Common sense tells us we're facing an era of subdued returns in the stock market. There are two kinds of return. "Investment return" measures the capital gains and dividends from companies experiencing earnings growth. "Speculative return" represents the emotions of investors that can add to or subtract from investment returns in the short term.
In 1999, if we'd had the Keynesian wisdom to consider the sources of past stock returns, we would have likely recognized a bubble that was about to burst. First, the dividend yield--a known quantity--had fallen to an all-time low of 1.2%. This eliminated the dividend's power to drive future investment returns and left the heavy lifting to earnings growth.
What about speculative return? Over the previous two decades, the market's price-to-earnings ratio had soared from 7 to 30.5, producing a 7.5% annual contribution to investment return. By 1999, the P/E level was more than double the century-long average of 14.5 times....MORE