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The Stock Market is Going to Go Up

The Stock Market is definitely going to be going up.  Unfortunately, the Stock Market is also definitely going to be going down.  In the previous blogs, I have been characterizing who owns Stocks and Bonds and how often they get bought and sold.  The next few blogs are going to delve into what makes the prices go up and down.  The most important thing to take away is that they will go up and they will go down.  We will look first at the Stock Market.

As was discussed in earlier blogs, you have to start by taking a look at just exactly what the Stock Market it is before looking at the movement of prices up and down.  Stocks are ownership in a company and as such have some value.  People buy stocks for one of three reasons:

  • Anticipation of getting income in the form of a future stream of dividends
  • The hope of being able to sell the stock later to someone else for a profit
  • The ability to control a corporation and direct what they do

So, which of these factors drive prices up and down.  The assumption is that all three drive it to some degree.  Can we test how much each of these motivations actually determine the price of a stock and whether it will go up and down?  Probably not, but, we will make an attempt anyway.

The dividends would be a good place to start.  The average dividend yield of the S&P 500 is 2.06%.  In the S&P 500 about 25% of the stocks offer no dividends and 75% do.  The 2.06% is all the dividends divided by all the stocks regardless if they paid dividends or not.  If you just look at the stocks paying dividends then the average dividend yield is 2.60%.  In any case, 2.6% does not look like a great return even in today’s paltry interest rates.  The following chart shows high quality bond yields versus the S&P 500 dividend yield.

As you can see, over the last 40 years or so bond yields are consistently at least twice as high as stock dividends.  Normally, bonds are less risky for a number of reasons including that if a company hits bad times a bond holder will get paid before a shareholder.  The other thing to notice is that both bond yields and stock dividend yields have been in a consistent down trend over the last 30 years.  The first thought is that this must be due to inflation.  Bond rates are not specifically tied to the inflation rate although with the role of the Federal Reserve Bank to control inflation, it is common policy for the Fed to raise the prime lending rate in order to “cool off” an economy and help control inflation.  A bond is tied to this prime lending rate and not directly to inflation.

Also notice the spikes associated with dividend yields.  There were huge spikes in 1929, 1982, 2008, etc.  These spikes were associated with the depression and some pretty big recessions.  So, does this mean that companies start paying out higher and higher dividends in order to lure people back into the stock market.  Unfortunately, that was not the case, it was the fact that the denominator (the total capitalization of the stock market) was lower that caused the dividend yield to spike and not the case of the numerator (dollars paid as dividends) that got higher.

So, the best that can be said for a person to hold stocks for the dividends is that you will earn half of what you could earn with bonds.  That means that people must hold stocks for the other two reasons (stock appreciation or wanting to own a company).  Let’s assume that individual investors don’t often try and own a company (Warren Buffet types not included).  Then the average investor is in the Market because they think that people will pay them more for their stocks than what they bought them for.

My next blog will go into why people would pay more for stocks than the future stream of dividends.  On the surface, it just doesn’t make any sense.  It seems like the worse kind of Ponzi scheme or is it just simple economics at work?

Categories: Stocks
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