This is MoneyClub

Stocks for the Long Run
Part 2: Valuation, Style Investing, and Global Markets.
Chapter 8

-What are the most important macrotrends in the economy that influence future stock market returns?
-Economic growth
-Stability of the overall economy
-reduction in transactions costs
-change in taxes on stock market income
-most importantly: the hundreds of millions of baby boomers planning to finance their retirement by selling their financial assets.
-the chapter comes to the conclusion that the long-term future of equity returns looks bright if the US keeps its capital markets open to the rest of the world.

-GDP Growth and Stock Returns.
-Suprising result: Plotting real GDP growth vs stock market returns of 16 developed markets and 25 developing markets shows GDP growth is negatively correlated with stock market returns. Why?
-Economic growth positively influences aggregate earnings and dividends, not per share earnings and dividends, which is part of stock market performance.
-Economic growth spurs technological improvement and investment which is funded by debt (adding interest cost) or equity (diluting earnings)
-While this may be mitigated by available capacity, history shows us that capital formation has grown in proportion with GDP – a 10% rise in GDP ultimately leads to a 10% rise in the capital stock.

-The low growth of real earnings per share caused economists to predict low future real returns for the stock market. But Siegel shows that they ignored the impact of the lower dividend-payout ratio on earnings growth. If Stock price P = dividend / (return-growth of future dividends), a lower dividend that causes a more than proportional increase in future dividend growth will still increase price.

Factors that raise valuation ratios
-We have established that historical returns on equity has been around 7%p.a. with an average PE ratio of 15. There may have been recent structural changes to this ratio.
-2 Changes to the expected rate of the return on equities
–Reduction in taxes on equity return (Chapter 5)
–Reduction in transactions costs. Research from Columbia’s Charles Jones reveals that fees paid to brokers as well as the bid-ask spread shows the average one-way cost to buy/sell a stock has dropped from over 1% of value as late as 1975 (before deregulation of brokerage fees) to under 0.18% today. Benefits: less costly to diversify, and, overall, stocks increase in liquidity and therefore in value.
-2 Change to the equity risk premium
–Historically, this has been around 3.5%. However, research has shown that increased knowledge of superior stock returns would cause a decrease in the equity risk premium. Studies show today’s historical premium to be as low as 1%.
–More stable economy: THere has been a major reduction in economic volatility over time since 1929. This trend has been called “The Great Moderation”, attributed to better monetary policy, a larger service sector, better inventory/production control helped by the information revolution.
-The lower the equity premium, the higher will be the valuation of stocks relative to economic fundamentals. This may also mean the average historical PE may not be appropriate any longer. One might justify ratios in the low 20s for the equity market.

The Age Wave
-Over the next 2 decades, nearly a quarter billion Americans, Europeans, and Japanese will leave the labor force. “Demography is the future that has already happened.”
-Though we know Social Security and Medicare will be threatened, private pensions will also be threatened. The assets of wealth can be transformed to goods and services only if they are sold to those willing to defer their consumption. if there is a shortage of savers in the future, retirees will have insufficient assets.
-Because of our aging population, it is most likely future increases in the age of retirement will exceed the increase in life expecatncy and cause an absolute reduction in the number of years in retirement.
-There is a solution that can help aging economies. the developing world is much younger: this is the “Global Solution” to the age wave – a graph shows that trade with a developing world that is growting at 8% will bring the retirement age down to below 60. The developing world has the capability of simultaneously providing us with goods and acquiring our assets.
-Why would developing countries wish to acquire American capital? we saw that the best returns are rarely found in countries that grow the fastest. Other reasons: US brand names, innovation, higher education.
-Conclusion: our nonreceptiveness to international capital has caused movement to London as the world’s financial capital. Resisting globalizing trends will lower our future returns and living standards.