I won’t bore you with a bunch of tables and graphs. I’ll just tell you that I’ve played around with inflation-adjusted stock-market indices (the Wilshire 5000 Total Return and the S&P Composite), and have discovered the following:
- Internal relationships (future performance vs. prior performance) suggest that 15 years from now real stock prices will have risen at a compounded annual rate of +5 to +10 percent.
- External relationships (future performance vs. current AAA corporate bond rate) suggest that 15 years from now real stock prices will have dropped at a compounded annual rate of about -5 percent.
The second result is based on a positive long-run relationship between the bond rate and stock-market performance. Why would there be such a relationship if an interest-rate hike usually causes stock prices to drop? Well, that’s a short-run phenomenon. But over the long run, higher interest rates mean more demand for money, which means that companies are making investments to generate higher profits. And over a period of sufficient length, like 15 years, those higher profits are realized and reflected in stock prices.
In sum, low interest rates signal sluggish business activity. Interest rates are at historically low levels, and have remained stubbornly low for a simple reason. It’s not just that inflation is low. It’s also that the demand for money is weak because the regulatory regime makes it more increasingly difficult and unprofitable for businesses to form and expand.
I see no hope for true regulatory reform, which would involve the beheading of almost every government bureaucrat in the United States. Therefore, my bet is on negative stock-market performance over the next 15 years — and beyond.
It can happen here if it can happen in Japan, where the Nikkei 225 index stands at 42 percent of its nominal level on December 1, 1989. Adjusted for inflation, the index probably has dropped about 75 percent in 27 years, which is a real decline of -5 percent a year.
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Related reading: Jon Hilsenrath, “Yellen Points to Slow Growth and Low Rates in the Long Run,” The Wall Street Journal, June 21, 2016