Edward Renshaw
Professor of Economics
State University of New York at Albany
In this essay we examine changes which have occurred over time in the valuation of the earnings and dividends associated with the S&P composite stock price index. These changes in conjunction with record amounts of retirement money that are now being funneled into mutual funds and wider fluctuations in the price of corporate bonds suggest that the earnings and dividend price ratios for representative stock market averages may some day be lowered to the point where the before tax returns on equities will not be greater than the returns on corporate bonds.
Since the publication of Stocks as Long-Term Investments, by Edgar L. Smith in [1925], every reputable investigator has been forced to conclude that the financial returns associated with representative stock price indexes have outperformed bonds over long periods of time. See Jeremy Siegel's [1994] book for a more recent review of the numbers and some of the literature supporting this conclusion.
A more detailed perspective of the annual and cumulative returns for the S&P composite stock price index and corporate bonds from 1926-95 can be obtained by examining Table 18.5. During this 70 year period there were only two, ten year sub-periods (1926-35 and 1966-75) when bonds outperformed the S&P index. One dollar invested in the S&P composite stock price index at the end of 1995 with dividends reinvested and no transaction costs would have increased to $989.09 at the end of 1995. The comparable cumulative return on corporate bonds was only $60.99.
While most of the theories that have been developed by professors of economics and finance to explain stock prices aren't very useful at discriminating between good and bad years to own equities, they may still be of some value in helping one to detect changes in the standards that have been employed by investors over time in valuing the earnings and dividends associated with representative stock market averages. Support for the notion that stocks may not continue to outperform corporate bonds can be found in a downward drift of both dividend yields and the inflation adjusted risk premiums for the earnings that are associated with the S&P index.
Most of the more advanced textbooks on corporate finance contain at least a few paragraphs devoted to the interpretation of an actuarial formula that has been of some value in projecting the financial returns for the S&P index from the end of one year containing a peak in business activity to the next.
If the dividend price ratio remains the same and if there is no change in the dividend growth rate, the actual financial return (dividends plus price appreciation expressed as a percent of price at the beginning of the period) will be equal to the current dividend yield plus the dividend growth rate. Gordon [1962] was among the first to promote this relationship.
In Table 18.1 we use this type of formula to project the financial returns for the S&P composite stock price index between years of peak prosperity. The actual returns in the following period, which are shown in column (6) assume that all dividends are reinvested at the end of each year and that there are no transaction costs.
It will be noted that the actual return of - 3.0 percent per year from the end of 1929 to the end of 1937 was quite a bit less than the projected average return of 16.5 percent at the end of 1929. From 1937 through the 1960s, when the stock market was still recovering from the trauma of the great depression of the 1930s, the actual returns associated with the S&P index were often closely related but consistently greater than the projected returns. Since 1969, however, there have been two cases where the actual returns through the following year containing another business peak have been less than the projected returns.
At the end of 1990 this projection scheme was predicting a compound average return of 10.6 percent for the current business expansion which has so far turned out to be quite a bit less than the actual return of 16.3 percent for the five year period from 1991-95.
It should be noted, however, that the dividend yield in column (3) of Table 18.1 has been trending downward from 7.6 percent in 1937 to about 1.9 percent at the end of 1996. When this happens the financial returns will be temporarily enhanced, if the dividend growth rate remains the same. In the long run, however, a lower dividend yield can be expected to reduce the financial returns associated with common stock.
At the end of 1996 the projected future return for the S&P index had declined to about 4.8 percent. For the five cases in column (5) of Table 18.1, where the projected following returns were less than 9.9 percent, the actual following returns in column (6) have so far always been less than ten percent. If the Fed has achieved its goal of a soft landing for the US economy our dividend growth model indicates that there could still be a dramatic reduction in the average return for the S&P index that is associated with the remainder of the current business expansion. A near term recession would be even worse for the stock market.
One of the more interesting points to note in connection with the dividend yields in column (3) of Table 18.1 is that there has never been a yield under 3.4 percent at the end of any year containing a peak in business activity. There have been several occasions when investors experimented with dividend yields of less than three percent in the midst of business expansions but they have (so far) all been wiped out by bear markets either before or shortly after the expansion was over.
The U.S. tax code makes it advantageous for some corporations to use part of their excess earnings to purchase other companies and buy back their own shares rather than increase their dividends. Stock buy-backs, however, help to support the notion that there is a law of diminishing profitability associated with internal investments since it wouldn't be rational for a firm to repurchase its own stock, under most circumstances, if it could reinvest its retained earnings at a higher expected return internally.
While the drift toward lower dividends may be rational, it is not necessarily a good omen for the stock market in either the short or the long run. History suggests, in any event, that investors should be cautious whenever the monthly dividend yield for the S&P composite stock price index has either established a new record low or tied the preceding low. (See those dividend lows identified with an asterisk in Table 18.2.)
In September 1929, before the memorable crash which occurred in October of that year, the dividend yield for the S&P index fell to 2.92 percent and the index then proceeded to lose more than 85 percent of its value.
The S&P stock price index more than doubled in value between June 1, 1932 and July 1933, pushing the dividend yield back down from an historic high of 10.30 percent to only 2.95 percent. This short lived, but rather spectacular bull market was followed by a less severe correction of not quite 25 percent.
During the bull market of 1961, when investors became fascinated with growth stocks that don't pay much dividends, the monthly average yield on the S&P index fell to a new low of 2.84 percent and the stock price index then proceeded to lose more than 25 percent of its value in the early stages of what was to turnout to be the longest expansion of economic activity in the history of business cycle analysis.
In 1971 President Nixon did what he had promised never to do and imposed a system of wage and price controls on a peace time economy. Corporations, for the most part, cooperated by investing increased earnings in new plant and equipment rather then using them to pay more dividends. By January 1973 the dividend yield on the S&P index had established a new record low of only 2.69 percent. This record was followed by the most severe stock market correction in the post World War II period.
On October 19, 1987, after leveraged buy-outs and speculative enthusiasm had pushed stock prices up enough in August to tie the previous dividend low of 2.69 percent, the S&P index experienced a record loss of more than 20 percent in a single trading day.
Since the economic recession of 1990-91 business enterprises have been using most of the recovery in corporate earnings to purchase computers and other types of equipment which might reasonably be expected to improve labor productivity and make US enterprises more competitive in the world market place. The expectation that dividend increases would follow and the lowest short term interest rates on savings accounts since the early 1960s encouraged many investors to continue a process of shifting more of their financial assets from maturing CDs to common stock without much regard for what happened in 1973 and 1987 when the yield on the S&P dipped to only 2.69 percent.
Low dividend yields will often persist for a prolonged period of time when the US economy is recovering from an economic recession and inflation is not regarded a serious threat. When low yields are accompanied by a policy of tight money and rapidly rising interest rates, however, one has all the ingredients that are necessary for a stock market correction.
The stock market correction of 1994 turned out to be rather mild and never did push the monthly yield associated with the S&P index above three percent. It is not yet clear, however, whether investors will be content with a yield of less than three percent when the US economy has slipped into another recession. Since the mild recession of 1960-61 the S&P index has declined more after the recessionary peaks in business activity designated by the National Bureau of Economic Research than before the peaks.
The standards that have been used by the financial community to value the earnings and dividends associated with representative stock market indexes have been subject to a great deal of variation over time.
From 1936-57 the December yield on Moody's high grade corporate bond index was consistently less than the December yield for the S&P composite stock price index. Since 1957, however, the December yields on high grade bonds have been consistently greater than the yields for the S&P index.
From 1961 to 1981 one could have identified all of the loss years for the S&P composite stock price index with a simple risk premium defined as the earnings-price yield on the S&P (measured by the average earnings over the last three years divided by the closing price in the last year) minus the December yield on Moody's high grade corporate bond index with only a few false signals [Renshaw 1992, Table 3.24].
During this period the financial returns associated with the S&P index were quite a bit lower, on the average, in the years following a risk premium under .35 percentage points than the financial returns that could have been obtained from long term bonds.
In [1979], however, Nobel Laureate Franco Modigliani and Richard Cohn criticized financial analysts for using a nominal rate of interest to capitalize corporate earnings and suggested that investors had been systematically undervaluing the stock market by 50 percent. "In the presence of inflation," they argued, "one properly compares the cash return on stocks, not with the nominal return on bonds, but with the real return on bonds."
Since 1979 the nominal risk premiums obtained by subtracting Moody's December Aaa Corporate Bond yields in column (4) of Table 18.3 from the high earnings-price ratios in collum (3) have consistently been negative.
The gradual acceptance of a new standard for valuing corporate earnings helped to set the stage for the bull market of the 1980s, which has now gone down in history as the second-best decade to have owned stock since the S&P index was extended back to the 1870s. During this decade, when the S&P index increased 227.4 percent, a 54.1 percent increase in earnings was more than offset by a 79.4 percent increase in the CPI without food and energy.
A more modern year-end risk premium is presented in Table 18.3 for the S&P index which assumes that its associated earnings should be discounted by a real interest rate. We start by calculating an earnings-price ratio for the index based on the highest earnings for the current or any previous year expressed as a percent of the closing value for the index. A real risk premium is then obtained by subtracting the December yield for Moody's Aaa corporate bond index from the high earnings-price ratio and adding to this residual the average annual inflation rate for the consumer price index without food and energy.
Basing the risk premium on the highest observed earnings for any calendar year probably over states the "true" risk premium for some years when earnings were depressed but enables one to avoid negative risk premiums for the S&P index from 1928-95. A "core inflation rate" without food and energy also helps one to avoid both negative and absurdly high risk premiums during years with food and energy price shocks. Negative risk premiums are not very plausible if investors believe that stocks are more risky than bonds in the short run.
From 1929-82 there were only two cases of a real year-end risk premium less than two percentage points (1961 and 1972) in Table 18.3 and no cases of a risk premium less than one percentage point. Since 1982 there have been seven cases of a real risk premium under two percentage points and only two cases of a risk premium over three percentage points. From 1991-96 the year-end risk premiums in column (6) of Table 18.3 were consistently less than two percentage points. The implication would seem to be that some investors may now be using something akin to this type of risk measurement in managing their own portfolios.
Lower dividend yields and smaller inflation adjusted risk premiums, other things equal, should help to narrow the longer run return differential for stocks and bonds.
For the seven years from 1960-94 when the December risk premium in column (6) of Table 18.3 was under two percentage points (1961, 1972, 1983, 1987, 1992, 1993 and 1994) the following year financial returns for the S&P index were -8.8, -14.5, 6.0, 16.3, 9.9, 1.3 and 37.1 percent respectively. In the 1995 edition of Johnson's Charts it is reported that corporate bonds would have provided investors with financial returns of (7.9, 1.1, 16.4, 10.7, 12.4, -3.4 and 21.2 percent respectively) which were higher on the average and less variable.
The bull market of 1995 was fueled in part by a large reduction in long term interest rates and an impressive increase in corporate earnings in 1994 and during the first half of 1995. Lower interest rates are beneficial to investors in both stocks and long term bonds in the short run. It is by no means certain, however, that long term interest rates will continue to move downward in a world where the CPI inflation rate has not been changing very much from one year to the next.
The data in column (2) of Table 18.4 indicate that big increases in corporate earnings are eventually followed by periods of stagnant or declining earnings. From 1929 to 1979 the inflation adjusted earnings associated with the S&P index increased at a compound rate of not quite 1.6 percent per year. In the more recent period from 1979-96 the average growth rate has only been about .6 percent in spite of the longest peace time expansion of the US economy in business cycle history during the 1980s and large percentage gains in corporate earnings in both 1994 and 1995. In a world where there is little or no growth in the inflation adjusted earnings for representative stock price indexes, the average dividend yield on common stock will eventually have to exceed the real inflation adjusted coupon rates on new issues of long term bonds, for one to be confident that stocks will continue to outperform bonds in the long run. See the appendix to this essay for the rationale behind this conclusion.
Since 1982 there have been no end of the year dividend yields associated with the S&P index in excess of the December yield on Moody's high grade corporate bond index in column (4) of Table 18.3 minus the CPI inflation rate in column (5). The implication would seem to be that the managers of many pension funds, that don't have to pay taxes on capital gains, are now betting--whether they know it or not--that the US economy has returned to a bright new (recession free) era where corporate earnings will continue to increase faster than the CPI inflation rate. That may be the case for firms in protected industries.
The current business expansion, however, is already the second longest peace time expansion in business cycle history. Corporate earnings, moreover, have a tendency to increase more rapidly in the early stages of a business expansion than in the waning years of the expansion. For many retail stores and firms in highly competitive industries we are already beginning to observe increases in sales that are not accompanied by higher earnings.
History suggests, in any event, that it has been safer to have invested in the stock market when earnings-price ratios have been high than when they have been low. For the ten years when the high earnings-price ratio in column (3) of Table 18.3 was in excess of 9.3 there was an average following year gain for the S&P amounting to almost 14 percent. This can be contrasted to an average decline of almost .6 percent after the ten years from 1958-94 when the earnings-price ratio was equal to 5.7 or less.
The stock market took its sharpest plunge in five months on the morning of December 6, 1996 after Fed Chairman Greenspan raised the specter of "irrational exuberance" on Wall Street. While no one can be certain about what Greenspan meant by this expression, it seems likely that he was concerned about the possibility of "over valuation" as exemplified by exceptionally high price-earnings ratios.
There have been seven occasions since the S&P composite stock price index was extended back to 1928 when its end of the quarter price-earnings ratio soared above 20.50 for one or more quarters. Some of these lofty P/E ratios (such as the ratio of 21.06 which prevailed at the end of the second quarter of 1987) were soon followed by nerve racking crashes in the midst of a business expansion. None of these crashes, however, lasted very long Table 18.6. Nor were they bad for the economy. P/E ratios in excess of 20.50 have (so far) always signaled at least two more good years for the U.S. Economy
It should be appreciated though that the S&P index has long been a component of the composite index of leading economic indicators that was developed by the National Bureau of Economic Research in the 1920s and 30s, handed over to the U.S. Commerce Department in the 1960s and then turned over to the Conference Board in 1995. Fed Chairman Greenspan might be correct in suggesting that there may have been a few occasions when exuberance on Wall Street eventually collapsed enough to help tip the U.S economy into a recession.
History would suggest, in any event, that the Fed ought to be more concerned with the problem of "irrational pessimism" than with high P/E ratios which usually occur in the early stages of a business expansion or in the midst of an expansion when there is an expectation that corporate earnings will continue to increase. The best way to cope with recurring pessimism, I believe, would be to allow the Fed to purchase stock index options and futures whenever the DJIA or the S&P 500 has experienced a cumulative new high decline of say 12 percent or more.
Since stock market corrections of this magnitude have not persisted for very long in the post 1947 period, if the Fed was not in an inflation fighting mood, there is a good chance that this type of intervention would turnout to be profitable and help to stabilize the U.S. economy and its financial markets. Since profits earned by the Fed are turned over to the U.S Treasury, and help to reduce the government deficit, it is reasonable to suppose that everyone might benefit from having the Fed intervene in the stock market when unwarranted pessimism gets out of hand.
In 1952 Nobel Laureate Jan Tinbergen was able to show that, in the absence of wonder drugs that can cure more than one disease and very special interrelationships between variables, there is a need for at least as many instruments of economic and financial control as there are goals or objectives to be achieved.
If Chairman Greenspan is worried about the possibility of irrational exuberance degenerating into a case of unjustified pessimism he should make sure that the Fed has the authority to intervene in the stock market in a manner that will prevent excessive pessimism on Wall Street from spilling over and having a depressing effect on the U.S. economy.
Accounting for differences in financial returns is an undeveloped science in part because of the problems that are encountered in measuring and compounding the financial returns for assets with different life expectancies but also because there is no generally accepted method of measuring risk premiums. The data presented in Tables 18.3 and 18.4 would strongly suggest, however, that most of the superior performance of stock over long term bonds from 1979-95 can probably be attributed to a dramatic reduction in the real risk premiums associated with common stock.
While the financial returns for stocks have varied more from year-to- year than the financial returns that have been calculated for bonds, it is by no means clear that a diversified portfolio of stocks will continue to be considered more risky than a portfolio of long term bonds. There is mounting evidence to suggest that the stock market is more stable now than it used to be [Renshaw, 1995] and that the financial returns associated with long term bonds are more variable than was formerly the case. Many long term bond issues were clobbered more severely than representative stock market indexes during the Fed's preemptive strike against the possibility of accelerating inflation in 1994. The record amounts of retirement funds that are now being automatically funneled into the stock market is another reason for supposing that stock market corrections may be less severe in the future.
If the stock market is perceived as not being more risky than the bond market and continues to provide many investors with tax deferment advantages, it wouldn't be very surprising if the prices paid for equities eventually get bid up to the point of providing the same or even a smaller before tax return, on the average, than bonds.
Modern portfolio theory presumes that investors are faced with a trade-off between risk and return. If the risk associated with a diversified portfolio of common stock is perceived to be the same as the risk associated corporate bonds the managers of mutual funds and other types of retirement funds will not be acting in a very professional manner if stocks continue to outperform bonds.
The Longer Run Returns from Holding Stock and Bonds
The financial return for a stock, Rs, will be equal to its price at the end of the holding period, P, plus the dividends received during the holding period, D, when this sum is expressed as a percent of the price at the beginning of the holding period, Pb:
Rs = (P + D)/Pb = P/Pb + D/Pb (1)
Let us assume that a corporation wants to keep the dividend yield, D/Pb, constant. To accomplish that objective over a long period of time, the dividend growth rate, D/Db, will have to be equal to the stock price growth rate, P/Pb. Replacing P/Pb in equation (1) with D/Db allows one to derive a close approximation of the dividend growth model that was used to project the financial returns for the S&P index from one business peak to the next in Table 18.1:
Rs = D/Db + D/Pb (2)
To maintain a constant dividend yield, corporate earnings must increase at least as fast in the long run as dividends. If earnings were to increase less rapidly than dividends, the dividend payout ratio will eventually exceed one and create an untenable deficit problem for the corporation. By a process of further substitution one can show that the longer run financial return will be equal to or less than the earnings growth rate, E/Eb, plus the dividend yield, D/Pb.
In a world where earnings are expected to increase at the same rate as consumer price inflation, CPI/CPIb, we can show by a process of further substitution that the real return on stock in the long run will be equal to a firm's dividend yield. And if bonds are perceived as being about as risky as stock, the real return on stock should be about the same as the real return on bonds in the long run.
With this type of reasoning in mind it is easier to appreciate why a dividend yield below the real return on long term bonds must be offset by a growth rate for corporate earnings that is in excess of the CPI inflation rate if stocks are to provide investors with a longer run return that is equal to the return on bonds. In the short run, however, there could still be lots of variation in the returns associated with these two asset classes.
*An earlier version of this essay has been accepted for publication in the Financial Analysts Journal. In this essay, however, we have obtained a real risk premium based on the average annual inflation rate for the consumer price index without food and energy rather than the December- December inflation rate for the all item CPI. The resulting risk premiums have been more stable.
Gordon, Myron. The Investment, Financing and Valuation of the Corporation. Homewood, Ilinois: Richard D. Irwin, 1962, Chapter 4.
Modigliani, F. and R. Cohn. "Inflation, Rational Valuation and the Market," Financial Analysts Journal, March 1979, pp. 24-44.
Renshaw, Edward. The Practical Forecasters' Almanac. Burr Ridge, Illinois: Irwin Professional Publishing, 1992.
-------"Is the Stock Market More Stable than It Used to Be?" The Financial Analysts Journal, November/December 1995, pp. 81-88.
Siegel, Jeremy. Stocks for the Long Run. Burr Ridge, Illinois: Irwin Professional Publishing, 1994.
Smith, Edgar. Stocks as Long Term Investments. New York: Macmillan, 1925.
S & P's Composite
Years of Stock Price Index Yield in Dividend Projected Actual
Peak ----------------- Percent Growth Average Average
Prosperity Year Associated Rate in Return for Return in
End Dividends Percent the Following Following
Price per Year Period Period
(1) (2) (3)n (4)n (5)n (6)n
1926 $.69
1929 21.45 .97 4.5 12.0 16.5 -3.0*
1937 10.55 .80 7.6 -2.4 5.2 9.6
1944 13.28 .64 4.8 -3.1 1.7 8.6
1948 15.20 .93 6.1 9.1 15.2 17.1
1953 24.81 1.45 5.8 9.3 15.1 17.2
1957 39.99 1.79 4.5 5.4 9.9 16.9
1960 58.11 1.95 3.4 2.9 6.3 8.5
1969 92.06 3.16 3.4 5.5 8.9 4.6*
1973 97.55 3.38 3.5 1.7 5.2 6.5
1979 107.94 5.70 5.3 9.1 14.4 11.9*
1981 122.55 6.63 5.4 7.8 13.2 16.0
1990 330.22 12.10 3.7 6.9 10.6 16.3p
1996 740.74 14.37 1.9 2.9 4.8
(3)n. Column (2) expressed as a percent of column (1).
(4)n. Compound average annual growth rates for the associated dividend figures in column (2), 1926-29, 1929-37, etc.
(5)n. Column (3) plus column (4).
(6)n. Compound average annual financial return (price appreciation plus dividends associated with the S&P index) from the end of the year in question to the end of the next year of peak prosperity.
*Actual return in the following period was less than the projected return. For these three cases there was both an increase in the dividend yield in the following period and a slump in the dividend growth rate.
p represents a preliminary estimate based on the compound average growth rate for the five year period 1991-95. One would hope that the next year containing a recessionary peak in business activity won't occur for many years in the future.
Source of basic data: Standard and Poor's Security Price Index Record.
Date of Dividend Yield Closing Value S&P Index
------------------------------ -------------- ------------------------
Dividend S&P Dividend At At After Interim After
Yield Index Yield Low High Dividend Low Dividend
Low Low High Low High
Sep. 1929 6/ 1/32 June 1932 2.92 10.30 30.16 4.40 4.43
July 1933 4/28/42 Apr. 1942 2.95 8.47 9.95 7.47 7.66
Nov. 1961 6/26/62 June 1962 2.84* 3.78# 71.32 52.32 54.75
Oct. 1965 10/ 7/66 Oct. 1966 2.91 3.76# 92.42 73.20 80.20
Nov. 1968 5/26/70 July 1970 2.92 4.20 108.37 69.29 78.05
Jan. 1973 10/ 3/74 Aug. 1982 2.69* 6.32 116.03 62.28 119.51
Aug. 1987 12/04/87 Oct. 1990 2.69* 4.01 329.80 223.92 304.00
Jan. 1994 4/ 4/94 Dec. 1994 2.69* 2.91# 481.61 438.92 459.27
Dec. 1996p 1.94*p
*Cases where the dividend yield either established a new record low or tied the preceding record low.
#Cases where the stock market correction occurred in the midst of prosperity and where the high yield for the S&P index is not associated with an economic recession.
p equals a preliminary record low estimate that may turnout to be too high.
Source of basic data: Standard & Poor's Security Price Index Record.
Year Closing Earnings High Moody's Percentage
Value for the Earnings December CPI Real Change
S&P S&P Price Aaa Corp. Inflation Risk S&P
Index Index Ratio Bond Yield Rate Premium Index
(1) (2) (3)n (4) (5) (6)n (7)
1958 55.21 2.89 6.56 4.08 2.42 4.90 38.1
1959 59.89 3.39 6.04 4.58 2.03 3.49 8.5
1960 58.11 3.27 6.23 4.35 1.32 3.20 - 3.0
1961 71.55 3.19 5.06# 4.42 1.31 1.95* 23.1
1962 63.10 3.67H 5.82 4.24 1.29 2.87 -11.8
1963 75.02 4.02H 5.36 4.35 1.27 2.28 18.9
1964 84.75 4.55H 5.37 4.44 1.57 2.50 13.0
1965 92.43 5.19H 5.62 4.68 1.24 2.18 9.1
1966 80.33 5.55H 6.91 5.39 2.45 3.97 -13.1
1967 96.47 5.33 5.75 6.19 3.58 3.14 20.1
1968 103.86 5.76H 5.55 6.45 4.61 3.71 7.7
1969 92.06 5.78H 6.28 7.72 5.79 4.35 -11.4
1970 92.15 5.13 6.27 7.64 6.25 4.88 .1
1971 102.09 5.70 5.66 7.25 4.66 3.07 10.8
1972 118.05 6.42H 5.44 7.08 3.04 1.40* 15.6
1973 97.55 8.16H 8.36 7.68 3.64 4.32 -17.4
1974 68.56 8.89H 12.97 8.89 8.33 12.41 -29.7
1975 90.19 7.96 9.86 8.79 9.11 10.18 31.5
1976 107.46 9.91H 9.22 7.98 6.49 7.73 19.1
1977 95.10 10.89H 11.45 8.19 6.27 9.53 -11.5
1978 96.11 12.33H 12.83 9.16 7.38 11.05 1.1
1979 107.94 14.86H 13.77 10.74 9.77 12.80 12.3
1980 135.76 14.82 10.95 13.21 12.38 10.12 25.8
1981 122.55 15.36H 12.53 14.23 10.40 8.70 - 9.7
1982 140.64 12.64 10.92 11.83 7.40 6.49 14.8
1983 164.93 14.03 9.31 12.57 3.97 .71* 17.3
1984 167.24 16.64H 9.95 12.13 5.02 2.48 1.4
1985 211.28 14.61 7.88 10.16 4.30 2.02 26.3
1986 242.17 14.48 6.87 8.49 4.03 2.41 14.6
1987 247.08 17.50H 7.08 10.11 4.14 1.11* 2.0
1988 277.72 23.76H 8.56 9.57 4.40 3.39 12.4
1989 353.40 22.87 6.72 8.86 4.54 2.40 27.3
1990 330.22 21.34 7.20 9.05 5.04 3.19 - 6.6
1991 417.09 15.97 5.70 8.31 4.87 2.26 26.3
1992 435.71 19.09 5.45 7.98 3.66 1.13* 4.5
1993 466.45 21.88 5.09 6.93 3.33 1.49* 7.1
1994 459.27 30.60H 6.67 8.46 2.83 1.04* - 1.5
1995 615.93 33.96H 5.51 6.82 3.00 1.69* 34.1
1996 740.74 35.27H 4.76# 7.20 2.73 .29* 20.3
Footnotes for Table 18.3
(3)n. The highest earnings for the current year or any previous year expressed as a percent of the closing value for the S&P index in column (1). The # marks for 1961 and 1996 identify the two lowest year-end earnings price ratios in the post 1929 period.
(6)n. Column (3) minus column (4) plus the year-year percentage change in the all item CPI less food and energy in column (5).
H indicates the record earnings that are used to compute the high earnings price ratios in column (3).
*Years when the risk premium in column (6) was less than 2.00 percentage points.
Source of basic data: Standard and Poor's Security Price Index Record and the Economic Report of the President.
Financial Returns
Year Earnings CPI Real ----------------------------
(dollars) (1982-84=100) Earnings Current Year Following Year
(1) (2) (3)n (4) (5)
1928 1.38 ---- ---- 41.9 - 7.9*
1929 1.61 17.3 9.31 - 7.9P -23.9
1948 2.29 24.1 9.50 5.4P* 17.8
1949 2.32 23.8 9.75 17.8 30.5
1950 2.84 24.1 11.78 30.5 23.4
1955 3.62 26.8 13.51 31.0 6.4*
1962 3.67 30.2 12.15 - 8.8* 22.5
1963 4.02 30.6 13.14 22.5 16.3
1964 4.55 31.0 14.68 16.3 12.3
1965 5.19 31.5 16.48 12.3 -10.0
1966 5.55 32.4 17.13 -10.0 23.7
1968 5.76 34.8 16.55 10.8 - 8.3*
1969 5.78 36.7 15.75 - 8.3P 3.5
1972 6.42 41.8 15.36 18.7 -14.5*
1973 8.16 44.4 18.38 -14.5P -26.0
1974 8.89 49.3 18.03 -26.0 36.9
1976 9.91 56.9 17.42 23.6 - 7.2*
1977 10.89 60.6 17.97 - 7.2 6.4
1978 12.33 65.2 18.91 6.4 18.4
1979 14.86 72.6 20.47 18.4 31.5
1981 15.36 90.9 16.90 - 4.8P* 20.4
1984 16.64 103.9 16.02 6.0* 31.1
1987 17.50 113.6 15.40 5.7* 16.3
1988 23.76 118.3 20.08 16.3 31.2
1994 30.60 148.2 20.65 1.3* 37.1
1995 33.96 152.4 22.28 37.1 22.2
1996 35.27 156.9 22.48 22.2 ?
Footnotes for Table 18.4
(3)n. Column (1) divided by column (2).
P signifies a financial return associated with a year containing a peak in business activity.
*Identifies the poorest financial return in either the current or following year when the earnings for the S&P have achieved a new record after being depressed for a year or more.
Source of Basic Data: BCI series 320 and Standard and Poor's Security Price Index Record.
Annual Financial Returns Cumulative Financial Returns
Stock Bonds 50-50 Stock Bonds 50-50
1925e 1.000 1.000 1.000 1.000 1.000 1.000
1926 1.116 1.074 1.095 1.116 1.074 1.095
1927 1.366 1.074 1.220 1.524 1.153 1.336
1928 1.426 1.028 1.228 2.175 1.573 1.641
1929P .921 1.033* .977 2.003 1.625 1.603
1930 .761 1.080* .920 1.524 1.755 1.475
1931 .583 .982* .782 .888 1.723 1.153
1932 .910 1.108* 1.009 .808 1.909 1.163
1933T 1.530 1.104 1.317 1.236 2.108 1.532
1934 .985 1.139* 1.062 1.217 2.401 1.627
1935 1.463 1.096 1.280 1.780 2.631 2.083
1936 1.333 1.068 1.200 2.373 2.810 2.500
1937P .661 1.027* .844 1.569 2.886 2.110
1938T 1.300 1.061 1.180 2.040 3.062 2.490
1939 .992 1.040* 1.016 2.024 3.184 2.530
1940 .901 1.034* .968 1.824 3.292 2.449
1941 .888 1.027* .958 1.620 3.381 2.346
1942 1.192 1.026 1.109 1.931 3.469 2.602
1943 1.257 1.028 1.142 2.427 3.566 2.971
1944 1.193 1.047 1.120 2.895 3.734 3.328
1945PT 1.357 1.041 1.199 3.929 3.887 3.990
1946 .922 1.017* .970 3.623 3.953 3.870
1947 1.055 .977 1.016 3.822 3.862 3.932
1948P 1.054 1.041 1.048 4.028 4.020 4.121
1949T 1.178 1.033 1.106 4.745 4.153 4.558
1950 1.305 1.021 1.163 6.192 4.240 5.301
1951 1.234 .973 1.104 7.641 4.126 5.852
1952 1.177 1.035 1.106 8.993 4.270 6.472
1953P .988 1.034* 1.011 8.885 4.415 6.543
1954T 1.512 1.054 1.283 13.434 4.653 8.395
1955 1.310 1.005 1.158 17.599 4.676 9.721
1956 1.064 .932 .998 18.725 4.358 9.702
1957P .895 1.087* .991 16.759 4.737 9.615
1958T 1.424 .978 1.201 23.865 4.633 11.548
1959 1.118 .990 1.054 26.681 4.587 12.172
1960P 1.003 1.091* 1.047 26.761 5.004 12.744
1961T 1.266 1.048 1.157 33.879 5.244 14.745
1962 .912 1.079* .996 30.898 5.658 14.686
1963 1.225 1.022 1.124 37.850 5.782 16.507
1964 1.163 1.048 1.106 44.020 6.060 18.257
1965 1.123 .996 1.060 49.434 6.036 19.352
1966 .900 1.002* .951 44.491 6.048 18.404
1967 1.237 .951 1.094 55.035 5.752 20.134
1968 1.108 1.026 1.067 60.979 5.902 21.483
1969P .917 .919* .918 55.918 5.424 19.721
1970T 1.035 1.184* 1.110 57.875 6.422 21.890
1971 1.141 1.110 1.126 66.035 7.128 24.648
1972 1.187 1.073 1.130 78.384 7.648 27.852
Annual Financial Returns Cumulative Financial Returns
Stock Bonds 50-50 Stock Bonds 50-50
1973P .855 1.011* .933 67.018 7.732 25.986
1974 .740 .970* .855 49.593 7.500 22.218
1975T 1.369 1.146 1.258 67.893 8.595 27.950
1976 1.236 1.186 1.211 83.916 10.194 33.847
1977 .928 1.017* .972 77.874 10.367 32.899
1978 1.064 .999 1.032 82.858 10.357 33.952
1979 1.182 .958 1.070 97.938 9.922 36.329
1980PT 1.315 .974 1.144 128.788 9.664 41.560
1981P .951 .990* .970 122.477 9.567 40.313
1982T 1.204 1.485* 1.344 147.462 14.207 54.181
1983 1.223 1.011 1.117 180.346 14.363 60.520
1984 1.060 1.164* 1.112 191.167 16.719 67.298
1985 1.311 1.309 1.310 250.620 21.885 88.160
1986 1.185 1.199* 1.192 296.985 26.240 105.087
1987 1.057 .997 1.027 313.913 26.161 107.924
1988 1.163 1.107 1.135 365.081 28.960 122.494
1989 1.312 1.162 1.237 478.986 33.652 151.525
1990P .969 1.068* 1.018 464.137 35.940 154.252
1991T 1.300 1.182 1.241 603.378 42.481 191.427
1992 1.074 1.091* 1.082 648.028 46.347 207.124
1993 1.099 1.124* 1.112 712.183 52.094 230.322
1994 1.013 .966 .990 721.441 50.323 228.019
1995 1.371 1.212 1.292 989.096 60.991 294.601
Cumulative Financial Returns
1926-35 1.780 2.631H 2.083
1936-45 2.207H 1.477 1.916
1946-55 4.479H 1.203 2.436
1956-65 2.809H 1.291 1.991
1966-75 1.373 1.424 1.444H
1976-85 3.691H 2.546 3.154
1986-95 3.947H 2.787 3.342
1926-95 989.096H 60.991 294.601
Footnotes for Table 18.5
e represents the equivalent of one dollar invested at the end of 1925. With reinvestment of dividends and no transaction costs one dollar invested in a portfolio similar to the S&P composite stock price index at the end of 1925 would have grown to $989.10 by the end of 1995.
*Identifies years when the financial return for corporate bonds was greater than the return for the S&P composite stock price index.
H identifies the portfolio with the highest cumulative financial return for the sub-period in question.
P identifies a year containing a recessionary peak. Bonds have almost always outperformed stock during peak years if there was no recessionary trough.
T identifies a year containing a recessionary trough. Trough years have been the best years to have owned stock on the average.
Source of return estimates: Johnson's Charts. Their estimates were obtained from Ibbotson Associates, Standard & Poor's, Salomon, Lehman, and Merrill Lynch.
Quarter End-of-the Quarter Values % Change S&P Index Monthly Lead
------------------------- -------------------- From Next
S&P 4-Qtr. P/E Following Following Business
index Earnings Ratio 6 Months 2 Years Peak
1933-4 10.10 .44 22.95 - 2.9 33.0 - 41
1934-1 10.75 .49e 21.94e -15.3 38.8 - 38
1938-4 13.21 .64 20.64 -17.8 -19.9 - 74
1946-2 18.43 .84 21.94 -17.0 - 9.2 - 29
1961-1 65.06 3.09 21.06 2.6 2.3 -105
-2 64.64 3.03 21.33 10.7 7.3 -102
-3 66.73 3.05 21.88 4.2 7.4 - 99
-4 71.55 3.19 22.43 -23.5 4.8 - 96
1962-1 69.55 3.37 20.64 -19.1 13.6 - 93
1987-2 304.00 14.42 21.08 -18.7 4.6 - 37
1991-3 387.86 17.82 21.77 4.1 20.6 ?
-4 417.09 15.97 26.12 - 2.1 11.8 ?
1992-1 403.69 16.20 24.92 3.5 10.4 ?
-2 408.14 17.05 23.94 6.8 8.9 ?
-3 417.80 18.04 23.16 8.1 10.7 ?
-4 435.71 19.09 22.82 3.4 5.4 ?
1993-1 451.67 19.84 22.77 1.6 10.9 ?
-2 450.53 19.33 23.31 3.5 20.9 ?
-3 458.93 20.41 22.49 - 2.9 27.3 ?
-4 466.45 21.88 21.32 - 4.4 32.0 ?
1996-4 740.74 35.27e 21.00e ? ? ?
Footnotes for Table 18.6
e represents an estimated based on the four quarter earning total for 1934 and a preliminary estimate of the four quarter earnings for 1996.
Source of Basic Data: Standard and Poor's Security Price Index Record.
Go on to Essay 19:
Return to the Introduction