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Comment by ericjang | Hacker News Reader

Is there a strong reason as to why a 9.7% annualized return on the S&P is a correct assumption we should make about the future?

I feel like in the 21st century, a lot of folks have come to put a lot of faith in the "stocks in the long run" mantra.

But any stationary effect in the markets can be arbitraged away. If 9.7% long-term returns were guaranteed, wouldn't everyone just borrow 30-year loans on margin at 5% interest rate and invest it in S&P?

Edit: agree with sibling comment. If one loses 27% in the first year and makes 9.7% annually after that, they would be operating at net loss. So even if long-term gains were assured, volatility can still make investing on borrowed money unprofitable.

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I've asked this question many times in many different formats and have never gotten a satisfactory response that's grounded in fundamentals.

I think it ultimately comes down to people trusting history to repeat itself.

How would an answer based on fundamentals even look like? Nobody can predict the future.

We can't predict the future with certainty, but we can certainly build models.

I'm basically saying I'd like a somewhat bottoms up approach to modelling the S&P index where the inputs can explain the x% YoY increase in price.

> How would an answer based on fundamentals even look like?

Start with demographics. Layer on productivity growth and you have a first-order approximation of national productivity. Figure gross margins and from that net margins, as well as average corporate tax rates–boom, you have the economy's profitability. Estimate a pay-out rate and you get a high-level return estimate. It's very approximate, but it's theoretically solid for any closed economic system. (Cf: natural resource inputs are not properly accounted for.)

How would you account for central bank actions?

Let's say you do this exercise and arrive at a discounted cash flow model that accurately predicts a 5-10% YoY appreciation in value for the S&P index.

How do you explain why this appreciation in value isn't arbitraged away, as suggested by GP? In his words, "if 9.7% long-term returns were guaranteed, wouldn't everyone just borrow 30-year loans on margin at 5% interest rate and invest it in S&P?" This would effectively drive up the current day price and eliminate any projected future growth in index price -- invalidating the hypothesis that the S&P price will continue growing in the future.

It's not arbitraged away because it's not guaranteed.

Investing in 1968, your S&P holdings would take until 1992 to regain their inflation adjusted starting value.

The S&P has not always generated positive returns relative to inflation.

Sometimes there are 30 year long dips.

That is demonstrably not true. 1968 was a positive year!

1968: +11%.

1969: -8.6%.

1970: +3.6%.

1971: +14.5%.

1972: +19.2%.

$1 of S&P500 in 1968 would be worth $1.23 in 1978, 10 years later.

There are large drops in some of the years, but they are usually followed by outsized rallies in the years afterwards.

Source: Moneychimp’s CAGR of the Stock Market calculator. http://www.moneychimp.com/features/market_cagr.htm

Inflation adjusted were the key words.

Even your link admits poor performance during periods of high inflation, and gives several other example periods.

But here was my original source:

http://www.multpl.com/inflation-adjusted-s-p-500

With your link, if you're just talking about value of the stocks and controlling for inflation, one dollar of stocks in 1969 grows to only $1.03 in December 1991.

9.7% (or maybe 0.8%) is the average over the last 90 years and I don't think there is any other data points you could reasonably use to say it won't continue like that over a long enough time frame.

Sure there are; valuations are considerably inflated now compared to the average (or starting point) of the last 90 years. Percentage earnings and dividend rate are both considerably lower. The long term expected return for the market is therefore also lower.

Well, over the last 90 years the USA moved from important regional power to the economic and military hegemon of the world. That's quite the wave to be riding as a US stock market investor. It's also quite a hard act to repeat.

To maintain the historical growth rate, you have to believe one of the following two things, or some combination of them:

1. The US will continue to amass a larger share of the world's wealth, indefinitely.

2. The economy of the world at large will begin to also grow ~10% a year, a number far in excess of the historical average or any well-informed estimate.

Personally, I wouldn't make that bet.

Taxes certainly complicate that, but most people do what you're describing. People with moderate and even high net worth (that is, in financial assets) still use mortgages because it's better to borrow at 5% instead of liquidating an asset that is returning 9.7%.

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