| BUSINESSWEEK ONLINE : JUNE 26, 2000 ISSUE | ||||||||
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| COVER STORY
Commentary: Son, Don't Count on Double-Digit Stock Returns For the past half-century, making money from stocks has been shockingly easy. From 1950 to 1999, real returns on the Standard & Poor's 500-stock index averaged 8.3% more than what you could have taken in on risk-free short-term debt. However, if you're a 30-year-old who's not saving much because you're relying on making returns just as profitable as those of the past decades from now until you retire, think again--or you just might end up living on dog food and government cheese. A new study called ''The Equity Premium,'' available soon on the World Wide Web at www.ssrn.com, strengthens the case that the stock market gains of the past 50 years are unlikely to persist. It's by two leading finance scholars, Eugene F. Fama of the University of Chicago and Kenneth R. French of Massachusetts Institute of Technology. RISKY BUSINESS. Fama and French argue that over the long run, stocks are likely to outperform risk-free debt by only 3% to 3.5% a year. (In the short run, the authors expect that number to be less than 1%, but Fama and French say that they're less confident about that statement, so let's leave it aside.) Their approach differs from that of other bearish professors such as Yale University's Robert J. Shiller, author of Irrational Exuberance. Fama and French focus on trying to measure the true level of the equity risk premium, which is the extra return that investors demand to compensate them for the riskiness of holding stocks. They note that from 1872 to 1949, stocks outperformed risk-free securities by only about 4% a year. From 1950 to 1999, the performance gap rose to 8.3%. Economists reason that the 8.3% must have been the premium that investors demanded in order to hold equities during that period. But Fama and French raise another possibility. Perhaps investors actually demanded a premium of only about 4%, as in the earlier period, and the rest was an unexpected bonus. ''GOOD SURPRISE.'' Their conclusion: Investors got lucky. The authors say that an unexpected flow of good news was largely responsible for the excellent performance of stocks over the past half-century. Says French: ''In 1950, the Depression was not so far in the past. Over the next 50 years, the economy was far more productive than we had imagined. The info-tech revolution hit. We won the Cold War. You got good surprise after good surprise after good surprise.'' One indicator that stocks did better than expected is that average stock-market returns actually outpaced the average return on equity of companies over the 50-year period. The bad thing about good surprises is that you can't count on them to keep happening. Fama and French estimate that in the future, stocks will return to more like their pre-1950 norm. Says French: ''We're saying that if you're a pension fund, you ought to pencil in returns of 3% or 3.5% [above the risk-free rate] for the next 30 years.'' French says the research results undermine the frequently stated prescription that long-term investors should hold only stocks. Are he and Fama too pessimistic? Maybe. However, even Jeremy J. Siegel, author of Stocks for the Long Run and a leading advocate of stocks in preference to bonds, says investors should prepare for much lower returns on stocks than the nominal 17% compound annual return they earned from 1982 to 1999. ''Half of that would be on the aggressive side,'' he says. Oh, well. It was a good half-century while it lasted. By PETER COY Coy is associate economics editor. _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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