On Past Returns

In the past 50 years, the American share market generated a remarkable annual return* of 9.8%. It is a common belief that the same 50-year pattern will continue in the future. I think this view is a grave mistake.

‘Studies’ about high share market yields are always based on the past and the USA, the most successful economy of the XXth century, alone. This is the true ‘survivorship bias’: retrospectively choosing the luckiest and strongest economy and capital market and concluding that entering early was a particularly profiting move (what happened to those who invested in the shares of the Russian Empire, Germany, France, Japan and Hungary though?)! Furthermore, evaluation levels, such as Shiller P/E, P/BV, have crawled even higher. So, we are talking about the increasingly expensive shares of an extremely prosperous economy; their return was high in the past. Nothing guarantees that this will continue in the future, moreover, its opposite is even more likely to happen.

– Firstly, the constant increase of evaluation rates is impossible; the bubbles of central banks will eventually deflate, so headwinds are expected from this direction
– Secondly, the profit/GDP rate, the profit rate seen here, has never been so high; profits falling back to the long-term average would come with 30-40% decrease in profits
– Thirdly, the nominal economic growth potential is probably lower than it used to – if not for anything, then because the population will not increase as much as it did in the past.

In the next 50 years, if we expect an annual 1% real increase, 2% inflation, and the profits and evaluation returning to an average, then the yield of shares – even with dividends – will be only 3-4% instead of 9-10%. Hello Neo! Welcome to the real world!

*The GDP grew by an annual 6.5% out of which 2.8% real increase, 3.7% inflation component, and 2.9% dividend yield, the change in evaluation indicators added 0.4% to the final yield.