Low-returns capitalism redux
Relatively few people have “portfolios.” That’s: the affluent upper 10% in countries like the US. The middle classes “participate” in the financial markets via retirement holdings like 401(k)’s; they don’t have millions of dollars in assets to invest, rarely even hundreds of thousands of dollars. The rest of the population in countries like the US (and the vast majority in the rest of the world) has no stake in and little interest in the financial markets. Yet those markets determine economic fates worldwide.
A long period of very low returns would be a big deal.
To concretize the idea, and to make the numbers easy, consider a portfolio of $500,000. The historic investment advice has been to keep 60% in stocks, 30% bonds, 10% in cash (or cash-equivalents like short-term CD’s, money market funds, or government bills). Stocks have appreciated the most over medium-term periods of time, but they can be volatile. Bonds have appreciated less but provide stability to a portfolio. It’s advisable to keep some investment money in cash for the sake of immediate liquidity.
So: $300K in stocks, $150K in bonds, $50K in cash = $500K.
For over a hundred years the average return on stock investments was about 9% (on average over any period of seven years or longer); average return on bond investments was about 5%; average return on cash-equivalent investments was about 2%. So, re: our portfolio, if we use the returns as income each year (so there’s no compounding) and the principal remains at $500K . . . an expected annual return of $35,500:
stocks: $300,000 x .09 = $27,000
bonds: $150,000 x .05 = $7,500
cash: $50,000 x .02 = $1,000
The easy-credit policies of the central banks for the last thirty years juiced up returns on stocks. Over that period of time the Global Dow Jones Average went up about 11% instead of the previously-typical 9%. This has made the affluent layer of the population super-affluent.
But there is an idea that stock prices appreciated too much during that 30-year period. Stock valuations relative to “real economy” valuations (like GDP and profits) went so high that they then had much less “up-side potential.” The Global Dow average hit 3000 three years ago and today is no higher. Meanwhile stock dividends have fallen to under 2%, returns on bonds have plummeted to 1%, and cash-equivalents return almost nothing.
This year the holder of a $500K portfolio might get income of $5K or $10K rather than the old expected norm of $35K.
If bond interest rates finally normalize back to around 5%, bond prices will crash (the interest rates and the prices have an inverse relationship). Stock prices would have to plateau for a decade or two just to re-establish a normal relationship to real-economy valuations.
It’s possible that after thirty years of seeing central bank policies over-stimulate the prices of financial assets, we’ve entered an extended period of low-returns capitalism.
The system may not survive it.