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February 12, 2005

Equity Returns and Economic Growth: Model-Building

As an exercise in clarification of thought--or is it procrastination? or p****** into the wind?--I've tried to set down all the analytically sustainable positions on the relationship between equity returns and economic growth.

The .pdf version.

The conclusions? That you can reconcile current 1.7% dividend yields, the SSA's 1.9% forecast GDP growth rate, and the SSA's 6.5% forecast stock-market return if and only if one of the following four scenarios is true:

  1. A substantial decline in the stock market in the near future to push dividend yields back up to the levels they need to be.
  2. Stagnant wages and a permanent jump in the profit share to push dividend yields up to the levels they need to be.
  3. A large jump in firm payouts, supported by the fact that accounting earnings are massively understated.
  4. A long-run trade surplus of 6% of GDP.

Now none of these are impossible exactly. But only the first is at all likely.

Posted by DeLong at February 12, 2005 09:47 AM