According to conventional wisdom, it is accepted as a good bet that shares on the stock market always rise over the long term. That belief is founded on the record that over any 20-year period, positive real returns have been forthcoming. However, some skepticism is in order.
First of all, how does one measure performance? If one were to look at the Toronto Stock Exchange Index, there have been so many substitutions that it is almost impossible to determine the results. For instance, several decades ago that index included many "clunkers," which, if they remained in the index, would have reduced substantially the gains. For instance, dropped were Canada Packers, Consolidated Paper, Dominion Stores, Industrial Acceptance, Moore Business Forms, and Stelco. More enterprising companies displaced them. In the United States, two former components of the index went bankrupt, Bethlehem Steel and Pennsylvania Railroad. As well, Packard Motor Car, Swift, the meat packer, and Woolworth Stores among others were replaced by IBM, Microsoft, and the like. Hence, the constant revisions of the companies used in the index, distort on the upside the increases in the list.
Besides survivorship, there is another problem with the conclusion that stock markets must always go up. The very existence of that view is likely to lead to disappointment. Investors would keep buying until prices reach stratospheric levels. That clearly happened in the late 1990s with technology-heavy companies.
Another factor to be considered is the period selected. If one were to select 1929 as a base, it took 35 years for the stock market to retain its former peak. Then too, in 1968 the market did not return to that year’s level until the mid-1980s.
Even though stock markets generally remained lower for some time, at least in earlier eras there was a decent dividend yield to hang on to. Yet nowadays, the yield has fallen to exceptionally low levels, very inadequate compared to the return from bonds.
A significant proportion of the return from equities during the last few decades, came from a re-rating of shares. Investors were willing to pay a higher multiple for profits. Still, re-rating obviously cannot continue forever. Later, if evaluations return to the mean of most of the last century, that would be a drag on the index.
The North American stock-markets have been unique, probably because hitherto our area was the most dynamic in the world. Now, Asian markets have assumed that role. In various countries, Germany and Spain, for example, shares have not increased at anything like those here.
Investors in equities should beware of over-committing themselves on the basis of a belief that higher prices are inevitable. History, not only in North America, but as well in other lands, should sound a cautionary note.
