Why stock markets have risen over the long term
By: Tim Bennett
01.05.2019
Despite some scary short-term dips, the stock market has always gone up over longer periods. Tim Bennett takes a look at why.
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Why stock markets have risen over the long-term

For many decades, Western stock markets all over the world have risen. An important question for investors is why, as understanding this will underpin their confidence in where they might go in the future.

Background

During periods of uncertainty, whether caused by Trump’s trade war with China, Brexit or the risk of unrest in the oil-critical Middle East, it is easy to focus on the negatives when it comes to investing. However, it is vital to remember too that, strip away the short-term noise, and a clear, positive picture emerges. Here, for example, is the S&P 500;
This equates, according to Shiller, to a 9% annual total return;
Furthermore, this decent headline number can be broken down into three components as follows;
To have faith in the future of the stock market over the long-term, it is important to understand how these factors work.

Why do earnings grow?

Many papers have been written on the lumpy relationship between economic growth and the performance of the stock market. There are well documented reasons why the two rarely deliver in tandem. However, timing differences aside, GDP growth is consistent with, and vital to, overall stock market performance. Here is a breakdown of numbers produced by the US Federal Reserve;
Let’s take each of these in turn briefly.

Population growth

This matters because labour is such a key component of many production processes globally and a growing population creates more eligible workers to fill this demand. They, in turn, want to look after themselves and their families and also enjoy the fruits of their labour through leisure.

Productivity gains

These come in two forms – there are gains that allow the pace of production to increase and others that change the game in terms of how production works. For example, an efficient teacher can increase the number of classes they teach and the size of them – this will boost their productivity. However, to really change the way teaching is delivered and consumed you need something like the internet as this brings the potential to scale good teaching far beyond the limits of one teacher and one classroom.

Inflation

We are used to inflation in Western economies and indeed Central Banks encourage it up to a point because it incentivises consumption (why wait to buy something when it will be pricier in the future?) and it also decreases the real burden of debt, such as a mortgage.
So, having looked at the three components of earnings growth, let’s now move onto the second big factor in long-term stock market performance – dividend reinvestment.

Why dividend reinvestment matters too

Here is a simple illustration as to why this can be so powerful.
In essence, by reinvesting dividends, investors not only keep their money working but they also reallocate it more efficiently. This is why Deloitte have estimated that around 50% of the total return enjoyed by US investors since 1926 has comes from dividend reinvestment.

Multiple expansion

To recap – we have looked at two key factors, leaving one more;
I cover this third (and smallest) ingredient in more detail elsewhere but in short, this is the contribution that forward expectations have made to stock market performance.
To sum up – no-one knows how these key factors will pan out in the future, but they have all done their part to drive stock markets to new highs to date.

To find out more

You can read more about all three factors here;
In addition, feel free to email me at [email protected] and/or speak to an Investment Manager.