Does the stock market always rise in the long run?

Why does the stock market always rise in the long run?

To understand this, I turn to William Bernstein's book, "The Four Pillars of Investing". According to Bernstein, the Gordon equation is the irrevocable law in investing. Put simply, the total growth of a stock market is equal to the sum of the dividend yield and the dividend growth of the stock market.

The stock market is made up on individual companies whose shares are traded. Each year, each company makes a profit, and gives out a portion of their earnings to shareholders as dividends. The rest of the earnings is kept by the company, and used to further increase their earnings.

This article from also provides a good explanation of the Gordon equation. However, it breaks up the growth of the market to three components, with the extra component being speculative growth. Speculative growth is random and do not comprise the real growth of the market.

If company dividend yield remains the same, but dividends payments increase due to increased in earnings, then the share price of the company must also rise. This is to keep the dividend yield constant. In other words, the total growth of the stock market is also equal to the sum of its dividend yield and price increase.

The premise that the stock market always rise must then be due to the fact that earnings must always increase. This is true and I will explain why.

Total aggregate earnings will always rise in the long run

An individual company's earnings might not increase forever, but the aggregate total of the earnings by all companies must always increase over time. In other words, world GDP will increase over time. Let me illustrate with an example.

Consider two persons, John and Emily. John has a garden at home, and he brings a bouquet of flowers, in which Emily buys from John for $10. John makes $10 even though the cost to produce the flowers is negligible or zero.

This is an abstract example, but it shows one thing. Wealth is created through trade, and wealth will continue to be created as long as there is demand and supply. There will continue to be supply as long as the world's natural resources are not completely depleted. If your trace the origins of any product, it will always come to a natural resource that is free, be it sunlight or fossil fuels.

World GDP will always increase as long as natural resources are not depleted

Even if the earth's natural resources run out, supply can still increase, if productivity increases. Productivity is defined as the amount of output over input. If input remains constant, while productivity increases, output will increase. It is no wonder the Singapore government tries to spur productivity growth.

In summary

Stock market growth is made up of two components: dividend yield and dividend growth. Dividend growth is spurred by earnings growth, which will always be positive in the long run. As long as our natural resources are not depleted, or our productivity increases, earnings will continue to grow and the stock market will always rise in the long run.
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