Why should we expect stocks to go up in the long term?

Question

I have read in many personal finance books that stocks are a great investment for the long term, because on average they go up 5-7% every year. This has been true for the last 100 years for the S&P500 index, but is there reason to believe this trend will continue indefinitely into the future?

Look at other markets. The Shanghai stock index trades much lower today than the same day 10 years ago, and the Japanese stock index has not grown for the last 20 years. Is the standard assumption of 5-7% growth true only for American stocks?

Can we expect the trend for the S&P500 to continue? The last 100 years have been a period of economic prosperity for the US, so it's no surprise that stocks have done so well, but is economic prosperity required for such stock growth?

Answer 1

Does it make sense for stocks to earn a premium indefinitely?

Yes. There is good reason to think that the stock market will make money indefinitely: the stock market is the primary mechanism through which investors bear market risk, which requires compensation. If you think of all the owners of firms (stockholders and bondholders, generally) the risk premium that stocks earn stocks is the way bondholders pay equityholders to bear the risk that they do not wish to.

Will stock prices always go up in the long run?

As long as companies pay out less in dividends than their profit, prices will go up. That could change if we were to change our corporate culture and/or tax practices so that firms paid out more in dividends. However, for the purposes of your question, I think it doesn't matter much whether the investor makes money as dividends or capital gains.

Does the 5-7% guess apply only to the US market?

I didn't write (nor read) the books in question, but most likely that is a global number. The US dominates the global equity market, so it's often a good proxy. However, international returns taken together have no less risk and earn no less over long horizons in general. The particular examples you have pointed out are special cases that only apply to a part of the global economy and a particular time period. There are plenty of examples of stock markets and time periods that did much better than the US market to offset your examples.

Is 5-7% a reasonable long-term estimate of equity returns?

Equity will always earn more in expectation than risk-free securities will. How much more depends on major economic factors. 5-7% has been a good estimate for the market risk premium for many, many decades (stocks should earn this plus whatever the risk-free rate is). However, that is just an empirical observation, not a rule. It can change. Some day technological progress could slow down or stop, we could run out of important resources in a way that we can't compensate for, our population permanently could stop growing, aliens could invade, etc.

Down the road it is certainly possible for expected equity returns to go down and never go back up again. This would result from a permanent, global, economic shift that I think would be pretty obvious. That is, you wouldn't have to look at stock prices to know it was happening.

Answer 2

I have read in many personal finance books that stocks are a great investment for the long term, because on average they go up 5-7% every year. This has been true for the last 100 years for the S&P500 index, but is there reason to believe this trend will continue indefinitely into the future?

It has also been wrong for 20+ year time periods during those last 100 years. It's an average, and you can live your whole career at a loss.

There are many things to support the retention of the average, over the next 100 years. I think the quip is out of scope of your actual investment philosophy.

But basically there are many ways to lower your cost basis, by reinvesting dividends, selling options, or contributing to your position at any price from a portion of your income, and by inflation, and by the growth of the world economy. With a low enough cost basis then a smaller percentage gain in the index gives you a magnified profit.

Answer 3

I feel something needs to be addressed

The last 100 years have been a period of economic prosperity for the US, so it's no surprise that stocks have done so well, but is economic prosperity required for such stock growth?

Two world wars. The Great Depression. The dotcom bust. The telecom bust. The cold war. Vietnam, Korea. OPEC's oil cartel. The Savings and Loans crisis. Stagflation. The Great Recession. I could go on.

While I don't fully endorse this view, I find it convincing: If the USA has managed 7% growth through all those disasters, is it really preposterous to think it may continue?

Answer 4

The total value of the stock market more or less tracks the total value of the companies listed in the stock market, which is more or less the total value of the US economy (since very few industries are nationalized or dominated by privately held companies).

The US economy has consistently grown over time, thanks to the wonders of industrialization, the discovery of new markets, new natural resources, etc. Thus, the stock market has continued to grow as well.

Will it forever? No. The United States will not exist for ever. But there's no obvious reason it won't continue to grow, at least for a while, though of course if I could accurately predict that I would be far richer than I am.

Why do other countries not have the same result? China is its own ball of wax since it's a sort-of-market-sort-of-command economy. Japan has major issues economically right now and doesn't really have the natural or people resources; it also had a huge market bubble a while back that it's never recovered from.

And many European countries are doing fine. German's DAX30 index was at around 2500 in 2004 and is now at nearly 13000. That's pretty fast growth. If you go back further (there was a crash ending in around 2004), you can see around the fall of the Berlin wall it was still around 2000; even going that far back, that's about an 8% annual bump. The FTSE was also around 2000 back then, around 8000 now, which is around 5% annual growth.

Many of these indexes were more seriously hurt than the US markets in the two major crashes of this millenium; while the US markets fell a lot in 2008, they didn't fall nearly as much as many smaller markets in 2002, so had less to recover from. Both DAX and FTSE suffered similar falls in 2002 to 2008, and so even though during good periods they've grown quite quickly, they haven't overall done as well as they could have given the crashes.

Answer 5

The last 300 years of civilization have been amazingly atypical.

We have experienced industrial revolution after industrial revolution. Economic revolutions that would have changed the world in 1000 AD show up as noise. Coal, Canal, Rail, Trade, Electricity, Refrigeration, Oil, Gas, Nuclear, Assembly Line, Vacuum Tube, Mass Education, Transistor, Integrated Circuit, Nano-tech, Antibiotics, Slaying of absolute Poverty, Democratic, Feminism, Superhighway, Automobile, Airplane, and on and on and on.

A cascade of miracles and world-shaking events that have intertwined and together generated a many century long economic singularity that has upended the entire world and generated today's world.

The question you should ask, is tomorrow going to be like today? And the answer is yes; in weather, and in economics, the most likely bet bet is always "things keep on going like they have in the short term". But next week? Next month? That is often not much like today.

There is reason to believe that the yield on the above revolutions will continue to propel the economy forward, and that there are multiple promising new revolutions on the horizon.

But barring that kind of world-shaking revolution, you are not going to maintain a 5% real return on investment over another centuries for the stock market. The value of investments has to go up by a factor of over 100 in order for that to happen, and the US stock market is already close to 20 trillion dollars.

For it to have a market cap of 2 quadrillion dollars the world economy will have to be much larger than it is today. And to be that much larger, the world would have to be a much stranger place that values very different things.

We are currently roughly a K-type 0.72 civilization. A simple linear expansion of our power of 100x brings us up to K-type 0.92, which is going to cook the planet from waste heat (not from CO2, but just from the waste heat of the energy it uses!)

Efficiency can mitigate this, but only to a degree. 100x more efficient technology is going to less believable than a beanstalk and space colonies.

If you believe that the stock market is going to continue to grow at 5%/year for the next century, start investing in really out-there technologies. Gene editing, virtual and augmented reality, space beanstalks and private lift, miraculously cheap energy storage, etc. Because simply refining the technology of today won't get us there.

Modern industrial civilization has been a miracle factory. That is what pulled off that growth rate. If the miracles stop coming, so does the growth.

There is a road to it. It would involve clean energy, mass personal automation and friendly (not smarter than human) AI, and the entire world lifted up to the standard of living of the top 3% of the USA on average. But it is far from guaranteed.

Answer 6

Companies are expected to make a profit, otherwise there is no point to their existence and no motivation for investment. That profit comes back to shareholders as growth and/or dividend. If a company is doing well and has a healthy profit to turn back into investment to facilitate increased future earnings, it increases shareholder equity and share price. If a company is doing well and has a healthy profit to pay out in dividend, it makes the shares more attractive to investors which pushes the price up. Either way, shares go up. Share prices drop when companies lose money, or there are market disturbances affecting all companies (recessions), or when individual companies fail. Averaged over all companies over the long term (decades), stocks can be reasonably expected to go up.

Answer 7

Stocks "go up 5-7% every year. This has been true for the last 100 years for the S&P500 index...."

This was true in the 20th century in America. It was not true (over the whole century) for other major countries like Germany, Russia, Japan, or China. (It was more or less true for Britain and certain Commonwealth countries like Australia and Canada.) A lot of this had to do with which countries were occupied (or not) during the two world wars.

In one of his company's annual reports, Warren Buffett pointed out that the U.S. standard of living went up 6-7 times in the 20th century, that this was unprecedented (and might not be repeatable in the 21st century). The performance of the U.S. stock market in the past century is representative of those (and other) past facts. If a different set of facts prevails going forward, the U.S. stock market would be reflective of those "different" facts.

Answer 8

If by "long term" we mean another 40 years or more, then I think the answer is no. The economy is built on top of the planet's ecology and the stability of society. Unless we change our relationship to our planet, the stock market will collapse dramatically. In order to have truly long term returns, our economy must live within the carrying capacity of the planet (number of people and how much each consumes).

We are at an inflection point where the planet can no longer support accelerating consumption. As long as our means of production damages our ecology, then the stock market "growth curve" can roughly be seen as a countdown to human extinction where the clock is ticking exponentially faster each year. It's truly a bad sign that essential things which used to be free (fresh water and air) are now places that corporations look to for profit. There's demand because growing portions of the population lack these essentials. Given the threat of nuclear weapons, degrading the planet's ecology is extremely dangerous because it adds tension to nation states that are already in competition for resources (water wars, oil wars, etc).

Dr. David Suzuki: "If we pollute the air, water and soil that keep us alive and well, and destroy the biodiversity that allows natural systems to function, no amount of money will save us."

https://thebulletin.org/doomsday-clock/

Answer 9

Stock returns cannot be evaluated on its own. You need to take into account inflation and the return of other investment vehicles. Over the long run, you want to earn more than your peers (ie inflation), or lose less than them.

Stock lets you buy into the profits of a company managed by others. So the fundamental question is "do those company managers make better decision than average person?" Of course there are times when they make awful decisions (eg just before dotcom bubble), and sometimes the best decision is to close the business. But overall those people are much better educated, have higher IQ, more resourceful, etc, and so over long time and across all the companies, this is correct and hence the stock market premium.

Answer 10

A lot of these answers are strong, but at the end of the day this question really boils down to: Do you want to own things?

Duh, yes. It means you have:

• A legal claim on what's left over at the end of the day resulting from a value-added activity
• Superior information and opportunities to invest in other value-added activities
• Protect yourself from the ever-increasing prices charged by other owners

By this logic, you would expect aggregate stock prices to increase indefinitely.

Whether the price you pay for that ownership claim is worth it at any given point in time is a completely different question entirely.