Long-term Stock Market Growth and GDP

A stock market represents the sum total of the public's perception of the business value of the companies trading in that market.

True business value, is the sum total of productive assets and, in particular, what those assets produce in the form of current and future earnings.

As long as companies produce more, it makes sense that their values rise.

And as long as the public perception matches true value, the stock value rises in lockstep.

GDP

You can and should expect, in aggregate, that the total value of all businesses would rise roughly in line with the increase in the size of the economy, as represented by gross domestic product (GDP). This is true.

Business value grows further through increases in productivity.

The value of market traded businesses could rise still more if the businesses grew their share of the total economy - as Borders Group and Barnes and Noble have grown their share of the total bookselling business.

Long-term stock market growth (by most measures of return, 10-11% annually) can be explained by adding together the following:

GDP growth of 3 to 5%
Productivity growth of 1 to 2%
Long-term inflation in the 3 to 6% range

In the short-term, depending on the value of alternative investments, such as bonds, real estate, and so on, market value may actually rise faster or slower than business value. And inflation also tampers with market valuations.

So can markets grow at 20% per year?

Not for long. It isn't impossible for the markets to rise 20% in a given year or two, but such growth year after year is hard to fathom if the economy at large is growing at only 3 to 5% annually.

But for a particular stock?

Sure, it's possible. If the company is building a new busines or is taking market share from existing businesses, 20% growth can be quite realistic.

But forever?

Doubtful. Some call this "reversion to the mean" - sooner or later, gravitational forces will take hold and a company will cease to grow at above-average rates. As an investor, you must realistically appraise when this will happen.