The following compares the 19yr bull market from 1981-2000 with the 19yrs before the bull market began. Why were S&P 500 returns so much higher from 1981-2000? If you answered GDP, you’d be wrong. Real and nominal GDP were both higher during the period from 1962-1981.
If you answered ‘corporate profits’ you’d be wrong. Corporate profits (a nominal measure) grew faster during 1962-1981 than during 1981-2000.
What really counts is the spread between nominal and real numbers (i.e. inflation) and how that impacts long-term interest rate trends. Interest rates impact corporate cost of capital and asset valuations. All things equal, a secular rise in rates will increase corporate cost of capital and decrease valuations.
Observations:
- Real GDP growth similar during both periods (slightly higher from 1962-1981)
- Nominal GDP grew faster from 1962-1981 due to higher inflation
- Corporate profits grew faster from 1962-1981 due to higher inflation
- Corporate bond yields (i.e. cost of capital) rose from 1962-1981 but declined from 1981-2000
Bottom Line: based on this data one can conclude that stock market returns are most impacted by the response of cost of capital to inflationary trends. Rising inflation will cause the cost of capital to rise. A long-term rise in the cost of capital will result in weaker equity market returns
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Also Read:
Web of Debt
BP Oil Spill: Conspiracy, Cost & Calculated Risk
Market Refuses to Rally
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