The NY Times does it again. A few weeks back, we praised their cogent article on the Social Security Trust Fund; today, we praise their article on the esoteric subject of economic growth and stock market returns:
In barnstorming the country over Social Security, administration officials predict that American economic growth will slow to an anemic rate of 1.9 percent as baby boomers reach retirement.
Yet as they extol the rewards of letting people invest some of their payroll taxes in personal retirement accounts, President Bush and his allies assume that stock returns will be almost as high as ever, about 6.5 percent a year after inflation.
...A growing number of economists, however, including many who favor personal accounts, say Mr. Bush's assumptions are optimistic.
Many believe that stock returns will be lower than they have been in the past, closer to 5 percent than 6.5 percent, and that returns on a balanced mix of stocks and bonds will be much lower than that.
"Most economists would argue that, over a long period of time, there is a linkage between what the stock market will return and how well the economy does," said David Blitzer, chairman of the Standard & Poor's index committee, which oversees the S.&P. 500 stock index.
...In a paper to be presented on Thursday at the Brookings Institution, three economists who are longtime critics of Mr. Bush argue that stock returns are likely to be about 4.5 percent if economic growth slows as much as the administration predicts.
"We find it arithmetically very difficult to construct scenarios in which asset returns are at their historic average values and real G.D.P. growth is markedly slowed," wrote the economists, Paul Krugman of Princeton University, whose Op-Ed columns in The New York Times have long been sharply critical of Mr. Bush's plan; J. Bradford DeLong of the University of California, Berkeley; and Dean Baker of the Center for Economic Policy and Research, a liberal research organization in Washington.
To make the numbers work, the economists contended in their paper, domestic profits would have to grow far more rapidly than they have in the past, or American companies would have to become huge exporters of capital to faster-growing countries. At the moment, the United States is a huge net importer of foreign capital.
Well, they also note that higher dividend payouts solve the problem, as will be mentioned below.
Administration officials and many independent analysts disagree, saying the link between overall economic growth and investment returns is weak.
But many Wall Street analysts warn that stock returns are likely to be significantly lower in the future for a separate reason: stock valuations are high relative to expected earnings, and they are likely to remain that way.
The S.&P. 500 index is currently valued at about 20 times earnings, which translates to an expected return of about 5 percent a year. The historical average is about 15 times earnings, or an expected return of more than 7 percent.
William C. Dudley, chief United States economist at Goldman Sachs, estimates that stock returns are likely to be about 5 percent in the future, because investors are accepting lower "risk premiums."
My official editorial prediction is "5%", for reasons similar to those mentioned by Mr. Dudley of Goldman, Sachs.
...Stephen Goss, chief actuary for the Social Security program, defended the administration's assumptions.
"Keep in mind that we are trying to make projections over a very long time, 75 years," Mr. Goss said. "I would suggest that 5 percent at the moment makes perfect sense. But if you buy at another time, when the price-earnings ratio is 10, you would expect a higher return over time."
Many experts agree that slower economic growth in the United States does not mean lower rates of return. Confronted with lower demand in the United States, companies can spend less money on expansion and more on dividends. Or they can invest more heavily in countries with faster-growing populations.
"Growth might slow in developed countries, but it's not clear to me that world growth is going to slow down at all," said Jeremy J. Siegel, a professor at the Wharton School of the University of Pennsylvania and a leading analyst of long-term stock trends. "I think world growth will go up."
Ahh, well. Regular readers will recall the brawl that was sparked by Paul Krugman's assertion a while back that returns of 6.5% were "impossible" in the projected lower growth environment. But the intellectual ball seems to be advancing.