This is the meme rallying cry against bears and crypto bulls. Stock prices only go up (given a long enough time horizon). This is something that is taught almost as a fact of economics. For example, The Great Courses' micro/macro 101 level course explains how the stock market has averaged a 10% return per annum, and how a slow and steady flow of savings into a diversified stock portfolio yields a large amount of savings over time. This is the famous "Warren Buffet," advice: "stick your money in S&P500 ETFs and forget about it."

There is a rather large problem with this ubiquitous outlook on the price of equities.

First, it is falsified by history.



Imagine pouring your savings into an S&P500 ETF in 1965 as it approached 800, only to see it not surpass that level until the early 1990s, at which point decades of high inflation had already greatly eroded the real value of nominal share prices. Investing at age 35 does not guarantee solid returns by age 65.

A look at other markets is even less friendly to this view:



The second problem is that, in all my time studying and now teaching economics, I have never seen an argument for why stock prices for large caps should necessarily outpace both inflation and % GDP growth. Yet the argument that parking your money in an index fund should be a rather fool proof strategy endures, and this argument presupposes that this is true. In reality, it seems odd that the value of shares of the largest 100-500 companies should continually grow significantly faster than overall GDP, wages, or inflation.

From an information theoretic perspective this also makes little sense. If stocks outperform fixed assets consistently in this way, this should be priced in already, and so we shouldn't have continuous growth. Continuous growth of this sort presupposes an informational deficit that, by my reckoning, should not exist.

What's up here?


It's an open question. My thought is that the long-term boom in stock prices is tied directly to central bank efforts to stimulate full employment by keeping interest rates very low. This has made fixed asset investments (e.g. bonds), produce a very low return on investment. This in turn has driven people to invest in equities. Helping this trend is the advice that "throwing money into equities is a sure thing." But, at some point, people will remember that it isn't. You can plow your money into a diversified large cap index in a developed country at age 35, come back at 65, and find your assets' real value are lower than it was when you bought it. This has indeed happened historically.

The reason "stonks only go up," then is central bank actions depressing the value of fixed asset investments, while at the same time cheap debt allows companies to do things like issue debt for stock buybacks and "debt funded dividends." My opinion is that both of these should be illegal. Corporations, like government entities, should only be allowed to borrow to fund investments or operating deficits.

Corporate debt to GDP hit record levels in the US even before the Pandemic borrowing binge. This debt service represents a considerable anchor on companies' future ability to generate profits. Yet stocks have soared. This seems mysterious until you realize that interest rates have been held so low, even as inflation rises, that stocks have represented one of the only places for yield chasing investors to plow their money into. Who wants to hold 30 year debt at 2.8% when inflation is 8%?

(The other place they've looked for yields? Single family homes .This also has had bad effects, on the one hand increasing housing scarcity, and on the other looking like a new bubble, as rents and home prices rise with no connection to wage growth.)

The problem I foresee is twofold. First, the policy of keeping rates low has now been identified as far from benign. It is a major driver of wealth inequality. To see why, simply look at the percentage of all equities held by the top 0.1%, 1%, and 10% wealthiest individuals in developed economies. Rising stock values inflate the value of assets largely held by the wealthy.

This wasn't politically untenable before because the middle class had still plowed most of their savings into the market. The fate of stock prices became very politically relevant as the ability of citizens to retire was increasingly tied to stock prices. Thus, there was considerable pressure to make sure "stonks only go up," which you see in the fact that so much debt was allowed to be issued for stock buybacks.

Now the interests of the wealthy and everyone else are diverging because inflation is back. It's more important for the median citizen to see inflation subside than it is to see stock values stay up.

How do we beat inflation? We dramatically increase interest rates. What happens if rates go up dramatically and eclipse the projected return for stocks (which are already probably unrealistic)? You get a massive vacuum pulling money out of stocks and into fixed assets. You get this not only because returns are higher in fixed assets, but because heavily indebted large corporations now are forced to roll over debt at much higher rates, which is going to tank profitability.

Which isn't to say I think stocks will plunge in value and stay low for 30+ years, but to say that it is totally possible and I find it hard to see why this is ignored. And while raising rates and keeping them high will be painful, it might be the right thing to do. Middle class people should not necessarily have most of their non-home related assets tied up in equities. Wouldn't it be nice if people who can't afford to gamble could make actual meaningful yields on savings bonds like they used to be able to? Isn't fixed asset income a better foundation for middle class savings? Aren't bonds, which are issued for real investments (stock buybacks aside), a better place to focus than stock prices, whose shift up or down does absolutely nothing for how much a company can invest?

ETFs are a great innovation. They allow you to quickly diversify your portfolio. They're also awful for amateur investors as far as fixed income is concerned. Instead of thinking about buying a coupon rate, you're buying shares of a bond ETF. The price of that share now moves around based on bond market behavior.

On a practical note, the US government does offer anyone with a Social Security number up to $10,000 in savings bonds that are tied to the rate of inflation. That, far more than equities, is where luminaries should be telling people to put their money first. There is a 9.6% coupon sitting out there and "experts" are saying "go buy stock" now?

Lot to unpack there. Figured it would be a fun topic of discussion.