12 ms·

The coming long-run slowdown in corporate profit growth and stock returns [pdf] (2023)

132 points by luu 2y ago

downrightmike 2y ago
It won't last, the algos ran by the billionaires will demand growth.
darby_nine 2y ago
Very interesting paper. > I show that the decline in interest rates and corporate tax rates over the past three decades accounts for the majority of the period’s exceptional stock market performance. It's interesting that they've shown this to the exclusion of other narratives, mainly frontier markets like semiconductors and software allowing "easy" creation of value. I think this is partially why investors are so eager to dump so much cash into AI/why Zuckerberg has been so focused on VR/AR—they're looking not just for a solid investment, but an opportunity to get into the rent-seeking class on the ground floor. Why would you invest in a piece of software when you could invest in a "platform" (aka privately-owned market) instead? Of course, we can't just create these platforms out of nowhere—they require enormous moats like exclusive access to IP or regulatory capture or enormous production capacity or some sort of similar gimmick, and there's only a finite number of these. It seems like this is also a significant reason why growth isn't infinite and should be expected to slow and even reverse in time. I haven't finished the paper but I eagerly look forward to reading it in full later. EDIT: spelling, wording, I'm done editing; apologies.
- VirusNewbie 2y ago
  well, they're looking at earnings growth, not profit margins. You could have a company that increases profitability YoY and not grow revenue as well. It's less typical, but certainly possible with technology companies. I think this paper misses that fact.
  - nine_k 2y ago
    This is fair. But the theoretical maximum of profitability is 100% of revenue. A company that increased their revenue 10x while keeping the same 10% profit margin (both numbers quite normal) achieved the same profit as if it kept the revenue the same and grew profitability to 100% (pure fantasy). Also, larger streams of money create the economic multiplier effect.
- nostrademons 2y ago
  Semiconductors and software have created enormous amounts of value for the companies that own them, but the Fed usually thinks in macroeconomic terms. For the macro economy, the effect of technical development on overall corporate profits is much more muted. Creative destruction destroys old industries as much as it creates new ones. For example, there's a TV show "Mad Men" about the dominance of Madison Avenue advertising firms; Google and Facebook have completely destroyed this industry. Berkshire Hathaway annual reports from the 1970s and 1980s used to say that the local newspaper for each major metro area was a natural monopoly and reliable source of corporate profits; now, this industry has been reliably commoditized by the Internet. Of course, the creative destroyers in question would much rather focus on the "creation of value" narrative, because it avoids attracting attention (and competition or regulation) from the industries that they're about to destroy. So there are pretty significant information distortions in the popular narrative. Interest rates and corporate taxes have the property that they affect the whole market, which makes them much more useful to the Fed. If you bought NVidia in 2022 or Apple in 1998, congrats, you made a good investing call. But if you bought the S&P 500 in 2009 and are congratulating yourself on your 600% returns over the decade, you should know that most of that is because of low interest rates, and if the low interest rate environment unwinds, so will your stock portfolio.
  - psunavy03 2y ago
    Interest rates have been all over the map over the last 60 years, including double digits in the 80s, and yet low-cost index funds have been a reliable driver of wealth that entire time.
    - nostrademons 2y ago
      "That entire time" only holds if you're looking at 20+ year time horizons, and zooming in shows the effect of interest rates. If you bought the S&P 500 in November 1968 and sold it in July 1982, you lost money in nominal terms, despite the CPI nearly tripling during that time period (so in real terms, you lost 2/3 of your investment). During that time period, interest rates went from 6% to 19%, also roughly tripling. Then if you held from 1982 to 1987, the S&P 500 nearly tripled, despite low inflation and relatively few major technological changes. What was the difference? Interest rates went from 19% to 6%. A useful lens with which to view this and other phenomena is "Which factors cancel out, and under what timeframes?" Technological development leads to large microeconomic winners and losers but little macroeconomic effect under short time frames, less than the business cycle, because the mechanism by which it increases overall welfare is to put workers out of work and firms into bankruptcy, freeing up those workers and that capital to be invested in new enterprises. Interest rates have a large effect over that timeframe, because they affect all firms in the economy equally. Over long time frames (multiple business cycles), the effect of interest rates washes out because they go up and then they go down and eventually they equilibrate near the long-term average. Technological development dominates then because you've given the economy a chance to adapt to new production methods and re-employ workers in obsolete jobs.
- fnordpiglet 2y ago
  I call bullshit. Tax rates and interest rates certainly help spur investment and expansion of production but it’s hard to look at the world we live in today, with electric cars that can self drive and hand held devices connected to natural language comprehending oracles of knowledge, JIT industries end to end, starships to mars for colonization in mid to late stages, etc, and think “yep the only value is the value the federal reserve has created” as a federal reserve economist posits.
  - crystalmeph 2y ago
    https://en.wikipedia.org/wiki/Productivity_paradox https://en.wikipedia.org/wiki/Productivity_paradox. "You can see the computer age everywhere but in the productivity statistics." There are definitely companies that are winning from the tech you pointed out, sure. The companies that make robotaxis and the companies that sell AI subscriptions are going to make bank. But at an aggregate level, that robotaxi means a human tax driver is no longer working, and if every sales person has their own personal robot translator for talking to foreign clients, then none of them has a competitive edge over the others, they've just had to invest that money in order to avoid giving up a competitive edge. That OP paper's argument is basically that the only rising tide that truly lifts all economic boats is being able to keep more of the money you make instead of having to spend it on interest or taxes. So the age-old wisdom of "just buy an index fund" may have run its course, and you will actually have to pay attention to valuations instead of just blindly buying the market going forward.
    - ryandrake 2y ago
      > So the age-old wisdom of "just buy an index fund" may have run its course, and you will actually have to pay attention to valuations instead of just blindly buying the market going forward. The efficient-market hypothesis would probably disagree. If "paying attention to valuations" ever consistently produces greater returns, then index funds will start weighting their holdings in such a way to capture that value. If it produces greater returns, but not consistently, then we're back to gambling and things like technical analysis and trying to time the market.
    - 2y ago
nemo44x 2y ago
I could be mistaken but using the S&P500 index might be slightly problematic in that the companies that compose this index change all the time. This almost guarantees that the index increases in value over time as high performers are added and low performers are removed. There is an upward bias. I don't doubt that overall, on average, much growth has come from a 40 year decline in interest rates and a consistent lowering of corporate taxes, but new companies in new industries will continue to be founded and feature explosive growth. We aren't stuck with a static set of companies.
- erokar 2y ago
  Yes, the S&P500 could in a sense be said to implement a momentum based trading strategy.
- paxys 2y ago
  The companies that compose the entire stock market also change all the time, and follow the same pattern (winners rise, losers go bankrupt). So the S&P 500 is still a good benchmark of overall stock market performance.
  - nemo44x 2y ago
    So as long as innovation is outgrowing stagnation then returns should continue to outpace typical zero risk interest. In essence if you believe the stock market will fail to exhibit growth you’re betting against technological progress and productivity gains. Bad bet I’d say.
    - kgwgk 2y ago
      > returns should continue to outpace typical zero risk interest. In essence if you believe the stock market will fail to exhibit growth Who are you arguing against? The paper linked talks about "significantly lower profit growth and stock returns in the future" not about decreasing earnings and negative returns.
- tway_GdBRwW 2y ago
  You are correct that even if the US stock market flatlines for the next 20 years, there will be individual companies which do extremely well, and others which die. That's not what this article is about. The article is about average corporate profits in the current-to-the-point-in-time largest US companies. And using the SP500 allows the analysis to be consistent even as the mix of the SP500 changes. And no, changing the mix does not guarantee that the index increases in value over time. Plenty of periods of 10 years or more where the SP500 flatlined. Also, economies in other countries have extended periods where the index of their top companies flatlined. Further, the explosive growth which you hope to find is generally not in the SP500 companies. The explosive growth is what puts a company INTO the SP500.
financiergoose 2y ago
I'm sure absurd parasitic government interference, lawfare, and shareholder activism in public corporations has nothing to do with all the good companies going private, ergo smart people telling the lawyers to go to hell, old people with pensions hardest hit.
- GenerWork 2y ago
  At this point, I'm not sure why you'd want to go public unless it's simply to cash out ASAP. Everything you just described seems like major hell to deal with.
  - financiergoose 2y ago
    I'm a founder, and I have zero intention of ever going public for these exact reasons.
    - calvinmorrison 2y ago
      I think we just call that a small business owner.
      - toomuchtodo 2y ago
        I would not consider Stripe to be a small business, an enterprise not considering going public (but still providing liquidity to those seeking it) [1]. Do you want to be beholden to public shareholders and potential activist investors if your money printer works without need for them? Perhaps it is more optimal to remain in control vs cashing out and have your control potentially diminished. It is okay to leave money on the table (by not going public in an attempt to maximize gains on shares held through potential public market exuberance) depending on what you are optimizing for. [1] https://www.axios.com/2024/02/29/payments-stripe-never-go-public https://www.axios.com/2024/02/29/payments-stripe-never-go-pu...
  - jandrese 2y ago
    The usual reason would be because you need a large infusion of capital to expand your successful business into a major corporation. Slow growth might be a slow death if some other bigger company gets into the space and eats your lunch. I don't disagree that too many companies go public with little plan beyond "make lots of money for the founders", but there is a time and place for it.
ingen0s 2y ago
The paper emphasizes that much of the extraordinary stock market performance since 1989 was driven by "good luck" rather than compensation for risk, and future returns will likely be more modest unless structural changes occur. This perspective underplays the role of innovation, globalization, and technological advancements.
ldjkfkdsjnv 2y ago
I believe in almost no predictions that assert a change from the existing regime. Regime shifts of this scale (a stop to equity growth) are extremely rare. But nobody publishes papers on why the existing status quo will continue. The show will go on, technology will be deflationary, which will support interest rate drops. Inflation will get sucked out of the economy, and life will go on. Anyone that ever acted on advice like in this paper lost insane amounts of money.
- TheGRS 2y ago
  If the pandemic didn't bring real a new world order to the economy I don't know what else would honestly.
julienchastang 2y ago
(2023) should be added to title.
chrisco255 2y ago
It's worth noting this is just one person's opinion, it's not an opinion of the Fed itself. The paper analyzes corporate profits on the basis of interest and tax rates alone, but ignores other monumental shifts in global markets over the past few decades like globalized supply chain networks. It's probably true that the efficiency gains from globalization have already passed their peak, but that would have as much of an impact on declines in profit growth rates as any other factor. The article also ignores technology as a factor. If globalization is at its peak, automation is probably still in its infancy. Robotics and AI are rapidly advancing and it's going to have a substantial impact to supply chains and labor markets over the coming decades, regardless of what happens with interest rates.
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- iwishiknewlisp 2y ago
  > efficiency gains from globalization have already passed their peak Is this true? Aren't there a ton of developing nations that have rapid debelopment that will increase efficiency of different industries as they grow?
  - pixelpoet 2y ago
    There aren't a lot of Indonesias left.
    - TheGRS 2y ago
      Sure there are, plenty of low income countries with fledging industries, but the governments get more and more risky to deal with the further down in income you go.
- tway_GdBRwW 2y ago
  Passing peak globalization might contribute to declining corporate profits from say 2020 onward; not sure that 2020 is peak globalization, but it is in the ballpark. Under standard assumptions of a capitalist economy, a new factor such as "technology" should not drive aggregate higher profits. Because companies don't exist in a vaccuum. Technology may allow a company to produce a good for lower cost, but it also allows that company's competitors to produce the similar good for a similarly lower cost. So of course the article ignored it, it is a non-factor in aggregate corporate profits. So "technology" can increase aggregate wealth of society (I'm a big fan of indoor plumbing) but it is not going to increase AGGREGATE corporate profits. Also, it isn't clear how the specific technology you point towards, "automation", is structurally different from earlier technologies such as i.e. railroads or containerized shipping or telephones or ... Look, obviously only aggregate corporate profits. Some companies made tremendous money off of the "railroad" technology, others went out of business because of it. Likewise, some companies made enormous profits off of computer chips, office software, etc, but the article is about aggregate profits, the economy as a whole, not individual companies.
eqballhejri 2y ago
[flagged]
feedforward 2y ago
There was an economist who predicted this in the 19th century https://en.wikipedia.org/wiki/Tendency_of_the_rate_of_profit_to_fall https://en.wikipedia.org/wiki/Tendency_of_the_rate_of_profit...
- intuitionist 2y ago
  From the abstract, the paper’s argument looks to be entirely different and reaches different conclusions than a Marxian TRPF argument. This paper claims that net profit margins have increased over the past few decades (which is certainly true at least for S&P 500 companies) and that the increase is mostly driven by lower interest expense and lower corporate taxes. If interest rates and tax rates can’t or won’t fall any further, then they won’t provide a tailwind to margins, and so corporate profits will grow much more slowly (not necessarily decline!) over the next few decades. Marxian economists generally speak of the TRPF as a decline in return on invested capital, which doesn’t come into play in this paper at all AFAICT, but they also have a bad habit of confusing ROIC with profit margins, which is what the paper is all about.
ChrisArchitect 2y ago
(2023) Overview page: https://www.federalreserve.gov/econres/feds/end-of-an-era-the-coming-long-run-slowdown-in-corporate-profit-growth-and-stock-returns.htm https://www.federalreserve.gov/econres/feds/end-of-an-era-th... Some previous discussion: https://news.ycombinator.com/item?id=33394486 https://news.ycombinator.com/item?id=33394486
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w10-1 2y ago
Data is based only on non-financial firms; I wonder what is the effect size of this exclusion. Economy said to be migrating up the value chain to financial services and using pervasive financial engineering, in GE, pharma, fintech, etc. The prospect of higher interest and more taxes would drive more such engineering. Another question is the stock value loss attributable to dwindling market competition depressing innovation and demand. Another is demand for stock: P/E multiples going up while most people are under increasing economic stress and lower investment puts all the burden on current stock owners to reinvest, but asset-weighted individual investors might be aging out. Again, unclear effect size to all this. Hard to imagine being an economist. But in any case signaling that US stocks long-term are likely to be bad seems counter-productive except as a threat to the incoming administration against increasing rates and taxation.
- tway_GdBRwW 2y ago
  The exclusion of financial firms is standard in economics literature. The usual reason is that their financials are inverted. The money YOU hold in a bank is an asset to you, the money the BANK holds in the bank is a debt to you.
jmoak 2y ago
This seems to have proven that growth leads to higher earnings and equity prices. Of course less taxation and a drop in interest rates will lead to more earnings over time and higher valuations. The crux is that he frames the drop in interest rates as a matter of "luck", as if the government just happened to be dropping them, as opposed to the government reacting to the drop in good/service prices by lowering rates, as a result of innovation, to maintain price stability and the 2% inflation target. Company A makes more of Good #1 for less money due to Innovation X, and can charge less money. When this occurs across the entire economy, the fed has to drop rates to prevent broad deflation in prices. Lower rates show up as more earnings. The alternative with fixed rates would be that Company A's revenue, after its impressive innovation, would remain roughly the same (or fall) while its competitors' revenues fall (more). The real (adjusted) growth in equity prices, earnings, and revenue would still be going up at the same rate IMO. It's entirely possible (maybe not likely) that a landmark innovation could deflate prices for most goods in the future and bring us back to low or even negative rates, which would (per his measurements) show up as higher earnings and equity prices. Maybe I don't know what I'm talking about, but this paper seems circular to me. What would be more compelling is an analysis on the future of goods/services availability, as interest rates and taxation are downstream of those. For example, what does China's potential decline forebode for good availability? What about the hyped up potential panacea of AI?
legitster 2y ago
I kinda wonder how much of this is chicken vs egg. Was corporate profit growth only what it was because of long term low interest rates? Or did low interest rates encourage passive investments and low innovation? Also, the elephant in the room is retirement. Aging populations represent a huge slowdown across the economy - and every year brings the highest percentage of non-working adults humanity has ever seen. For all the ink spilled over innovation and growth and etc this is going to be the real market wrecker.
languagehacker 2y ago
Quite a few authors have pointed out that the "financialization" of American businesses, with a focus less on innovation or investing in their workforce and more on massaging their numbers to meet shareholder expectations, has created a lot of short-term enrichment for the super-wealthy while absolutely destroying the middle class as we know it. This seems like more fuel for that fire.
- pdxandi 2y ago
  I’ve shared this opinion for a while, and would love to hear more informed opinions. Do you have any links to articles you’d recommend reading?
  - spenrose 2y ago
    Trade Wars are Class Wars: https://www.amazon.com/Trade-Wars-Are-Class-International/dp/0300244177 https://www.amazon.com/Trade-Wars-Are-Class-International/dp...
  - languagehacker 2y ago
    I'm currently reading "When McKinsey Comes to Town" and just finished "The Man Who Broke Capitalism" about Jack Welch and GE.
- SoftTalker 2y ago
  Really, anyone with a 401k or similar investments has benefited from this. That's a lot of middle class folks. Your parents, your grandparents, and very likely you. It's far from limited to the super-wealthy.
  - anotherhacker 2y ago
    Not quite. This behavior leads to firing of middle-class workers. John Deere just laid off 300 workers, moved the factory to Mexico, engaged in buyback, and gave the CEO a huge pay. So, yeah, it helps your 401k, but in the mean time you don't have a job. And if you do have a job, your salary is not increasing in line with inflation...
cs702 2y ago
The abstract does a great job of summarizing the OP's findings: > I show that the decline in interest rates and corporate tax rates over the past three decades accounts for the majority of the period’s exceptional stock market performance. Lower interest expenses and corporate tax rates mechanically explain over 40 percent of the real growth in corporate profits from 1989 to 2019. In addition, the decline in risk-free rates alone accounts for all of the expansion in price-to-earnings multiples. I argue, however, that the boost to profits and valuations from ever- declining interest and corporate tax rates is unlikely to continue, indicating significantly lower profit growth and stock returns in the future. Great paper, very though-provoking. Thank you for sharing it on HN!
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- yieldcrv 2y ago
  I think more stock traders should be bond traders, or learn how that seemingly boring market works. Too many people are stuck on technical analysis concepts from the 1980s because their first exposure was related to them. The bond market is such a larger market than the entire stock market that its very easy to quantify the money flows out of the central banks, into that market and to other markets such as the stock market. How people are aiming to frontrun central bank behaviors. Then it no longer matters if a PE ratio doesn't match your historical sector expectations, it no longer matters if an RSI is in overbought territority for longer than you thought. You dont have to rationalize your inadequate trades as “the market being irrational longer than you can remain solvent”, you can just make better trades understanding where the money is going, how it behaves.
- wiz21c 2y ago
  > decline in interest rates and corporate tax rates mechanically explain over 40 percent of the real growth I interpret that as : "capitalists have taken over the control of our governments"... Is that right ?
  - WJW 2y ago
    That's what you want to read. All the paper says is that interest rates and corporate tax rates have fallen over the past three decades. There were a variety of reasons for that, only some of which had anything to do with capitalists in the government.
criddell 2y ago
Stock returns grow because that's where people and institutions put their money. If stock return growth slows (assuming they aren't talking only about dividends), that means either there's less money in general or it's being parked elsewhere. Which is it? Or do I misunderstand what stock growth is?
- paxys 2y ago
  The two aren't conflicting ideas. Stock returns are directly tied to dividends and buybacks and indirectly tied to profits and overall company performance. If I think a company isn't returning enough, I'll invest my money elsewhere, and its share price will go down. If I think the stock market isn't returning enough, I'll invest my money in bonds or commodities or foreign countries or Bitcoin or cash under my mattress, and the entire market will go down.
- marcosdumay 2y ago
  The money doesn't get "parked" in stocks. It's sent to a company, that will use it. Anyway, the idea is approximately right. When there's more money on the economy than stuff to buy, you get inflation, and the extra money gets places to go. Alternatively, yes, the amount of money and the number of time it transacts both change all the time.
  - criddell 2y ago
    > It's sent to a company, that will use it. So if I sell a share of Microsoft and you end up buying it, market makers get some of that and your broker might too, but I would get most of the money.
jhallenworld 2y ago
So can the fed keep interest rates high for long? I think they can't.. because then government debt is too expensive. Pushback from treasury will be intense.
- tootie 2y ago
  There's no need to. High rates only exist to combat inflation.
paxys 2y ago
It'll be interesting to see what this analysis looks like today, considering there have been 2+ years of substantially higher interest rates since this paper was published.
- crystalmeph 2y ago
  In five years you might be able to start teasing out the effects of the sudden rise in interest rates. Right now, we're still feeling echoes of the pandemic and subsequent "snap-back" in economic activity. Look at https://fred.stlouisfed.org/series/CCSA https://fred.stlouisfed.org/series/CCSA, set the units to "percent change from year ago," and zoom out to "Max". The pandemic effect dwarfs anything else in the entire history of the unemployment program. I think future economic research may well have to discard the years 2020-2024 because the circumstances were so unique and the distortions were so severe.
m0llusk 2y ago
This fits well with some of what Ray Dalio has been saying. The are business cycles and also cycles of those business cycles. At this time we appear to be in a long term transition downward following a long period of relatively strong upsides.
jgalt212 2y ago
Of course nothing on the money supply or the Fed's Balance Sheet. They're not allowed to admit what they've done.
advael 2y ago
This seems like an overall good thing, since a lot of the effect of these essentially artificially inflated growth numbers has been investors' expectations becoming tied to an unsustainable and unrealistic expectation of growth year over year, and this has a myriad of downstream negative consequences for the actual operation of businesses, which has in turn wreaked havoc on the real economy. Maybe this can trigger a sort of reset of those expectations
SebFender 2y ago
I know nothing - but my girlfriend worked for more than a decade with financial groups essentially betting on economic downturns. Started ok around 2000 but most were eventually sold at rebate to a larger firm's lately - and these aren't really in a comeback. Let's just say most outlook on the past 25 years has been generally positive and should get better in the next 25. These "negative" aren't really popular currently, but I'd be surprised if they ever are. I know nothing - just sharing from people who actually played billions into these downturns articles for multiple decades...
Swiftdream 2y ago
[flagged]

132 points by luu 2y ago

It won't last, the algos ran by the billionaires will demand growth.

Very interesting paper. > I show that the decline in interest rates and corporate tax rates over the past three decades accounts for the majority of the period’s exceptional stock market performance. It's interesting that they've shown this to the exclusion of other narratives, mainly frontier markets like semiconductors and software allowing "easy" creation of value. I think this is partially why investors are so eager to dump so much cash into AI/why Zuckerberg has been so focused on VR/AR—they're looking not just for a solid investment, but an opportunity to get into the rent-seeking class on the ground floor. Why would you invest in a piece of software when you could invest in a "platform" (aka privately-owned market) instead? Of course, we can't just create these platforms out of nowhere—they require enormous moats like exclusive access to IP or regulatory capture or enormous production capacity or some sort of similar gimmick, and there's only a finite number of these. It seems like this is also a significant reason why growth isn't infinite and should be expected to slow and even reverse in time. I haven't finished the paper but I eagerly look forward to reading it in full later. EDIT: spelling, wording, I'm done editing; apologies.

VirusNewbie 2y ago
well, they're looking at earnings growth, not profit margins. You could have a company that increases profitability YoY and not grow revenue as well. It's less typical, but certainly possible with technology companies. I think this paper misses that fact.
- nine_k 2y ago
  This is fair. But the theoretical maximum of profitability is 100% of revenue. A company that increased their revenue 10x while keeping the same 10% profit margin (both numbers quite normal) achieved the same profit as if it kept the revenue the same and grew profitability to 100% (pure fantasy). Also, larger streams of money create the economic multiplier effect.
nostrademons 2y ago
Semiconductors and software have created enormous amounts of value for the companies that own them, but the Fed usually thinks in macroeconomic terms. For the macro economy, the effect of technical development on overall corporate profits is much more muted. Creative destruction destroys old industries as much as it creates new ones. For example, there's a TV show "Mad Men" about the dominance of Madison Avenue advertising firms; Google and Facebook have completely destroyed this industry. Berkshire Hathaway annual reports from the 1970s and 1980s used to say that the local newspaper for each major metro area was a natural monopoly and reliable source of corporate profits; now, this industry has been reliably commoditized by the Internet. Of course, the creative destroyers in question would much rather focus on the "creation of value" narrative, because it avoids attracting attention (and competition or regulation) from the industries that they're about to destroy. So there are pretty significant information distortions in the popular narrative. Interest rates and corporate taxes have the property that they affect the whole market, which makes them much more useful to the Fed. If you bought NVidia in 2022 or Apple in 1998, congrats, you made a good investing call. But if you bought the S&P 500 in 2009 and are congratulating yourself on your 600% returns over the decade, you should know that most of that is because of low interest rates, and if the low interest rate environment unwinds, so will your stock portfolio.
- psunavy03 2y ago
  Interest rates have been all over the map over the last 60 years, including double digits in the 80s, and yet low-cost index funds have been a reliable driver of wealth that entire time.
  - nostrademons 2y ago
    "That entire time" only holds if you're looking at 20+ year time horizons, and zooming in shows the effect of interest rates. If you bought the S&P 500 in November 1968 and sold it in July 1982, you lost money in nominal terms, despite the CPI nearly tripling during that time period (so in real terms, you lost 2/3 of your investment). During that time period, interest rates went from 6% to 19%, also roughly tripling. Then if you held from 1982 to 1987, the S&P 500 nearly tripled, despite low inflation and relatively few major technological changes. What was the difference? Interest rates went from 19% to 6%. A useful lens with which to view this and other phenomena is "Which factors cancel out, and under what timeframes?" Technological development leads to large microeconomic winners and losers but little macroeconomic effect under short time frames, less than the business cycle, because the mechanism by which it increases overall welfare is to put workers out of work and firms into bankruptcy, freeing up those workers and that capital to be invested in new enterprises. Interest rates have a large effect over that timeframe, because they affect all firms in the economy equally. Over long time frames (multiple business cycles), the effect of interest rates washes out because they go up and then they go down and eventually they equilibrate near the long-term average. Technological development dominates then because you've given the economy a chance to adapt to new production methods and re-employ workers in obsolete jobs.
fnordpiglet 2y ago
I call bullshit. Tax rates and interest rates certainly help spur investment and expansion of production but it’s hard to look at the world we live in today, with electric cars that can self drive and hand held devices connected to natural language comprehending oracles of knowledge, JIT industries end to end, starships to mars for colonization in mid to late stages, etc, and think “yep the only value is the value the federal reserve has created” as a federal reserve economist posits.
- crystalmeph 2y ago
  https://en.wikipedia.org/wiki/Productivity_paradox https://en.wikipedia.org/wiki/Productivity_paradox. "You can see the computer age everywhere but in the productivity statistics." There are definitely companies that are winning from the tech you pointed out, sure. The companies that make robotaxis and the companies that sell AI subscriptions are going to make bank. But at an aggregate level, that robotaxi means a human tax driver is no longer working, and if every sales person has their own personal robot translator for talking to foreign clients, then none of them has a competitive edge over the others, they've just had to invest that money in order to avoid giving up a competitive edge. That OP paper's argument is basically that the only rising tide that truly lifts all economic boats is being able to keep more of the money you make instead of having to spend it on interest or taxes. So the age-old wisdom of "just buy an index fund" may have run its course, and you will actually have to pay attention to valuations instead of just blindly buying the market going forward.
  - ryandrake 2y ago
    > So the age-old wisdom of "just buy an index fund" may have run its course, and you will actually have to pay attention to valuations instead of just blindly buying the market going forward. The efficient-market hypothesis would probably disagree. If "paying attention to valuations" ever consistently produces greater returns, then index funds will start weighting their holdings in such a way to capture that value. If it produces greater returns, but not consistently, then we're back to gambling and things like technical analysis and trying to time the market.
  - 2y ago

nemo44x 2y ago

I could be mistaken but using the S&P500 index might be slightly problematic in that the companies that compose this index change all the time. This almost guarantees that the index increases in value over time as high performers are added and low performers are removed. There is an upward bias. I don't doubt that overall, on average, much growth has come from a 40 year decline in interest rates and a consistent lowering of corporate taxes, but new companies in new industries will continue to be founded and feature explosive growth. We aren't stuck with a static set of companies.

erokar 2y ago
Yes, the S&P500 could in a sense be said to implement a momentum based trading strategy.
paxys 2y ago
The companies that compose the entire stock market also change all the time, and follow the same pattern (winners rise, losers go bankrupt). So the S&P 500 is still a good benchmark of overall stock market performance.
- nemo44x 2y ago
  So as long as innovation is outgrowing stagnation then returns should continue to outpace typical zero risk interest. In essence if you believe the stock market will fail to exhibit growth you’re betting against technological progress and productivity gains. Bad bet I’d say.
  - kgwgk 2y ago
    > returns should continue to outpace typical zero risk interest. In essence if you believe the stock market will fail to exhibit growth Who are you arguing against? The paper linked talks about "significantly lower profit growth and stock returns in the future" not about decreasing earnings and negative returns.
tway_GdBRwW 2y ago
You are correct that even if the US stock market flatlines for the next 20 years, there will be individual companies which do extremely well, and others which die. That's not what this article is about. The article is about average corporate profits in the current-to-the-point-in-time largest US companies. And using the SP500 allows the analysis to be consistent even as the mix of the SP500 changes. And no, changing the mix does not guarantee that the index increases in value over time. Plenty of periods of 10 years or more where the SP500 flatlined. Also, economies in other countries have extended periods where the index of their top companies flatlined. Further, the explosive growth which you hope to find is generally not in the SP500 companies. The explosive growth is what puts a company INTO the SP500.

financiergoose 2y ago

I'm sure absurd parasitic government interference, lawfare, and shareholder activism in public corporations has nothing to do with all the good companies going private, ergo smart people telling the lawyers to go to hell, old people with pensions hardest hit.

GenerWork 2y ago
At this point, I'm not sure why you'd want to go public unless it's simply to cash out ASAP. Everything you just described seems like major hell to deal with.
- financiergoose 2y ago
  I'm a founder, and I have zero intention of ever going public for these exact reasons.
  - calvinmorrison 2y ago
    I think we just call that a small business owner.
    - toomuchtodo 2y ago
      I would not consider Stripe to be a small business, an enterprise not considering going public (but still providing liquidity to those seeking it) [1]. Do you want to be beholden to public shareholders and potential activist investors if your money printer works without need for them? Perhaps it is more optimal to remain in control vs cashing out and have your control potentially diminished. It is okay to leave money on the table (by not going public in an attempt to maximize gains on shares held through potential public market exuberance) depending on what you are optimizing for. [1] https://www.axios.com/2024/02/29/payments-stripe-never-go-public https://www.axios.com/2024/02/29/payments-stripe-never-go-pu...
- jandrese 2y ago
  The usual reason would be because you need a large infusion of capital to expand your successful business into a major corporation. Slow growth might be a slow death if some other bigger company gets into the space and eats your lunch. I don't disagree that too many companies go public with little plan beyond "make lots of money for the founders", but there is a time and place for it.

ingen0s 2y ago

The paper emphasizes that much of the extraordinary stock market performance since 1989 was driven by "good luck" rather than compensation for risk, and future returns will likely be more modest unless structural changes occur. This perspective underplays the role of innovation, globalization, and technological advancements.

ldjkfkdsjnv 2y ago

I believe in almost no predictions that assert a change from the existing regime. Regime shifts of this scale (a stop to equity growth) are extremely rare. But nobody publishes papers on why the existing status quo will continue. The show will go on, technology will be deflationary, which will support interest rate drops. Inflation will get sucked out of the economy, and life will go on. Anyone that ever acted on advice like in this paper lost insane amounts of money.

TheGRS 2y ago
If the pandemic didn't bring real a new world order to the economy I don't know what else would honestly.

julienchastang 2y ago

(2023) should be added to title.

chrisco255 2y ago

It's worth noting this is just one person's opinion, it's not an opinion of the Fed itself. The paper analyzes corporate profits on the basis of interest and tax rates alone, but ignores other monumental shifts in global markets over the past few decades like globalized supply chain networks. It's probably true that the efficiency gains from globalization have already passed their peak, but that would have as much of an impact on declines in profit growth rates as any other factor. The article also ignores technology as a factor. If globalization is at its peak, automation is probably still in its infancy. Robotics and AI are rapidly advancing and it's going to have a substantial impact to supply chains and labor markets over the coming decades, regardless of what happens with interest rates.

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iwishiknewlisp 2y ago
> efficiency gains from globalization have already passed their peak Is this true? Aren't there a ton of developing nations that have rapid debelopment that will increase efficiency of different industries as they grow?
- pixelpoet 2y ago
  There aren't a lot of Indonesias left.
  - TheGRS 2y ago
    Sure there are, plenty of low income countries with fledging industries, but the governments get more and more risky to deal with the further down in income you go.
tway_GdBRwW 2y ago
Passing peak globalization might contribute to declining corporate profits from say 2020 onward; not sure that 2020 is peak globalization, but it is in the ballpark. Under standard assumptions of a capitalist economy, a new factor such as "technology" should not drive aggregate higher profits. Because companies don't exist in a vaccuum. Technology may allow a company to produce a good for lower cost, but it also allows that company's competitors to produce the similar good for a similarly lower cost. So of course the article ignored it, it is a non-factor in aggregate corporate profits. So "technology" can increase aggregate wealth of society (I'm a big fan of indoor plumbing) but it is not going to increase AGGREGATE corporate profits. Also, it isn't clear how the specific technology you point towards, "automation", is structurally different from earlier technologies such as i.e. railroads or containerized shipping or telephones or ... Look, obviously only aggregate corporate profits. Some companies made tremendous money off of the "railroad" technology, others went out of business because of it. Likewise, some companies made enormous profits off of computer chips, office software, etc, but the article is about aggregate profits, the economy as a whole, not individual companies.

eqballhejri 2y ago

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feedforward 2y ago

There was an economist who predicted this in the 19th century https://en.wikipedia.org/wiki/Tendency_of_the_rate_of_profit_to_fall https://en.wikipedia.org/wiki/Tendency_of_the_rate_of_profit...

intuitionist 2y ago
From the abstract, the paper’s argument looks to be entirely different and reaches different conclusions than a Marxian TRPF argument. This paper claims that net profit margins have increased over the past few decades (which is certainly true at least for S&P 500 companies) and that the increase is mostly driven by lower interest expense and lower corporate taxes. If interest rates and tax rates can’t or won’t fall any further, then they won’t provide a tailwind to margins, and so corporate profits will grow much more slowly (not necessarily decline!) over the next few decades. Marxian economists generally speak of the TRPF as a decline in return on invested capital, which doesn’t come into play in this paper at all AFAICT, but they also have a bad habit of confusing ROIC with profit margins, which is what the paper is all about.

ChrisArchitect 2y ago

(2023) Overview page: https://www.federalreserve.gov/econres/feds/end-of-an-era-the-coming-long-run-slowdown-in-corporate-profit-growth-and-stock-returns.htm https://www.federalreserve.gov/econres/feds/end-of-an-era-th... Some previous discussion: https://news.ycombinator.com/item?id=33394486 https://news.ycombinator.com/item?id=33394486

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w10-1 2y ago

Data is based only on non-financial firms; I wonder what is the effect size of this exclusion. Economy said to be migrating up the value chain to financial services and using pervasive financial engineering, in GE, pharma, fintech, etc. The prospect of higher interest and more taxes would drive more such engineering. Another question is the stock value loss attributable to dwindling market competition depressing innovation and demand. Another is demand for stock: P/E multiples going up while most people are under increasing economic stress and lower investment puts all the burden on current stock owners to reinvest, but asset-weighted individual investors might be aging out. Again, unclear effect size to all this. Hard to imagine being an economist. But in any case signaling that US stocks long-term are likely to be bad seems counter-productive except as a threat to the incoming administration against increasing rates and taxation.

tway_GdBRwW 2y ago
The exclusion of financial firms is standard in economics literature. The usual reason is that their financials are inverted. The money YOU hold in a bank is an asset to you, the money the BANK holds in the bank is a debt to you.

jmoak 2y ago

This seems to have proven that growth leads to higher earnings and equity prices. Of course less taxation and a drop in interest rates will lead to more earnings over time and higher valuations. The crux is that he frames the drop in interest rates as a matter of "luck", as if the government just happened to be dropping them, as opposed to the government reacting to the drop in good/service prices by lowering rates, as a result of innovation, to maintain price stability and the 2% inflation target. Company A makes more of Good #1 for less money due to Innovation X, and can charge less money. When this occurs across the entire economy, the fed has to drop rates to prevent broad deflation in prices. Lower rates show up as more earnings. The alternative with fixed rates would be that Company A's revenue, after its impressive innovation, would remain roughly the same (or fall) while its competitors' revenues fall (more). The real (adjusted) growth in equity prices, earnings, and revenue would still be going up at the same rate IMO. It's entirely possible (maybe not likely) that a landmark innovation could deflate prices for most goods in the future and bring us back to low or even negative rates, which would (per his measurements) show up as higher earnings and equity prices. Maybe I don't know what I'm talking about, but this paper seems circular to me. What would be more compelling is an analysis on the future of goods/services availability, as interest rates and taxation are downstream of those. For example, what does China's potential decline forebode for good availability? What about the hyped up potential panacea of AI?

legitster 2y ago

I kinda wonder how much of this is chicken vs egg. Was corporate profit growth only what it was because of long term low interest rates? Or did low interest rates encourage passive investments and low innovation? Also, the elephant in the room is retirement. Aging populations represent a huge slowdown across the economy - and every year brings the highest percentage of non-working adults humanity has ever seen. For all the ink spilled over innovation and growth and etc this is going to be the real market wrecker.

languagehacker 2y ago

Quite a few authors have pointed out that the "financialization" of American businesses, with a focus less on innovation or investing in their workforce and more on massaging their numbers to meet shareholder expectations, has created a lot of short-term enrichment for the super-wealthy while absolutely destroying the middle class as we know it. This seems like more fuel for that fire.

pdxandi 2y ago
I’ve shared this opinion for a while, and would love to hear more informed opinions. Do you have any links to articles you’d recommend reading?
- spenrose 2y ago
  Trade Wars are Class Wars: https://www.amazon.com/Trade-Wars-Are-Class-International/dp/0300244177 https://www.amazon.com/Trade-Wars-Are-Class-International/dp...
- languagehacker 2y ago
  I'm currently reading "When McKinsey Comes to Town" and just finished "The Man Who Broke Capitalism" about Jack Welch and GE.
SoftTalker 2y ago
Really, anyone with a 401k or similar investments has benefited from this. That's a lot of middle class folks. Your parents, your grandparents, and very likely you. It's far from limited to the super-wealthy.
- anotherhacker 2y ago
  Not quite. This behavior leads to firing of middle-class workers. John Deere just laid off 300 workers, moved the factory to Mexico, engaged in buyback, and gave the CEO a huge pay. So, yeah, it helps your 401k, but in the mean time you don't have a job. And if you do have a job, your salary is not increasing in line with inflation...

cs702 2y ago

The abstract does a great job of summarizing the OP's findings: > I show that the decline in interest rates and corporate tax rates over the past three decades accounts for the majority of the period’s exceptional stock market performance. Lower interest expenses and corporate tax rates mechanically explain over 40 percent of the real growth in corporate profits from 1989 to 2019. In addition, the decline in risk-free rates alone accounts for all of the expansion in price-to-earnings multiples. I argue, however, that the boost to profits and valuations from ever- declining interest and corporate tax rates is unlikely to continue, indicating significantly lower profit growth and stock returns in the future. Great paper, very though-provoking. Thank you for sharing it on HN!

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yieldcrv 2y ago
I think more stock traders should be bond traders, or learn how that seemingly boring market works. Too many people are stuck on technical analysis concepts from the 1980s because their first exposure was related to them. The bond market is such a larger market than the entire stock market that its very easy to quantify the money flows out of the central banks, into that market and to other markets such as the stock market. How people are aiming to frontrun central bank behaviors. Then it no longer matters if a PE ratio doesn't match your historical sector expectations, it no longer matters if an RSI is in overbought territority for longer than you thought. You dont have to rationalize your inadequate trades as “the market being irrational longer than you can remain solvent”, you can just make better trades understanding where the money is going, how it behaves.
wiz21c 2y ago
> decline in interest rates and corporate tax rates mechanically explain over 40 percent of the real growth I interpret that as : "capitalists have taken over the control of our governments"... Is that right ?
- WJW 2y ago
  That's what you want to read. All the paper says is that interest rates and corporate tax rates have fallen over the past three decades. There were a variety of reasons for that, only some of which had anything to do with capitalists in the government.

criddell 2y ago

Stock returns grow because that's where people and institutions put their money. If stock return growth slows (assuming they aren't talking only about dividends), that means either there's less money in general or it's being parked elsewhere. Which is it? Or do I misunderstand what stock growth is?

paxys 2y ago
The two aren't conflicting ideas. Stock returns are directly tied to dividends and buybacks and indirectly tied to profits and overall company performance. If I think a company isn't returning enough, I'll invest my money elsewhere, and its share price will go down. If I think the stock market isn't returning enough, I'll invest my money in bonds or commodities or foreign countries or Bitcoin or cash under my mattress, and the entire market will go down.
marcosdumay 2y ago
The money doesn't get "parked" in stocks. It's sent to a company, that will use it. Anyway, the idea is approximately right. When there's more money on the economy than stuff to buy, you get inflation, and the extra money gets places to go. Alternatively, yes, the amount of money and the number of time it transacts both change all the time.
- criddell 2y ago
  > It's sent to a company, that will use it. So if I sell a share of Microsoft and you end up buying it, market makers get some of that and your broker might too, but I would get most of the money.

jhallenworld 2y ago

So can the fed keep interest rates high for long? I think they can't.. because then government debt is too expensive. Pushback from treasury will be intense.

tootie 2y ago
There's no need to. High rates only exist to combat inflation.

paxys 2y ago

It'll be interesting to see what this analysis looks like today, considering there have been 2+ years of substantially higher interest rates since this paper was published.

crystalmeph 2y ago
In five years you might be able to start teasing out the effects of the sudden rise in interest rates. Right now, we're still feeling echoes of the pandemic and subsequent "snap-back" in economic activity. Look at https://fred.stlouisfed.org/series/CCSA https://fred.stlouisfed.org/series/CCSA, set the units to "percent change from year ago," and zoom out to "Max". The pandemic effect dwarfs anything else in the entire history of the unemployment program. I think future economic research may well have to discard the years 2020-2024 because the circumstances were so unique and the distortions were so severe.

m0llusk 2y ago

This fits well with some of what Ray Dalio has been saying. The are business cycles and also cycles of those business cycles. At this time we appear to be in a long term transition downward following a long period of relatively strong upsides.

jgalt212 2y ago

Of course nothing on the money supply or the Fed's Balance Sheet. They're not allowed to admit what they've done.

advael 2y ago

This seems like an overall good thing, since a lot of the effect of these essentially artificially inflated growth numbers has been investors' expectations becoming tied to an unsustainable and unrealistic expectation of growth year over year, and this has a myriad of downstream negative consequences for the actual operation of businesses, which has in turn wreaked havoc on the real economy. Maybe this can trigger a sort of reset of those expectations

SebFender 2y ago

I know nothing - but my girlfriend worked for more than a decade with financial groups essentially betting on economic downturns. Started ok around 2000 but most were eventually sold at rebate to a larger firm's lately - and these aren't really in a comeback. Let's just say most outlook on the past 25 years has been generally positive and should get better in the next 25. These "negative" aren't really popular currently, but I'd be surprised if they ever are. I know nothing - just sharing from people who actually played billions into these downturns articles for multiple decades...

Swiftdream 2y ago

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