16
Growth factor and growth premium
• The next four chapters discuss four underlying factors that I consider most important for determining long-run returns: growth, inflation, liquidity, and tail risks. All these factors tend to offer larger ex ante risk premia following adverse shocks.
• The growth factor is closest to the equity market factor and the equity premium. It captures general economic growth prospects but is also closely related to market risk aversion.
• Long-lived risky assets reflect both secular and cyclical growth prospects, neither of which is easy to predict.
• Overall economic growth sets some speed limits to aggregate profit growth although the profits-to-GDP ratio can make very large and long-lasting swings around its normal level. However, the speed limit that is relevant for stock investors is earnings-per-share growth—not aggregate earnings (profits) growth. The real trend rate of growth in earnings or dividends per share is only 0% to 2% over long periods, lagging the real GDP growth rate and aggregate profit growth rate because of dilution (the necessity for companies to issue more shares to raise the capital needed for growth).
• The link between equity market returns and economic growth is surprisingly tenuous. Even over long time windows, countries with high economic growth have not had particularly high equity returns. The predictive relation from growth to returns is even worse than the contemporaneous relation because abnormal growth appears mean-reverting. ...

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