In the United States, the majority of retirement savings are invested in equity — shares in publicly traded companies.  Traditionally, high average returns have offset the inherent risks of investments in stocks, but that equation changed following the recent financial crisis. In the past three years, the value of equity has declined, growth has been sluggish and many forecasters have continued to predict low returns from stocks in the coming decade.

A 2011 report by the Center for Retirement Studies at Boston College, “Equity Returns in the Coming Decade,” analyzes the ways in which corporations have, over time, used earnings to ensure that gains on stocks exceed the rate of economic growth. The report discusses the implications of this strategy of “synthetic growth” for shareholders and how this may impact the value of investing in stocks over the next decade.

Important points in the report include:

• During the economic boom from the late 1990s through to the mid-2000s, profits averaged almost 9% of output. Today, profit margins for non-financial sector corporations have recovered substantially, reaching 8.5% of output.
• Currently, stock prices are 15 times earnings and offer investors an earnings yield that matches the long-run average return on equity of 6.5%. Shareholders can expect to realize this return in coming years, provided corporations can maintain their profits.
• From 2005 to 2010, corporations have continued to drive up their stock value not by expansion of their business but by using earnings to buy back their own stock, buy stock in other companies and retire debt.
• Many forecasters have said the expected weak economic recovery means that stocks are not a good bet, as capital gains will remain constrained by low growth.
• However, because earnings may be more important for shareholder returns, rather than capital gains, stocks might be expected to pay good returns provided that earnings recover.

In sum, the report’s authors note that projections for economic growth and the outlook for investing in stocks should not necessarily be linked. They state that “corporations do not require strong economic growth to engineer relatively high rates of appreciation of their stocks.” Moreover, companies also “do not need to produce relatively high rates of appreciation to offer their shareholders a high rate of return.”

Tags: economy, financial crisis, retirement, consumer affairs

By Christopher Olver | May 12, 2011