Stock Returns: Current Prices Matter

The Washington Post reported on a new study from the Pew Center on the States which purportedly criticized state governments for making overly optimistic assumptions on stock returns in their pension fund investments:

"On average, states predict they will see an 8 percent return every year from their investments in the markets. Meanwhile, the S&P 500, the broadest measure of stocks, fell more than 20 percent over the past decade. "

Actually, the sharp decline in stock prices over the last decade makes 8 percent nominal returns far more plausible. The ratio of stock prices to trend earnings is now close to its long-term average of 14 to 1. This allows for a much higher dividend yield and if stock prices rise at the same rate as the economy is projected to grow, then it will easily reach the 8 percent return assumed by pension fund trustees.

--Dean Baker

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