The stock market is perfectly normal

I don’t really believe that. I am just saying that hoping to generate a stock market crash. I don’t have a job and if equities stay priced to generate low returns, then I may be screwed.

But take a look at the top two panels in the chart immediately below.  It is kind of weird, don’t you think, that the real return index for the S&P500 (and its historical analog) is right on its fitted trend line, of 6.5% a year growth, since 1870.  Spooky! Unless you believe that survivorship bias plays a role here, which I do.


The Shiller earnings yield has been historically depressed for the past couple decades, and is now 3 ¾%, just over half its long-run average of 7%.  Moreover, according to Robert Gordon’s calculations, total factor productivity (TFP) has grown at less than ½% during the past decade, which is far below the glory days of 1920 to 1970, during which it rose at almost 2% a year. *

The secular stagnationists will tell you that there is no imminent rebound in TFP coming. I am not sure the stagnationists are ultimately right, but they seem right from here til the end of the current cycle. Anyhow, if the earnings yield is low and the free growth from TFP advance is looking spare, then things don’t look so great. And yet the real return index is right on its historical trend line.

What is going on here?

Short answer: I don’t know. How would I possibly know?

But I’ll throw some spaghetti on the wall, anyway, as is my wont.  The slowdown of economic growth and earnings growth since the late 1990s, and reduced forecasts of growth looking forward, have been offset by two forces.  First, lower bond yields have offset the darkened outlook for growth, which is a wash within a market DDM.

And second, a renewed reduction of economic volatility has arguably pushed up the “fair” multiple, or pushed down the “fair” earnings yield, relative to what would otherwise be implied by a comparison of prospective growth with the risk-free return implied by bond yields.

Another way to put this is that a greater share of the lower prospective return has been drawn forward into the present.

Equities are not dramatically or even demonstrably overvalued. But the returns from here are probably shite, compared with history.  There is not necessarily any contradiction involved in making those seemingly-dissonant two points.  That’s why the stock rally has irritated people.  I wish the market would crash so returns would go back up. But what I wish and what will happen are different things. Bummer. And a novel bummer at that.

One final thought on this, which is not that serious, unlike the truly deep insights offered above, but more just for fun.  Look at the lower-right panel in the chart above. Its shows the number of months required to retake the old highs in the real total return index.  You might say it measures the duration of “bear markets”, very informally construed.

The bear markets have been getting longer as the returns have been driven lower by the higher valuation and (recently) slower growth. It took almost 12 years, to January 1985, to retake the real highs achieved just before the 1970s inflation and margin compression. And it took almost 13 years, to April 2013, to get over the effects of the NASDAQ bubble and Great Recession. No wonder there is a whole generation of financial professionals trained to see the downside.

But I don’t see any evidence that they are now in the driver’s seat. To me, equities look indistinguishable from fairly priced to deliver the crap returns that we deserve over the long haul from here. Come the next recession, they may be more attractive, but guys won’t like getting there.

Like it or lump it.

* See page 575 of The Rise and Fall of American Growth. Definitely not that I read that far. That book is way too big. But I figured a reference to that chart would be in the appendix.