Why does the stock market go up in the long term?
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Why does the stock market go up in the long term?
Everyone says: the stock market will always go up in the long term. Why is that the case?
Stock prices reflect the expected net present value of all future earnings. If a company reports lower than expected earnings the stock price tends to drop and vice versa.
Why does the stock market as a whole seem to always go up? That would seem to suggest that stocks consistently outperform expectations. Why doesn’t the stock market fluctuate up or down, but remain relatively stable? It seems to me a stock could just as easily underperform as overperform expectations.
I know that long term there are several tailwinds for earnings to increase. Inflation. Population growth. Improved productivity. New markets. Technological innovation. Etc. But all of these factors should be baked into the price of a stock. If you estimate that a company’s earnings will increase 3% a year for the next 20 years, you can buy at a price that reflects this. The only way for such a stock price to change from what you paid would be for earnings to increase faster than expected, which would lead to a stock price increase, or not as fast as you expect, leading to a stock price decrease.
For the stock market to always go up over the long term, that would seem to suggest that stocks are perpetually outperforming expectations, which doesn’t seem to make sense.
Thanks in advance everyone.
Stock prices reflect the expected net present value of all future earnings. If a company reports lower than expected earnings the stock price tends to drop and vice versa.
Why does the stock market as a whole seem to always go up? That would seem to suggest that stocks consistently outperform expectations. Why doesn’t the stock market fluctuate up or down, but remain relatively stable? It seems to me a stock could just as easily underperform as overperform expectations.
I know that long term there are several tailwinds for earnings to increase. Inflation. Population growth. Improved productivity. New markets. Technological innovation. Etc. But all of these factors should be baked into the price of a stock. If you estimate that a company’s earnings will increase 3% a year for the next 20 years, you can buy at a price that reflects this. The only way for such a stock price to change from what you paid would be for earnings to increase faster than expected, which would lead to a stock price increase, or not as fast as you expect, leading to a stock price decrease.
For the stock market to always go up over the long term, that would seem to suggest that stocks are perpetually outperforming expectations, which doesn’t seem to make sense.
Thanks in advance everyone.
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Re: Why does the stock market go up in the long term?
"Everything is worth what its purchaser will pay for it."
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Re: Why does the stock market go up in the long term?
I see no reason to disagree with the dividend discount theory of stock prices, which is, as you say, "Stock prices reflect the expected net present value of all future earnings."
The thing that you are missing is that corporations do not pay out all of those earnings as dividends--not even so-called "dividend stocks." Earnings that are not paid out as dividends are reinvested to grow the company.
Imagine an idealized situation in which a company earns 6% of its value every year, and chooses to pay out 3% of that as dividends. Then each year, the company will retain half of its earnings and grow by 3% in value. It reinvests this 3% in its capital assets, which enable its earnings to keep growing at 3% per year. So, every year, each share of stock represents 3% more in capital assets than it did the year before. It also represents a claim on a future stream of dividends that are now 3% more than they were a year before. So, the value of the stock increases by 3% per year.
I'm no cheerleader for stocks. It seems obvious to me that the stock market is a mixture with large elements of two things going on at the same time. One of them is the rational, virtuous, business-earnings activity, in which stock is issued to raise capital for a long-term growing concern, the price follows the discounted value of the future stream of earnings, and so forth. I think that activity exists. John C. Bogle says it does. Warren Buffett says it does.
At the same time, there is also a large, important, gambling element that's based on speculation, on "players" out-psyching each others' "moves," in which--like bitcoin or gold--there is no obvious anchor in economics, and the value is whatever people think it is, which is based on what other people think it is, which is based on what other people think it is.
So, it's both. But I don't believe its pure gambling, and I believe there are rational reasons to expect the stock market to go up, in the long term--at least, unless there comes a time when we reach such hard limits to economic growth that it is no longer possible for businesses to make profits.
The thing that you are missing is that corporations do not pay out all of those earnings as dividends--not even so-called "dividend stocks." Earnings that are not paid out as dividends are reinvested to grow the company.
Imagine an idealized situation in which a company earns 6% of its value every year, and chooses to pay out 3% of that as dividends. Then each year, the company will retain half of its earnings and grow by 3% in value. It reinvests this 3% in its capital assets, which enable its earnings to keep growing at 3% per year. So, every year, each share of stock represents 3% more in capital assets than it did the year before. It also represents a claim on a future stream of dividends that are now 3% more than they were a year before. So, the value of the stock increases by 3% per year.
I'm no cheerleader for stocks. It seems obvious to me that the stock market is a mixture with large elements of two things going on at the same time. One of them is the rational, virtuous, business-earnings activity, in which stock is issued to raise capital for a long-term growing concern, the price follows the discounted value of the future stream of earnings, and so forth. I think that activity exists. John C. Bogle says it does. Warren Buffett says it does.
At the same time, there is also a large, important, gambling element that's based on speculation, on "players" out-psyching each others' "moves," in which--like bitcoin or gold--there is no obvious anchor in economics, and the value is whatever people think it is, which is based on what other people think it is, which is based on what other people think it is.
So, it's both. But I don't believe its pure gambling, and I believe there are rational reasons to expect the stock market to go up, in the long term--at least, unless there comes a time when we reach such hard limits to economic growth that it is no longer possible for businesses to make profits.
Last edited by nisiprius on Tue Apr 16, 2019 8:47 am, edited 1 time in total.
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Re: Why does the stock market go up in the long term?
I've always held the long term view that it's due to the increase in population, world-wide.
More people? More goods and services required, regardless of the current state of economy from developing to fully developed countries.
I'm a simple person and therefore think in simple solutions ...
- Ron
More people? More goods and services required, regardless of the current state of economy from developing to fully developed countries.
I'm a simple person and therefore think in simple solutions ...
- Ron
Re: Why does the stock market go up in the long term?
As well as future technologies that allow for ? in the future.Ron wrote: ↑Tue Apr 16, 2019 8:33 am I've always held the long term view that it's due to the increase in population, world-wide.
More people? More goods and services required, regardless of the current state of economy from developing to fully developed countries.
I'm a simple person and therefore think in simple solutions ...
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Re: Why does the stock market go up in the long term?
It's because the economy as a whole has consistently expanded throughout modern human history (as long as there have been stock markets). Generally, public companies have captured a portion of that growth. The economy has expanded due to population increase and efficiency increased spurred by technology.
Of course, there were times when this was not the case (Europe after the fall of Rome, for example). Political instability and warfare tend to be the biggest factor in large-scale long-term decline.
Of course, there were times when this was not the case (Europe after the fall of Rome, for example). Political instability and warfare tend to be the biggest factor in large-scale long-term decline.
Re: Why does the stock market go up in the long term?
If markets are reasonably efficient, then stocks should have a higher expected return than risk free investments. Stocks are suppsed to be priced low enough that they are expected to outperform safe investments. Because why would anyone own a stock if they could get the same return with lower or virtually no risk?
In some causes, stocks do even better than expected, but even in periods in which stocks don’t beat expectations, you are “supposed to” get a premium over risk-free investments, the so-called risk-premium.
In some causes, stocks do even better than expected, but even in periods in which stocks don’t beat expectations, you are “supposed to” get a premium over risk-free investments, the so-called risk-premium.
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Re: Why does the stock market go up in the long term?
A senior multi-gazillionaire mentor put it this way (I was told this in the 60's):Ron wrote: ↑Tue Apr 16, 2019 8:33 am I've always held the long term view that it's due to the increase in population, world-wide.
More people? More goods and services required, regardless of the current state of economy from developing to fully developed countries.
I'm a simple person and therefore think in simple solutions ...
- Ron
The economy will always grow. For example: Gerber Baby Food. The world will always make babies and more babies. Which means more baby food and more baby food. So, you're investing in the long term economy of the population of the world.
Fellow simple person.
jim
Last edited by Sandtrap on Tue Apr 16, 2019 8:53 am, edited 1 time in total.
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Re: Why does the stock market go up in the long term?
Because those high returns are not guaranteed. Other world markets have sometimes seem catastrophe. Also over shorter times anything can happen.
If the stock market prices in its future gain potential by rising to a much higher level, then future returns would decline. If they declines sufficiently then they wouldn't be much above lower risk investments to warrant taking on the risk.
If the stock market prices in its future gain potential by rising to a much higher level, then future returns would decline. If they declines sufficiently then they wouldn't be much above lower risk investments to warrant taking on the risk.
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Re: Why does the stock market go up in the long term?
Yes, this hits the nail on the head, I believe. The history of GDP-per-capita growth has been one of amazingly steady expansion over two centuries — with exception of a few world wars, depressions and financial crises (chart below).alfaspider wrote: ↑Tue Apr 16, 2019 8:40 am It's because the economy as a whole has consistently expanded throughout modern human history (as long as there have been stock markets). Generally, public companies have captured a portion of that growth. The economy has expanded due to population increase and efficiency increased spurred by technology.
NOTE: Values are real (inflation-adjusted) GDP per-capita.
Data source: Maddison Project
Last edited by SimpleGift on Tue Apr 16, 2019 9:45 am, edited 1 time in total.
Re: Why does the stock market go up in the long term?
Over time the trend is for the stock market to go up but it doesn't always go up, stock markets can and have gone to zero or stagnate for long periods of time. We are rewarded for one thing in life: assuming risk. Without risk there would be no room for return, and that's true of financial markets, marriages, careers, and everything else in life.
History shows us a country's share of worldwide GDP rises and falls, having a well diversified global portfolio does more than tame volatility, it also prepares the portfolio for the inevitable collapse of US domination of worldwide GDP. That may happen in our lifetime or 200 years but it will happen and most people wont see it coming.
History shows us a country's share of worldwide GDP rises and falls, having a well diversified global portfolio does more than tame volatility, it also prepares the portfolio for the inevitable collapse of US domination of worldwide GDP. That may happen in our lifetime or 200 years but it will happen and most people wont see it coming.
Re: Why does the stock market go up in the long term?
Is this chart inflation adjusted? According to google, $100 in 1830 inflation adjusted to the year 2000 becomes $1871. Therefore $1000 in 1830 dollars (roughly where some of the lines start) is worth $18710 in the year 2000.SimpleGift wrote: ↑Tue Apr 16, 2019 9:10 amYes, this hits the nail on the head, I believe. The history of GDP-per-capita growth has been one of amazingly steady expansion over two centuries — with exception of a few world wars, depressions and financial crises (chart below).alfaspider wrote: ↑Tue Apr 16, 2019 8:40 am It's because the economy as a whole has consistently expanded throughout modern human history (as long as there have been stock markets). Generally, public companies have captured a portion of that growth. The economy has expanded due to population increase and efficiency increased spurred by technology.
I'll submit that there's not a variable in financial history that has shown a more consistent, straight-line expansion over 200 years than global GDP per-capita growth — and public companies reflect this growth, to the benefit of their shareholders.
Data source: Maddison Project
Does it make sense to attribute some of stock market growth to inflation - in the sense that a dollar this year is worth less than a dollar in the future?
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Re: Why does the stock market go up in the long term?
Yes. This is the documentation that comes with the latest 2018 version of the Maddison database:
I've edited the original post to clarify this point. Thank you.Maddison Project wrote:We implement a multiple benchmark approach for the MPD based, primarily, on (i) post-1950 price benchmarks (as also used in Penn World Tables) and (ii) pre-1950 real GDP per capita benchmarks based on a variety of historical studies.
Re: Why does the stock market go up in the long term?
I wish I could remember which boglehead said this a couple years ago when the subject came up. He was referring to both individual companies and industry as a whole:
"It's not a closed system; work is the input."
I read "work" as meaning both the inspiration and the perspiration that goes into growing a business.
"It's not a closed system; work is the input."
I read "work" as meaning both the inspiration and the perspiration that goes into growing a business.
"I know nothing."
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Re: Why does the stock market go up in the long term?
I concur with the other posters re demographics and technological growth. As long as there is room for people to grow and they are in fact growing, so will the "money" necessary for use by people.
Re: Why does the stock market go up in the long term?
Because people buy stock to make money. If the price of a stock was bid up to the point that the expected return over the next 20 years was zero, then no one would buy it. People do their best to evaluate all the factors you mention and bid up the price of stock to the point that there is an expected long term payoff that is worth it given the risk.FatFire87a wrote: ↑Tue Apr 16, 2019 8:00 am I know that long term there are several tailwinds for earnings to increase. Inflation. Population growth. Improved productivity. New markets. Technological innovation. Etc. But all of these factors should be baked into the price of a stock. If you estimate that a company’s earnings will increase 3% a year for the next 20 years, you can buy at a price that reflects this.
Re: Why does the stock market go up in the long term?
Because every 2 weeks you have massive inflows from 401k contributions.
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Re: Why does the stock market go up in the long term?
Because (some) work adds value, or at least perceived value.
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Re: Why does the stock market go up in the long term?
It makes sense to me that the market always goes up at least with inflation and GDP. I think it remains to be seen whether it will "always" go up at the historical return of the S&P500. Certainly we are aware of international markets that have had lower return over long periods.
Re: Why does the stock market go up in the long term?
Warren Buffet said this in one of his annual letters...
“American GDP per capita is now about $56,000. In real terms – that’s a staggering six times the amount in 1930, the year I was born, a leap far beyond the wildest dreams of my parents or their contemporaries. U.S. citizens are not intrinsically more intelligent today, nor do they work harder than did Americans in 1930. Rather, they work far more efficiently and thereby produce far more. This all-powerful trend is certain to continue: America’s economic magic remains alive and well."
So the 2 reasons that markets will always go up long term are Productivity Improvements and Innovation
Buffet said this about Productivity: “America’s population is growing about .8% per year (.5% from births minus deaths and .3% from net migration). Thus 2% of overall growth produces about 1.2% of per capita growth. That may not sound impressive. But in a single generation of, say, 25 years, that rate of growth leads to a gain of 34.4% in real GDP per capita."
Basically more people are bound to produce more goods & services.
Innovation is self explanatory. Technological advances are everywhere and will continue in the future.
“American GDP per capita is now about $56,000. In real terms – that’s a staggering six times the amount in 1930, the year I was born, a leap far beyond the wildest dreams of my parents or their contemporaries. U.S. citizens are not intrinsically more intelligent today, nor do they work harder than did Americans in 1930. Rather, they work far more efficiently and thereby produce far more. This all-powerful trend is certain to continue: America’s economic magic remains alive and well."
So the 2 reasons that markets will always go up long term are Productivity Improvements and Innovation
Buffet said this about Productivity: “America’s population is growing about .8% per year (.5% from births minus deaths and .3% from net migration). Thus 2% of overall growth produces about 1.2% of per capita growth. That may not sound impressive. But in a single generation of, say, 25 years, that rate of growth leads to a gain of 34.4% in real GDP per capita."
Basically more people are bound to produce more goods & services.
Innovation is self explanatory. Technological advances are everywhere and will continue in the future.
Re: Why does the stock market go up in the long term?
Actually, some say “will always”. Others, more accurately, say “tends to”.FatFire87a wrote: ↑Tue Apr 16, 2019 8:00 am Everyone says: the stock market will always go up in the long term. Why is that the case?
Assuming that valuations are bounded within a finite range, this tendency relies on earnings growth net of inflation. Which in turn relies on productivity increases and/or market expansion.
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Re: Why does the stock market go up in the long term?
Tentative summary of why the stock market always goes up (if not smoothly) based on the above comments:
Too much overlap?
Things missung?
Things wrong?
- Population growth
- GDP/population (Is this a result of 3, 4, 5, more?)
- Accumulating work product (e.g. infrastructure)
- Accumulating/improving technology (information, communications, travel)
- Accumulating knowledge/skill/effectiveness (farming techniques, political organization -- i.e. free market capitalism. Need a better overall term?)
Too much overlap?
Things missung?
Things wrong?
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Re: Why does the stock market go up in the long term?
Thank you for everyone’s response. With all due respect to several posters who cite growth in GDP per capita, technological innovation, population growth, etc. I think you missed my point. I mentioned these factors in my original post. These factors will increase earnings over the long-term, but the price should reflect these increases in earnings. A company that returns $1 next year, $2 the year after, and an extra dollar every year after that due to the above-factors, will have a price that is the present value of these future earnings.
For those posters who brought up the risk premium, thank you, that’s something I didn’t consider. If, for example, the right risk spread is 5%, ie bonds returning 2% and stocks returning 7%, and dividends are only 2%, then stocks would have to appreciate 5% every year forever to return 7%.
At least for me, that answers the question. Thanks again.
For those posters who brought up the risk premium, thank you, that’s something I didn’t consider. If, for example, the right risk spread is 5%, ie bonds returning 2% and stocks returning 7%, and dividends are only 2%, then stocks would have to appreciate 5% every year forever to return 7%.
At least for me, that answers the question. Thanks again.
Re: Why does the stock market go up in the long term?
OP, even if there is no earnings growth and no change of expectations stocks should still go up, as future earnings are (in theory) discounted at a risk adjusted rate. In the extreme simple case, imagine there is a company comprised of only one share and its business is only one, risky cash flow of $1 million 1 year from now - after paying this, the company just disappears. The 1y "risk free rate" is 2%. If you are a risk averse rational investor, you'd obviously pay less than $1 million/1.02 for this company. Let's say you'd pay something like $1 million/1.1 = $909k. However, after one year, the stock is worth $1 million, since you got the expected cash flow. Hence, stock price goes up just for fulfilling expectations.
Re: Why does the stock market go up in the long term?
And also plain inflation?
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Re: Why does the stock market go up in the long term?
Stocks do tend outperform expectations. The problem is that you don't know which stocks will outperform expectations, and by how much.FatFire87a wrote: ↑Tue Apr 16, 2019 8:00 am For the stock market to always go up over the long term, that would seem to suggest that stocks are perpetually outperforming expectations, which doesn’t seem to make sense.
This tend-to-outperform expectation is partially reflected in stock prices. Most stocks have slightly negative returns. The performance of the market as a whole is largely driven by the right tail of astronomical returns.
Current portfolio: 60% VTI / 40% VXUS
Re: Why does the stock market go up in the long term?
My guess is economic growth largely due to increases in productivity. I'd be skeptical about attributing economic growth to population growth for a number of reasons.
Productivity increases are not a sure thing, especially over the short term. And our investing horizons are relatively short term.
The stock market is not steady because people's willingness to hold risky assets is not highly dependent on expected economic growth over decades and centuries.
JT
Productivity increases are not a sure thing, especially over the short term. And our investing horizons are relatively short term.
The stock market is not steady because people's willingness to hold risky assets is not highly dependent on expected economic growth over decades and centuries.
JT
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Re: Why does the stock market go up in the long term?
Because, over the long run, more people will buy stocks than sell them.
Where else are people going to put their money if they want it to grow in a qualified retirement plan?
Where else are people going to put their money if they want it to grow in a qualified retirement plan?
Potential - distraction = performance.
Re: Why does the stock market go up in the long term?
I wonder if the widespread adoption of retirement accounts like 401ks, low cost investment vehicles, more knowledge available with the internet , more indexing has created a situation where the market is more likely to keep going up since more people are buying?
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Re: Why does the stock market go up in the long term?
Also, natural resources are extracted and innovations are invented. Both of those activities add value.
Re: Why does the stock market go up in the long term?
The stock market goes up over the long term because of overall economic growth. You never see a public company whose goal is to just maintain the existing level of sales. They all want to grow! So as companies have more and more sales, they tend to be more valuable. Add them all up and you have economic growth. As someone mentioned above, the ability to do this is largely from productivity. As companies find ways to do things more efficiently (automation for example), they can produce more goods or services with the same (or less) number of people. Stated another way, the output per person increases.FatFire87a wrote: ↑Tue Apr 16, 2019 8:00 am Everyone says: the stock market will always go up in the long term. Why is that the case?
During a recession, consumers spend less and the economy contracts. With less demand, companies produce less, often resulting in layoffs which further reduces demand. With less sales, companies are less profitable, therefore less valuable, and the stock price falls.
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Re: Why does the stock market go up in the long term?
Growth isn't infinite but index replacement could make it seem that way. Even at zero % real growth companies that have peaked and falter are replaced by companies that have a better place in the economy. As Sears declines Amazon, Walmart, and a few others benefit in fresh markets.
Overproduction, excessive debt, and bankruptcy shrink the field and those with better balance sheets rise along with those with innovative approaches, usually by surprise.
There's still be a S&P 500 but at zero growth it could be somewhat deflated. Don't want to get too confident.
Overproduction, excessive debt, and bankruptcy shrink the field and those with better balance sheets rise along with those with innovative approaches, usually by surprise.
There's still be a S&P 500 but at zero growth it could be somewhat deflated. Don't want to get too confident.
age in bonds, buy-and-hold, 10 year business cycle
Re: Why does the stock market go up in the long term?
At constant P/E (i.e. market valuation) going from $1 to $2 will double the "P".FatFire87a wrote: ↑Tue Apr 16, 2019 11:43 am Thank you for everyone’s response. With all due respect to several posters who cite growth in GDP per capita, technological innovation, population growth, etc. I think you missed my point. I mentioned these factors in my original post. These factors will increase earnings over the long-term, but the price should reflect these increases in earnings. A company that returns $1 next year, $2 the year after, and an extra dollar every year after that due to the above-factors, will have a price that is the present value of these future earnings.
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Re: Why does the stock market go up in the long term?
Also, survivorship bias. As OP pointed out, some companies lose value, and some companies even fail. OP asked about "the Stock Market" which at any given time does not include prices/valuations from failed companies, even if individual investors are still hurt by the losses. Indexes are usually tweaked to drop losers before they crater entirely, which is another great reason to use index-tracking funds.FatFire87a wrote: ↑Tue Apr 16, 2019 11:43 am With all due respect to several posters who cite growth in GDP per capita, technological innovation, population growth, etc. I think you missed my point. I mentioned these factors in my original post. These factors will increase earnings over the long-term, but the price should reflect these increases in earnings. A company that returns $1 next year, $2 the year after, and an extra dollar every year after that due to the above-factors, will have a price that is the present value of these future earnings.
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Re: Why does the stock market go up in the long term?
The thread asks "Why does the stock market go up in the long term?", not "how can the value of a stock increase over time?". The value of any company's stock can increase over time while the value of the stock market goes down. Ever seen the value of the stock market go up during a sell off??
Potential - distraction = performance.
Re: Why does the stock market go up in the long term?
I think they are causally related. The value of individual stocks goes up over time, and consequently the value of the stock market goes up over time. At least that is what I meant to imply. And I think that is true even if there are not more people buying stocks than selling.Mofritty wrote: ↑Tue Apr 16, 2019 3:39 pmThe thread asks "Why does the stock market go up in the long term?", not "how can the value of a stock increase over time?".
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Re: Why does the stock market go up in the long term?
The stock market goes for the same reason that GDP grows, and standards of living grow: productivity. In basic terms, productivity means that we have gotten much better at getting more out of every unit of input we put into everything we do. It's not just a matter of gross consumption, but also the qualitative gains in all of that consumption per dollar of input.
A 2019 Toyota Corolla is by every measurable criteria far superior to a Rolls Royce Phantom, and costs a fraction of the price (measured in both inflation-adjusted dollars, or in terms of the number of hours the average person has to work in order to afford it). The reason for that is that we have grown much better at every aspect of building cars over the last hundred years (including all the required secondary industries, like steel production, plastics, and computers). In fact, we are vastly superior at very nearly everything; that consumer surplus between the price of making stuff, versus the quality of that stuff, is equal to the productivity gains over time.
The stock market's value is not exactly the same as all of that productivity or the consumer surplus it creates, but it is correlated with it. It is entirely possible that the global economy might contract due to nuclear war, or global climate change. Alternately, it is entirely possible it will continue to grow due to increased trade and economic liberalization around the world, or we discover a means of producing cheap, plentiful, clean energy.
(I'm actually more optimistic on the latter than the former. The former depends on politics; the latter depends on engineering, and I believe we are not far from having Thorium Molten Salt Reactors commercially available. And once we do, the implications of cheap clean energy would be staggering).
A 2019 Toyota Corolla is by every measurable criteria far superior to a Rolls Royce Phantom, and costs a fraction of the price (measured in both inflation-adjusted dollars, or in terms of the number of hours the average person has to work in order to afford it). The reason for that is that we have grown much better at every aspect of building cars over the last hundred years (including all the required secondary industries, like steel production, plastics, and computers). In fact, we are vastly superior at very nearly everything; that consumer surplus between the price of making stuff, versus the quality of that stuff, is equal to the productivity gains over time.
The stock market's value is not exactly the same as all of that productivity or the consumer surplus it creates, but it is correlated with it. It is entirely possible that the global economy might contract due to nuclear war, or global climate change. Alternately, it is entirely possible it will continue to grow due to increased trade and economic liberalization around the world, or we discover a means of producing cheap, plentiful, clean energy.
(I'm actually more optimistic on the latter than the former. The former depends on politics; the latter depends on engineering, and I believe we are not far from having Thorium Molten Salt Reactors commercially available. And once we do, the implications of cheap clean energy would be staggering).
- Phineas J. Whoopee
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Re: Why does the stock market go up in the long term?
I think the titular question has a flaw, and should read why did the stock market go up in the long term.
What's the long term? What's the stock market?
Investors in Imperial Russia experienced a collapse of stock and bond prices, to zero. The same happened in Revolutionary China and countless other places.
How much are Roman Empire companies earning these days? Is that not the long term?
Why has it gone up for several decades in the United States? One could postulate reasons. Does it go up over the long term? Will it go up over the long term? That's a matter of faith.
A century ago the Argentina stock market was the best performing. Is it now?
I'm expressing my opinion. I am substantially invested in global stocks. They may go up, sideways, down, or lose all value whatsoever. In the long run we're all dead.
PJW
What's the long term? What's the stock market?
Investors in Imperial Russia experienced a collapse of stock and bond prices, to zero. The same happened in Revolutionary China and countless other places.
How much are Roman Empire companies earning these days? Is that not the long term?
Why has it gone up for several decades in the United States? One could postulate reasons. Does it go up over the long term? Will it go up over the long term? That's a matter of faith.
A century ago the Argentina stock market was the best performing. Is it now?
I'm expressing my opinion. I am substantially invested in global stocks. They may go up, sideways, down, or lose all value whatsoever. In the long run we're all dead.
PJW
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Re: Why does the stock market go up in the long term?
Because there are millions of hard working people at thousands of public corporations working really hard every day to compete in a capitalist economy to try and out do each other for the best product, service or both. The worst a stock can do is become worthless. The best a stock can do is unlimited potential. The net result is a generally lurching grinding upward movement of stocks of public companies ultimately in aggregate.
“You only find out who is swimming naked when the tide goes out.“ — Warren Buffett
Re: Why does the stock market go up in the long term?
GDP growth + Inflation + Survivorship bias + Market cap weighting = rising stock market (*indexes*) over the long term. Plain and simple.
There’s no mystery here, tin foil hats are not needed...
There’s no mystery here, tin foil hats are not needed...
- White Coat Investor
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Re: Why does the stock market go up in the long term?
It seems to me that every buyer has a seller and vice versa. This explanation for stock market movement never made sense to me.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy |
4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course
Re: Why does the stock market go up in the long term?
Yes, but the sellers are not selling the same thing they bought.White Coat Investor wrote: ↑Tue Apr 16, 2019 5:34 pm It seems to me that every buyer has a seller and vice versa.
Re: Why does the stock market go up in the long term?
FatFire87a wrote: ↑Tue Apr 16, 2019 8:00 am Everyone says: the stock market will always go up in the long term. Why is that the case?
Stock prices reflect the expected net present value of all future earnings. If a company reports lower than expected earnings the stock price tends to drop and vice versa.
Why does the stock market as a whole seem to always go up? That would seem to suggest that stocks consistently outperform expectations. Why doesn’t the stock market fluctuate up or down, but remain relatively stable? It seems to me a stock could just as easily underperform as overperform expectations.
I know that long term there are several tailwinds for earnings to increase. Inflation. Population growth. Improved productivity. New markets. Technological innovation. Etc. But all of these factors should be baked into the price of a stock. If you estimate that a company’s earnings will increase 3% a year for the next 20 years, you can buy at a price that reflects this. The only way for such a stock price to change from what you paid would be for earnings to increase faster than expected, which would lead to a stock price increase, or not as fast as you expect, leading to a stock price decrease.
For the stock market to always go up over the long term, that would seem to suggest that stocks are perpetually outperforming expectations, which doesn’t seem to make sense.
Thanks in advance everyone.
I dislike with the statement that "Stock prices reflect the expected net present value of all future earnings", almost to the point of direct disagreement.
That definition is sufficiently ambiguous and amorphous that it's going to mislead you when it comes to valuation. When you try to think about questions like "why does the stock market go up in the long run", it just doesn't impel any particular direction. It does no real work as a definition in my opinion.
I think of stock as your share of the shareholders equity in the company. That to me is a much better definition. It reflects the legal reality of what you own when you buy stock. Assets = Liabilities + Equity. Therefore, a better definition of a stock is the delta of the assets over the liabilities. If you find for instance that there is no equity, that liabilities exceed assets, then it impels the notable point that legally you are buying something worth zero, or even negative in value, so that if you are to profit, you are doing so based on that company's chance of turning things around, while they can still pay their liabilities as a going concern.
This definition lets you see deeper. Not every company pays dividends. What does the stock price have to say about that?
Suppose I start a company with 10 shares. Suppose for simplicities sake, there are no property taxes, the assets are a plot of attractive land, and there are no liabilities. Why does your share rise in value? There is no dividends to be had here. The company is inert.
But your stock price will rise as the value of the land, which is the only equity the company has, rises in market value.
If you stick with this net present value of all future earnings, its an awkward and I'll be so bold as to claim, erroneous view of the stock. Shareholder's equity may well increase despite having no stream of future earnings. But corporate management which is successful in increasing your equity should also increase your wealth as a result.
Secondly, the stock as it exists under US law, allows you the power to vote out management. Power is money. That vote is worth something. It is worth something both intrinsically as a legal right you own, and because it is a check on poor management. Once again, the simplistic view of valuation of a stream of cash flows is kind of a hollow definition. Yes I know that is is taught. But in my opinion, it mucks up thoughtful consideration.
Finally, you ran into trouble when using that definition did you not? Perpetually outperforming expectations?
Here's an analysis using the legal definition of the stock. As a stockholder, you own your respective share of the equity---whats left over after liabilities. That equity includes all things considered assets, including land, property. All of those will rise in price over time, as a function of inflation. To the extent the company is able to grow those assets---building new factories, developing land, increasing the value of physical or intangible enterprise, so too will your share price grow.
Thus by using the legal definition of a stock, is it easier to see why your stocks can keep appreciating. They will increase by virtue of inflation alone, by virtue of applying the funds to increase the value of existing assets, and even the increase in aggregate demand for those assets from a rising population (which i did not get into)
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Re: Why does the stock market go up in the long term?
These are my two reasons, but no one really knows what the future will bring. I do know that investors that have been optimists have been rewarded handsomely.
1. Returns and risk have correlations. If you take higher risks with low fees, you should be rewarded with higher returns.
2. Being a owner instead of a loaner should give you better returns.
Think about it. Would you rather loan money to corporations, or would you rather be the corporation?
1. Returns and risk have correlations. If you take higher risks with low fees, you should be rewarded with higher returns.
2. Being a owner instead of a loaner should give you better returns.
Think about it. Would you rather loan money to corporations, or would you rather be the corporation?
Re: Why does the stock market go up in the long term?
You are assuming stationary holdings. The increase based on inflation is not a real increase; let's focus on real gains. The increase due to higher demand (increasing population, or scarcity) is not sustainable; that goes together with the valuation effect, which is bounded.TomCat96 wrote: ↑Tue Apr 16, 2019 8:05 pm Thus by using the legal definition of a stock, is it easier to see why your stocks can keep appreciating. They will increase by virtue of inflation alone, by virtue of applying the funds to increase the value of existing assets, and even the increase in aggregate demand for those assets from a rising population (which i did not get into)
The point is that stocks prices, in aggregate naturally, tend to increase because they represent ownership of a growing asset. Remove the growth and there is no good reason for expecting continuing positive real returns.
Re: Why does the stock market go up in the long term?
Increase based on inflation is absolutely not a real increase. But my point was a contention with the definition used. Seeing stocks as units of ownership in equity allows one to see both how stocks can grow, and how stock appreciation is tied to inflation, whereas most fixed income by contrast is not.Thesaints wrote: ↑Tue Apr 16, 2019 8:35 pmYou are assuming stationary holdings. The increase based on inflation is not a real increase; let's focus on real gains. The increase due to higher demand (increasing population, or scarcity) is not sustainable; that goes together with the valuation effect, which is bounded.TomCat96 wrote: ↑Tue Apr 16, 2019 8:05 pm Thus by using the legal definition of a stock, is it easier to see why your stocks can keep appreciating. They will increase by virtue of inflation alone, by virtue of applying the funds to increase the value of existing assets, and even the increase in aggregate demand for those assets from a rising population (which i did not get into)
The point is that stocks prices, in aggregate naturally, tend to increase because they represent ownership of a growing asset. Remove the growth and there is no good reason for expecting continuing positive real returns.
edit: besides. I greatly dislike discussions of inflation and focusing on the real component because such argumentation is superfluous. Where does it lead? Suppose I argue stocks grow 7% a year, 3% of that is inflation 4% is real. Let's now talk bonds. Bonds grow by 4%. Where's the inflation talk there? Don't you mean 1% real? Again you have to discount the bond growth by inflation do you not?
Unless your bond growth is quoted in real terms (like TIPS), it just more math. It mucks up the point trying to be made.
Let's talk about how real estate grows at 2-3% a year. Inflation? What's the real growth? 0?
If you want to include it in the discussions, you must include it in all discussions of growth, otherwise you will penalize your analysis of the growth of stocks without penalizing your analysis of the growth of any other asset class you are comparing it to.
If you include it for all, then it is implicit. It makes no sense to use one inflation computation when talking about stock growth, but using a different computation in the context of another discussion. The inflation correction...computing the real component basically is a constant then, to be equally applied to all points of the discussion. So then what's the point? It only makes sense to talk about real vs nominal when that is the issue at hand. Otherwise it's just a point people seem to like making for the sake of making it.
- gmaynardkrebs
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Re: Why does the stock market go up in the long term?
Earnings are only half the story.. Most of the stock market gains lately have been due to P/E expansion. The price people are willing to pay for $1 of earnings has increased at a greater rate than the earnings themselves.FatFire87a wrote: ↑Tue Apr 16, 2019 8:00 am The only way for such a stock price to change from what you paid would be for earnings to increase faster than expected, which would lead to a stock price increase, or not as fast as you expect, leading to a stock price decrease.
Last edited by gmaynardkrebs on Wed Apr 17, 2019 8:32 am, edited 1 time in total.
- Orbuculum Nongata
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Re: Why does the stock market go up in the long term?
Of course there are not more stocks being sold than bought, but can you explain fluctuation in price independent of value without including demand. Sellers wanting to sell have to sell for less than they paid to create a demand that is no longer there. If this weren’t real would there ever be any discussion whatsoever on market timing?White Coat Investor wrote: ↑Tue Apr 16, 2019 5:34 pmIt seems to me that every buyer has a seller and vice versa. This explanation for stock market movement never made sense to me.
Potential - distraction = performance.
- Orbuculum Nongata
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Re: Why does the stock market go up in the long term?
A great example of there being less buyers than sellers is a company stock buyback whereby demand is low, price is suppressed, there is one buyer offering the suppressed market rate and there are many individual sellers. Number of stocks bought vs sold is equal. Number of buyers vs sellers is disproportionate.White Coat Investor wrote: ↑Tue Apr 16, 2019 5:34 pmIt seems to me that every buyer has a seller and vice versa. This explanation for stock market movement never made sense to me.
Potential - distraction = performance.