Equity Returns in the Coming Decade

The majority of retirement savings is invested in cor-porate equity, attracted by the historically high average returns offered by stocks. But substantial risk also accompanies investments in stocks, a risk that seems especially costly after the recent financial crisis. Not only did the value of equity plunge, but many fore-casters also expect subpar returns from stocks over much of the coming decade as the economy recovers slowly from the recent recession. They point out that stocks in recent years have paid shareholders lean dividends, and now the sluggish recovery will limit the growth of corporations’ earnings and stock prices. This brief discusses a broader way of viewing the prospect for equities. The return on stocks will depend on corporations’ profitability. Companies’ earnings have recovered strongly since the recent re-cession, and the valuation of those earnings reflected in current stock prices is near its historical average. If companies maintain their profitability, stocks are likely to pay returns that match their historical aver-ages over the coming decade, even if the recovery of the economy is weaker than average. This brief is organized as follows. The first section reviews the history of returns since 1950. The second explains how corporations have used their earnings to support a pace of capital gains on stocks that has exceeded the rate of economic growth. The third sec-tion discusses why earnings, more than capital gains or dividends, matter most in determining the return on stocks. The fourth describes the outlook for the real return on stocks. The final section concludes that the outlook for stock returns may be better than many forecasters anticipate.