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I am relatively new to investing. I understand that the stock market, in some sense, reflects what happens in the real economy. For example, if the U.S. economy grows, the stock market in the long term will trend up as well.

Now, hypothetically, assume that the U.S. produces no GDP growth at all in the future due to population declining. Would this mean that the stock market (index) would also stay close to the same level in the long term, making it a bad investment?

This was actually my first intuition, but then I thought that perhaps the companies included in the stock market index can still produce a steady profit. Say, for example, that while the total GDP level does not grow, the GDP/capita will grow because of population declining.

In this case, would the stock market still be a good investment? Can you explain the logic behind your answer?

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    I'm reading this question along with the answer, and trying to understand if it's not actually an economics question. If not, it's hypothetical enough to still be borderline. – JoeTaxpayer Mar 6 '16 at 17:35
  • Point granted, @JoeTaxpayer. I thought it was a point with clarifying so folks don't approach personal investing with incorrect models, independent of the hypothetical. But I can argue it either way. – keshlam Mar 6 '16 at 19:30
  • The US population isn't forecast to fall any time before 2100. The population is projected to be about 450 million then. – zeta-band Jan 27 '17 at 22:01
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    Beware survivorship bias when looking at the U.S. market and how it has grown for a long time. For example, here is a chart of Germany 1930-1950: twitter.com/adam_tooze/status/824996378287939584 – jtolle Jan 28 '17 at 16:38
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"The stock market" may not grow "forever". There will be growth in the stock market, though.

The stock market is a positive-sum game, since it is driven in large part by the profits earned by the companies. This doesn't mean that any individual stock will go up forever, it doesn't mean that any given index will go up forever, and it doesn't mean there won't be periods when the market as a whole drops. But it is reasonable to expect that long-term investing in the market as a whole will continue to return profits that reflect the success of companies invested in. Historically, that return has averaged about 8%; future results may be different and exact results will depend on exactly when and how you invest.

Re "what about Japan, which has been flat over 30 years": Market being flat doesn't mean individual companies may not be growing strongly. Picking stocks may become more important, and we might need to relearn to focus on dividends rather than being so monomaniacal about growth (dividends are not reflected in the indices, please note), but there will be money to be made. How much, and how much effort is required to get it, and whether the market offers the best available bets, deponent sayeth not.

Past results are no guarantee of future returns, and your results may be better or worse than average. You should be diversified into bonds and such anyway, rather than only in the stock market.

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    The question is about what happens to the stock market if GDP is not growing. Can you give me a reason why it is reasonable to expect (as you state) that long-term investing in the market will continue to return profits, even if GDP is not growing? What about Japan, where the stock market has returned virtually nothing for the past 30 years? – kettle823 Mar 6 '16 at 11:43
  • Answered in edit. I'd bet that most semi-serious investors in the Japanese market have been turning a profit, or prices would have tanked until they were and/or companies would have repurchased their own shares. – keshlam Mar 6 '16 at 15:36
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    It's important to remember also that markets, segments and individual businesses are valued based on a number of things including earnings multiples, economic indicators, debt rates, etc. As one factor changes so will the expectation of the others. Maybe flat earnings or GDP may make investors more comfortable with larger earnings multiples. As long as there are enough people who think the market will go up, it will go up. Japan is interesting because that nation simply lost faith in the market and capital preservation became more valuable than capital growth. – quid Mar 6 '16 at 17:59
  • By the way,When I looked at the Japanese TOPIX index I saw a down period of about six years followed by a surge from 800 to 1400 between 2012 and now. If you bought during the dip, you made quite a respectable profit on those shares. This is one of the places where simple dollar cost averaging works in your favor. – keshlam Mar 6 '16 at 19:26
  • I'd suggest replacing "deponent saith not" because it's a very obscure turn-of-phrase or at least using the more common old spelling "sayeth". – Lilienthal Mar 7 '16 at 10:20
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The answer to your question depends on what you mean when you say "growth". If you mean a literal increase in the aggregate market capitalization of companies, across the entire market, then, no, this sort of growth is not possible without concomitant economic growth. The reason why is that the market capitalization of each company is proportional to its gross revenue, and the sum of all revenue from selling "final goods" (i.e., things purchased and used by consumers) is, apart from a few technicalities, the definition of GDP. The exact multiplier might fluctuate up or down depending on investors' expectations about how sales will grow or decline going forward, but in a zero-growth economy this multiplier should be stable over the long run. It might, however, still fluctuate over the short term, but more about that in a minute.

Note that all of this applies to aggregate growth across all firms. Individual firms can still grow, of course, but as they must do this by gaining market share from other companies such growth would be balanced by a decline for some other firm. Also, I've assumed zero net exports (that's one of the "technicalities" I mentioned above) because obviously you could have export-driven growth even if the domestic economy were stationary.

However, often when people talk about "growth" in the market, what they really mean is "return". That is, how much does your investment earn for you. This isn't really the same thing as growth, but people often think of it that way, particularly in the saving phase of their investing career, when they are reinvesting their returns, and therefore their account balances are growing. It is possible to have a positive return, averaged across the market, even in a stationary economy. The reason why is that there are really only two things a firm can do with its net profits. One possibility is that it could invest it in growing the business. However, there is not much point in doing that in a stationary economy because by assumption no increase in aggregate consumption (and therefore, in the long run, aggregate production) are possible. Therefore, firms are left with only the second option, which is to pay them out to investors as dividends. Those dividends provide a return that is independent of economic growth.

Would the stock market still be a good investment in such an economy? Yes. Well, sort of. The rate of return from firms' dividend payouts will depend on investors' demand (in aggregate) for returns on their investments. Stock prices will rise or fall, causing returns to respectively fall or rise, to find that level. If your personal desire for returns is lower than the average across the investing public, then the stock market would look like a good investment. If your desired return is higher than the average, then it will look like a poor investment. The marginal investor will, of course be indifferent. The practical upshot of this is that the people who invest in the stock market in this scenario will be precisely the ones for whom the stock market is a good investment, given their personal propensity to save and desire for returns, and so forth.

Finally, you mentioned that in your scenario the GDP stagnation is due to declining population. I am less certain what this means for investment, but my first thought is that you would have a large retired population selling its investments to fund late-life consumption, and you would have a comparatively small (relative to history) working population buying those assets. This would lead to low asset prices, and therefore high rates of return. However, that's assuming that retirees need to sell assets to fund their retirement consumption. If the absolute returns on retirees' assets are large enough to fund their retirement consumption then you would wind up with relatively few sellers, resulting in high prices and therefore relatively low rates of return. It's not obvious to me which effect would dominate, and so it's hard to say whether or not the resulting returns would look attractive to the working-age population.

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Yes! Look at any graph or chart covering the last 100 years. The graph goes up. It will continue to grow unless there is an extinction event and the population gets reduced. Corporations will continue to grow to meet the needs of the ever expanding population.

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