The S&P 500 Composite Price Index was only created in 1957 and indexed back to a base period of 1941-1943. So Doug maybe being very generous in his analysis. Get my drift?
Your email pal,
Tom L.
Greg Nowell wrote:
> On the subject of why the total returns to stocks,
> using 30-year moving avg, is higher than growth in GDP.
>
> Question: Apples n oranges? Should we use a 30-year
> "look back weighted average" on GDP?
>
> Discussion:
>
> I think one of the problems is that Doug is assuming an
> "ergodic" relationship between stock prices and GNP
> growth (and total returns traditionally include prices
> with the assumption of dividends reinvested in the same
> stock index, but before taxes and not counting
> transaction fees). Doug may roll his eyes. But
> really, asset valuation is not necessarily an
> inherently logical process.
>
> In particular, we might break a stock "price" down in
> the following way. To make it concrete let's assume a
> $100 stock. Assume a car factory.
>
> $25 might be the actual physical cost of setting up the
> factory.
> $15 might be the "brand effect" -- why you with your
> factory that is long established have a putative
> advantage over someone with an identical factory but
> just starting out.
> $25 might be a "bid to normal rate of return effect."
> By this I mean that if the 30 year govt bond rate of
> return is 5%, you might demand a 7% return on a stock
> with a higher risk premium. If the car can be made and
> marketed at a nominal cost of $40 a share but pays
> dividends of, say, 50% at that price, then it is
> clearly undervalued. The price will be bid up to the
> "risk adjusted rate of return." But we're not done
> yet.
> $10 might be the "anticipation effect" a reasonable
> assessment of this particular firm's prospects of
> increasing its business given such factors as how "hot"
> its cars are, how the economy is faring, and so on.
> $25 might be Keynes' "pretty face effect." That is,
> everyone's estimate of what everone else thinks the
> stock is worth.
>
> Now, you can play with these numbers all you want. (On
> NASDAQ issues the last category would be 99% of total
> share price. )
>
> But here's the point: in the example above, 40% (and
> even more, if you consider the subjective element of
> "brand") of the total price is "subjective
> anticipation." It is possible, then that at any given
> moment in its entire history, a component of the stock
> market's total return is not based on
> "fundamentals"--such as might be deduced ex-post from
> GNP growth, but from the psychological condition which
> determines asset valuation. Because on any given day
> D1 there is *always* an anticipation about future
> prospects for D2, D3....Dx, there is *always* a
> valuation component of the stock index which is, as it
> were, disjoined from the objectively measured economy
> (after the fact). Ergo your stock index will be only
> loosely connected to GDP.
>
> There are other factors which could be at work. For
> one, even the riskless rate of return on a govt bond
> demands a calculation about inflation which translates
> into an inflation premium. We charge a higher rate of
> return, anticipating inflation today, then might be
> justified after the fact. This forces stocks to offer
> an even higher "risk adjusted" premium. The net effect
> of these attitude-driven adjustments is to make capital
> more dear and to slow economic growth. But
> paradoxically the valuation process for stocks, and
> perhaps even bonds, could outpace the growth in real
> productivity, because on average "anticipation"
> exaggerates and affects performance.
>
> It's a thought, anyhow. If we posit instead a
> mechanistic connection between real GDP and stock
> valuations than it ought to be possible to come up with
> relatively good S&P 500 predictor just by tracking
> quarterly GDP.
>
> --
> Gregory P. Nowell
> Associate Professor
> Department of Political Science, Milne 100
> State University of New York
> 135 Western Ave.
> Albany, New York 12222
>
> Fax 518-442-5298