Transcript Stocks For the long run - FBE Moodle

STOCKS FOR THE
LONG RUN
Eastern Mediterranean University
Dr. Korhan Gokmenoglu
Mohamad Kaakeh 137618
Masimba Mutuke
118198
Victoria Adedayo oni 128123
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The impact of
Economic growth on
market valuation and
the coming age wave
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GDP growth and stock
return
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GDP growth and stock
return
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GDP growth and stock
return
• Real GDP growth is negatively correlated with stock
market returns.
• Why does this occur?
• price is the present value of future dividends
• Would economic growth positively impact future
dividends and increase stock prices?
• the determinants of stock prices are dividends and
earnings on a per share basis, although economic
growth influences aggregate earnings and
dividends favorably, economic growth does not
necessarily increase the growth of per share
earnings or dividends.
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GDP growth and stock
return
• Why?
• Economic growth requires increased capital
expenditures, this extra capital is financed by debt
(loans, bonds,..) or equity (issuing new shares) and
the added interest costs (debt) and the reduction
of earnings (equity) reduce the growth of per share
earnings.
• growth can occur in the short term without capital
expansion by using the existing plant more intensely.
But the long run historical evidence strongly
suggests that capital must be expanded to support
higher growth.
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The Gordon Dividend
Growth Model
• d is the next period dividend per share
• r is the discount rate
• g is the constant rate of future growth of dividends
per share
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Economic growth and
stock returns
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Factors that raise
valuation ratios
• Expected rate of returns on equities
• The Equity-Risk premium
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Factors that impact
expected returns
• the reduction in taxes on equity return due to the
reduction in marginal and capital gains tax rates
and inflation.
• the reduction in transactions costs
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The Equity-Risk premium
• given the standard models of risk and return that
economists had developed over the years, one
could not explain the large gap between the
returns on equities and fixed-income assets found in
the historical data.
• economic models predicted that either the rate of
return on stocks should be lower, or the rate of
return on fixed-income assets should be higher, or
both. In fact, an equity premium as low as 1
percent or less could be justified.
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More stable Economy
• Attempts to justify the 3 to 3 1⁄2 percent risk
premium found in the historical data
o Some of these are based on very high aversion by
individuals to lowering their consumption.
o Others on those who dislike taking short-term losses on their
investments even when they have substantial long-run
gains.
• Increasing stability of the real economy is the
reason why premium might narrow in the future.
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More stable Economy
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New justified P-E Ratios
• Average historical P/E ratio may no longer be
appropriate
• If inflation stays low, the tax policy remains
favorable for equities, and the business cycle
remains muted, one can justify price-to-earnings
ratios in the low 20s for the equity market.
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The Age Wave
• Inflation, tax policy, macroeconomic stability, and
the drop in transactions costs are important factors
influencing the valuation of equities.
• Many are expecting a long and comfortable
retirement by relying on government and private
pension plans as well as tax supported medical
services.
• Unless we can exploit the change in demographic
and economic changes then we may face a
poorer future.
• This forecast is not based on an unpredictable
future but on events that have already transpired.
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Demography is Destiny
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The Bankruptcy of Government
and Private Pension Systems
• Although it is widely known that our Social Security
and Medicare programs are threatened by these
demographic trends, there are many who believe
that they have accumulated sufficient private
wealth to fund their retirement.
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The Bankruptcy of Government
and Private Pension Systems
• But this may not be so. The same crisis that strikes
the public pension programs can overwhelm
private pensions as well. Since there will not be
enough workers earning income, there will not be
enough savings generated to purchase the assets
the retirees must sell to finance their retirement.
• Reasons why retirees cannot turn their savings into
consumption
• In a modern economy, wealth does not represent
“stored consumption,”
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Reversal of a CenturyLong Trend
• Implication of less demand and more supply
• Social Security was passed in 1935, the average
retirement age was 69. That age fell to 67 by 1950,
and to 62 today. In 2003, for the first time, more
Americans chose the reduced Social Security
benefits at age 62 than the full benefit that starts at
65. Despite improving health, surveys indicate that
the bulk of Americans and Europeans want to retire
earlier, not late.
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Reversal of a CenturyLong Trend
• But that will not be possible. Because of our aging
population, it is most likely that future increases in
the age of retirement will actually exceed the
increase in the life expectancy and will cause—for
the first time in history—an absolute reduction in the
number of years in retirement.
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The Global Solution: An
Opportunity to Make a Trade
• There is no easy solution. Nevertheless there is a
solution that can help aging economies. This
solution is call GLOBAL SOLUTION to the age wave
• How effective is this solution will be?
• Growth rate in the developing world
• Degree to which world trade and capital market
are kept open.
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The figure below shows how crucial the growth rate of the
developing world is to future retirees
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Attraction of U.S. Capital
• Why would the developing world wish to acquire
our capital when their countries are expanding so
rapidly?
• that end, U.S. capital markets have many attractive
attributes. Our country is still viewed as the
fountainhead of innovation, discovery, invention,
and entertainment, and our institutions of higher
education are second to none.
• For these capital movements to occur, we must be
viewed as receptive to international capital.
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CONCLUSION
• faster economic growth in no way guarantees
higher returns.
• there are persuasive reasons why future valuation
measures may be higher. Lower transactions costs,
lower taxes, and increased economic stability.
• the aging of the population is a critical issue
impacting financial market returns. We cannot
escape from our demographic realities. But we can
take actions that will lead to a much brighter
outcome.
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Thank you for your
attention
Any questions?
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questions
• Why GDP growth and stock returns as shown in the
historical data are negatively correlated?
• Why the growth of earnings and dividends per
share is higher since World War II than before even
though the GDP growth is lower?
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