The Future of the Stock Market
How do you predict the future of the stock market?
Simple - by making two easier predictions about (1) the economy and (2) market valuations:
- How fast will corporate earnings grow?
- How much will P/E ratios change?
This calculator lets you run the numbers:
* Updated Jan 1, 2013
(Source: multpl.com. P/E is Shiller's PE10.)
Adding dividends to the change in the price level gives you total return:
Note that the huge wildcard here is the change in the P/E ratio, which can totally dominate the results.
If P/E ratios drop significantly, your returns may be crummy.
Inflation and Stock Returns
In 1979, Business Week ran a cover story titled
The Death of Equities - an article derided today as an example of mindless fear right before the greatest bull market ever.
But that judgment is unfair, because the article really explains how inflation had been bad for the stock market for two specific reasons:
- Inflation is bad for corporate earnings
(See the Business Week article, or this 1977 article by Warren Buffett, for details.)
- Inflation leads to lower P/E ratios
(That's because investors seek inflation hedges and wind up doing strange things, like buying gold at record highs instead of stocks at reasonable prices.)
In the 1970s the US government increased the money supply in order to finance the deficit (and let people blame the resulting inflation on the Arabs' raising oil prices).
Now that Big Deficits are back, we have to hope that our politicians won't try to feed us the same old witches' brew of inflation and scapegoats.