near-term returns below the
historical 1O percent average. A few analysts are even predicting substantial
declines in stock prices over the next year.
The authors next looked at stock returns and macroeconomic factors that
determine long-run economic growth. They used a traditional economic growth
model to see if the return to capital would rise, signalling higher corporate
earnings, thus justifying high stock prices.
"If official estimates of the growth of capital, labor, and total factor
productivity are approximately correct," they write, "macroeconomic effects
could actually reduce returns a little below their 10 percent historical
average." Even if productivity rises a bit faster than expected, they say
recent trends will not change long-run returns much from their historical
average.
Finally, Golob and Bishop address the question of whether high stock
prices could be a sign of lower long-run returns. Some researchers believe
investors may be willing to accept lower future returns because stocks are
being seen as less risky than previously, especially as individual investment
horizons increase.
In an analysis of P/E ratios, they found that "a modest decline in long-
run returns from 1O to 9 percent would be consistent with a rise in the P/E
ratio from its historical average near 14 to its recent level near 22. This
analysis, of course, presumes that stock prices remain high. If the price
rise is only temporary, near-term returns will be below average and the
subsequent long-run returns will be about the same as their historical
averages."
SOURCE Federal Reserve Bank of Kansas City
/CONTACT: Lowell Jones of the Federal Reserve Bank of Kansas City, Public
Affairs Department, 816-881-2797/
/Web site: kc.frb.org
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