Jeremy Grantham's 2012 article “My Sister's Pension Assets and Agency Problems” has lots of interesting content, especially the first two pages. He demonstrates that going back to 1882, GDP and stock market fair value both rise very consistently; they are not volatile. Stock market fair value is from Shiller's methodology, using hindsight perfect knowledge of future earnings. Surprisingly, stock market fair value always has stable growth. Stock market price, on the other hand, is very volatile and does not track fair value or GDP. Prices are all over the place, and often above or below fair value for decades at a time! However, there is eventually a reversion to the mean.
Barry Ritholtz posted some similar charts, going back to 1871. He has simply drawn an exponential trend line over the US stock market chart. (On the log-scale, an exponential curve becomes a straight line.) There is no fair value calculation here, but it's a similar overall picture to Grantham's: long-term exponential growth rate is stable. However, stocks can remain above or below the mean (trend line) for very long periods.
There are many important messages that stem from this long-term data.
While stock fair value growth is remarkably consistent, stocks can be under or over-valued for decades at a time.
The stock market is not a rational valuation of the economy and corporate growth, until your time horizon is about 40 years. It's a silly idea to simply buy the stock index to benefit from “economic growth”.
The American stock market has been continuously over-valued since the early 1990s. In the '08 crash, stocks came down to touch fair value (Shiller) for just an instant, before rebounding. Or using the long-term trend line, we didn't even get down to historical mean! Either way, we're about 20 years into an over-valuation period.
Historically, there has always been a reversion to the mean. We are now 20 years and counting.
Decades of under-valuation is also possible. People have forgotten how common it is.
- Perpetual Bull, email@example.com