The red Dow Jones Industrial Average total returns line is "smoothed" by taking an average of three years at the
beginning and end point. This eliminates some of the volatility due to sharp
annual moves in the DOW and allows a better view of the underlying trend.
A 30-year rolling holding period graph is also provided based on data for the S&P 500 as compiled by Ibbotson Associates in
their Large Stock Index2. The pattern was remarkably similar
to the DOW graph although the total returns on the S&P 500 (red line)
tracked the GDP +
Dividends line more closely (particularly in recent years) than did the DOW
The graph above shows that the the summation of the average nominal GDP
growth over 30 years plus the average dividend on the stock market has been
trending down for many years. The relationship suggests that the average return
on the S&P 500 will trend down with it. Current forecasts of nominal GDP
plus dividends are even lower in the 7% range and the graph suggests that the
S&P 500 total return average will follow it down.
Interpreting the lines based on 30-year rolling data above can be very difficult.
A more direct view of the Dow earnings (not return but earnings) versus GDP is shown below.
Note that the above graph has logarithmic which is the ONLY proper way to show
long-term trends but which can make a large percentage change appear quire
small. Also notice that the two lines on the chart use two different but
consistent scales. The
scale for the Dow earnings (red line, left scale is 1/10th of the value of the
GDP scale (blue line, right scale). This makes sense because the GDP is (very)
roughly ten times as large as the Dow Earnings. My two scales are consistent in
that in each case the top of the scale is 10,000 times larger than the bottom.
Many analysts will use a left scale that has a range of say 1 to 50, while the
right scale goes from say 10 to 200, rather than 10 to 500. Such inconsistent
scales are very mis-leading. I always use scales that are consistent.
This graph shows the steady growth in U.S. GDP (blue line) versus the growth
in the earnings of Dow Jones Industrial index which are more volatile but which
also rose steadily in the long-run. The slope of the earnings line is slightly lower than
that of the GDP line. Thus, stock market earnings growth is driven by growth in
GDP, in the long run, but is slightly lower. Dow Jones Industrial Average total
returns are in turn, in the long term, of course, driven by the earnings and
dividend yield on the Index.
Below I show the exact same data but this time with a linear scale:
This chart with a linear scale is not the proper way to look at the trend of
GDP or Dow earnings since 1930. (Log scales are best). However the linear scale
confirms how DOW Jones Industrial Average Earnings have trended up with GDP over
the years. The linear scale does a better job of showing the big drop in the Dow
earnings in 2008.
What Does This Imply For Future Long-Term Returns In The Market?
For 30 year periods (and for other longer periods of at least 15 years) starting today we should expect the nominal GDP plus dividends
figure to be in the range of about 7.0% (although with huge volatility around that average
figure in any given year). This lower-than-historic level is driven by today's very low interest
rate outlook, low inflation outlook and relatively modest real GDP growth
outlook. Due to the historical and logical relationship of large-capitalization
stock returns being no greater than the sum of nominal (after-inflation) GDP plus the dividend yields, we
should not expect large-capitalization stock returns to exceed about 7.0%. And this
is before trading and management costs and before any income taxes.
We would have to adjust our expected returns figure if we thought that
today's stock market values were very high or very low according to historical
norms. The stock market as of May 25, 2013 is probably reasonably valued..
The result is that our disappointing estimate of 7.0% is not only
reasonable but in fact may be biased high since actual large-capitalization
total stock earnings and returns historically
lags the sum of GDP growth plus the dividend yield over 30 year periods.
The average total return on the DOW and S&P 500 has been very low over the past
dozen years. But that does not mean we should expect negative or
tiny returns going forward. Both the approximate 18% ten-year compounded average
annual returns that we saw in the ten years ended 1998,1999 and 2000 as well as
the recent very low ten-year compounded average return were abnormal. Something
closer to our 7.0% is a better guess going forward.
As mentioned, I first heard this theory from Warren Buffett and the data
indeed seems to prove his theory (not a surprise). But, this relationship only holds (even
approximately) over long periods such
as 20 years or more. It is not meant to be a short-term indicator.
Shawn Allen, CFA, CMA, MBA, P.Eng.
First written July 10, 2003 last updated May 25, 2013
See also our related article on what
return to expect from the Dow.
Warren Buffett in Fortune Magazine,
November 22, 1999, said:
Let's say that GDP grows at an average 5% a year - 3% real
growth, which is pretty darn good, plus 2% inflation. If GDP grows at 5%, and
you don't have some help from (declining) interest rates, the aggregate value of
equities is not going to grow a whole lot more. Yes, you can add on a bit of
return from dividends. But with stocks selling where they are today (this was
1999), the importance of dividends to total return is way down from what it
used to be. Nor can investors expect to score because companies are busy
boosting their per share earnings by buying in their stock. The offset
here is that the companies are just about as busy issuing new stock, both
through primary offerings and those ever present stock options.
At the May 2001 Berkshire Hathaway annual meeting, Buffett
again spoke of long-term returns based on 5% for GDP and he estimated the
dividend yield at 1.5% at that time. And he noted that this (6.5%) return would
be before the investor's trading costs.
Warren Buffett's Fortune article was updated December 10, 2001.
2. The Ibbotson Large Stock return figures are from the
Stocks, Bonds, Bills and Inflation Yearbook by Ibbotson Associates. They indicate that the "large company stock total return index
is based on the S&P Composite Index". Since 1997, Ibbotson has obtained its data
directly from S&P. Prior to 1997 the dividend or income return was calculated by
parties other than S&P. Consult the Ibbotson Yearbook for further discussion.