Pensions: The Danger of Extrapolation

by: Brad DeLong

Alison Schraeger writes in the Economist (Pensions: The retirement solution):

If equities continue to perform the same way they have the last ten years...

No, no, no, no no. No. NO!

Naive straight-line extrapolation is rarely your friend.

Over the past ten years...

  • Cyclically-adjusted real earnings have grown at a rate of 2.5% per year.
  • Stocks have paid dividends at a rate of 2.5% per year.
  • Price-to-cyclically-adjusted earnings ratios have collapsed at an average rate of 6% per year.

producing average real equity returns of -1% per year.

If this were to continue for the next two decades, the S&P composite would stand in 2030 at 6 times its cyclically-adjusted earnings, which would be 56% higher than they are now.

My mind, at least, boggles at the idea of an S&P Composite where the earnings yield is 17%.