The abstract does a great job of summarizing the OP's findings:<p>> I show that the decline in interest rates and corporate tax rates over the past three decades accounts for the majority of the period’s exceptional stock market performance. Lower interest expenses and corporate tax rates mechanically explain over 40 percent of the real growth in corporate profits from 1989 to 2019. In addition, the decline in risk-free rates alone accounts for all of the expansion in price-to-earnings multiples. I argue, however, that the boost to profits and valuations from ever- declining interest and corporate tax rates is unlikely to continue, indicating significantly lower profit growth and stock returns in the future.<p>Great paper, very though-provoking.<p>Thank you for sharing it on HN!
Very interesting paper.<p>> I show that the decline in interest rates and corporate tax rates over the past three decades accounts for the majority of the period’s exceptional stock market performance.<p>It's interesting that they've shown this to the <i>exclusion</i> of other narratives, mainly frontier markets like semiconductors and software allowing "easy" <i>creation</i> of value. I think this is partially why investors are so eager to dump so much cash into AI/why Zuckerberg has been so focused on VR/AR—they're looking not just for a solid investment, but an opportunity to get into the rent-seeking class on the ground floor. Why would you invest in a piece of software when you could invest in a "platform" (aka privately-owned market) instead?<p>Of course, we can't just <i>create</i> these platforms out of nowhere—they require enormous moats like exclusive access to IP or regulatory capture or enormous production capacity or some sort of similar gimmick, and there's only a finite number of these. It seems like this is also a significant reason why growth isn't infinite and should be expected to slow and even reverse in time.<p>I haven't finished the paper but I eagerly look forward to reading it in full later.<p>EDIT: spelling, wording, I'm done editing; apologies.
Quite a few authors have pointed out that the "financialization" of American businesses, with a focus less on innovation or investing in their workforce and more on massaging their numbers to meet shareholder expectations, has created a lot of short-term enrichment for the super-wealthy while absolutely destroying the middle class as we know it. This seems like more fuel for that fire.
It's worth noting this is just one person's opinion, it's not an opinion of the Fed itself. The paper analyzes corporate profits on the basis of interest and tax rates alone, but ignores other monumental shifts in global markets over the past few decades like globalized supply chain networks. It's probably true that the efficiency gains from globalization have already passed their peak, but that would have as much of an impact on declines in profit growth rates as any other factor.<p>The article also ignores technology as a factor. If globalization is at its peak, automation is probably still in its infancy. Robotics and AI are rapidly advancing and it's going to have a substantial impact to supply chains and labor markets over the coming decades, regardless of what happens with interest rates.
I could be mistaken but using the S&P500 index might be slightly problematic in that the companies that compose this index change all the time. This almost guarantees that the index increases in value over time as high performers are added and low performers are removed. There is an upward bias.<p>I don't doubt that overall, on average, much growth has come from a 40 year decline in interest rates and a consistent lowering of corporate taxes, but new companies in new industries will continue to be founded and feature explosive growth. We aren't stuck with a static set of companies.
This seems to have proven that growth leads to higher earnings and equity prices.<p>Of course less taxation and a drop in interest rates will lead to more earnings over time and higher valuations. The crux is that he frames the drop in interest rates as a matter of "luck", as if the government just happened to be dropping them, as opposed to the government reacting to the drop in good/service prices by lowering rates, as a result of innovation, to maintain price stability and the 2% inflation target.<p>Company A makes more of Good #1 for less money due to Innovation X, and can charge less money. When this occurs across the entire economy, the fed has to drop rates to prevent broad deflation in prices. Lower rates show up as more earnings. The alternative with fixed rates would be that Company A's revenue, after its impressive innovation, would remain roughly the same (or fall) while its competitors' revenues fall (more). The real (adjusted) growth in equity prices, earnings, and revenue would still be going up at the same rate IMO.<p>It's entirely possible (maybe not likely) that a landmark innovation could deflate prices for most goods in the future and bring us back to low or even negative rates, which would (per his measurements) show up as higher earnings and equity prices.<p>Maybe I don't know what I'm talking about, but this paper seems circular to me. What would be more compelling is an analysis on the future of goods/services availability, as interest rates and taxation are downstream of those. For example, what does China's potential decline forebode for good availability? What about the hyped up potential panacea of AI?
There was an economist who predicted this in the 19th century <a href="https://en.wikipedia.org/wiki/Tendency_of_the_rate_of_profit_to_fall" rel="nofollow">https://en.wikipedia.org/wiki/Tendency_of_the_rate_of_profit...</a>
I believe in almost no predictions that assert a change from the existing regime. Regime shifts of this scale (a stop to equity growth) are extremely rare. But nobody publishes papers on why the existing status quo will continue. The show will go on, technology will be deflationary, which will support interest rate drops. Inflation will get sucked out of the economy, and life will go on.<p>Anyone that ever acted on advice like in this paper lost insane amounts of money.
Data is based only on non-financial firms; I wonder what is the effect size of this exclusion. Economy said to be migrating up the value chain to financial services and using pervasive financial engineering, in GE, pharma, fintech, etc. The prospect of higher interest and more taxes would drive more such engineering.<p>Another question is the stock value loss attributable to dwindling market competition depressing innovation and demand.<p>Another is demand for stock: P/E multiples going up while most people are under increasing economic stress and lower investment puts all the burden on current stock owners to reinvest, but asset-weighted individual investors might be aging out.<p>Again, unclear effect size to all this. Hard to imagine being an economist.<p>But in any case signaling that US stocks long-term are likely to be bad seems counter-productive except as a threat to the incoming administration against increasing rates and taxation.
I kinda wonder how much of this is chicken vs egg. Was corporate profit growth only what it was because of long term low interest rates? Or did low interest rates encourage passive investments and low innovation?<p>Also, the elephant in the room is retirement. Aging populations represent a huge slowdown across the economy - and every year brings the highest percentage of non-working adults humanity has ever seen. For all the ink spilled over innovation and growth and etc this is going to be the real market wrecker.
This seems like an overall good thing, since a lot of the effect of these essentially artificially inflated growth numbers has been investors' expectations becoming tied to an unsustainable and unrealistic expectation of growth year over year, and this has a myriad of downstream negative consequences for the actual operation of businesses, which has in turn wreaked havoc on the real economy. Maybe this can trigger a sort of reset of those expectations
I know nothing - but my girlfriend worked for more than a decade with financial groups essentially betting on economic downturns. Started ok around 2000 but most were eventually sold at rebate to a larger firm's lately - and these aren't really in a comeback.<p>Let's just say most outlook on the past 25 years has been generally positive and should get better in the next 25. These "negative" aren't really popular currently, but I'd be surprised if they ever are.<p>I know nothing - just sharing from people who actually played billions into these downturns articles for multiple decades...
It'll be interesting to see what this analysis looks like today, considering there have been 2+ years of substantially higher interest rates since this paper was published.
Stock returns grow because that's where people and institutions put their money.<p>If stock return growth slows (assuming they aren't talking only about dividends), that means either there's less money in general or it's being parked elsewhere. Which is it?<p>Or do I misunderstand what <i>stock growth</i> is?
This fits well with some of what Ray Dalio has been saying. The are business cycles and also cycles of those business cycles. At this time we appear to be in a long term transition downward following a long period of relatively strong upsides.
So can the fed keep interest rates high for long? I think they can't.. because then government debt is too expensive. Pushback from treasury will be intense.
I'm sure absurd parasitic government interference, lawfare, and shareholder activism in public corporations has nothing to do with all the good companies going private, ergo smart people telling the lawyers to go to hell, old people with pensions hardest hit.
The paper emphasizes that much of the extraordinary stock market performance since 1989 was driven by "good luck" rather than compensation for risk, and future returns will likely be more modest unless structural changes occur.<p>This perspective underplays the role of innovation, globalization, and technological advancements.