This is just one of the stories from our “I’ve Always Wondered” series, where we tackle all of your questions about the world of business, no matter how big or small. Ever wondered if recycling is worth it? Or how store brands stack up against name brands? Check out more from the series here.
Listener Andrew Bellak from Amherst, Massachusetts, asked:
Why will the stock market indices go up forever?
The major U.S. stock indexes — the Dow Jones Industrials, S&P 500 and Nasdaq — have all trended upward since their inceptions.
Despite the Black Monday crash of 1987, despite the Great Recession, despite COVID, they’ve recovered. Experts say that, over the long run, you can expect stocks to rise based on their profit growth, which traditionally is every company’s primary mission and which investors expect management to stay focused on.
A look at the historical performance of the major stock indexes
One of the biggest drivers contributing to stock market returns is the pace of innovation, explained Avanidhar Subrahmanyam, a finance professor at the University of California, Los Angeles’ Anderson School of Management.
“Once in a while, we’ll see an unusual innovation that essentially is unanticipated and will just boost the returns immensely,” Subrahmanyam said.
Meir Statman, a finance professor at Santa Clara University, pointed out that some of the prominent companies in these indexes started off as humble businesses — like Netflix, which once only sent DVDs in the mail, and Amazon, which once only sold books. Since then, they’ve grown into tech powerhouses.
“It does not mean that every company is going to be successful. That is to the contrary. Many companies just shrivel or go bankrupt. But sort of, on average, what is pulling that locomotive of the train are the new companies,” Statman explained.
Even if you do see some businesses decline, Statman said, others are likely to take their place and flourish. For example, alternative energy companies might replace oil companies. He also noted that some of the gains in the stock market are due to inflation. However, there is a real increase in value, even when you adjust for that.
People continue to invest in stocks because they typically reap greater returns, in the form of capital gains and dividends, than other financial vehicles provide, Subrahmanyam said. Those other investments, though, are less risky.
“Stocks should outperform [certificates of deposit] and bonds, government bonds, because otherwise nobody would want to invest in stocks,” he added.
Japan’s Nikkei index: A contrast
While the major U.S. stock indexes have risen, Japan’s Nikkei 225 index suffered a steep decline in the 1990s and has failed to surpass its 1989 peak.
Ryan Detrick, chief market strategist at LPL Financial, pointed to the existence of insolvent “zombie banks” as one reason for Japan’s inability to recover.
“They kept these companies alive that shouldn’t have been left alive. And it kind of held them back,” he said. Zombie banks survived through “regulatory forbearance,” in which the government acted as if their bad loans had worth, wrote Bloomberg’s Yalman Onaran.
“But growing economies, which are innovative, generally have stock markets that are pretty successful in the long run,” Subrahmanyam said.
U.S. markets are among them. But, of course, there have been dips and periods of stagnation.
Uncertainty in the short run
“There can be extended periods, years, honestly, where they don’t go up,” Detrick said.
He said the stock market has risen since last March, when stocks initially plummeted because of the COVID-19 crisis.
“I think people are getting spoiled into thinking this is how it normally is. And it’s not. But again, for a longer-term investor who’s looking out, say 20 to 25 years, stocks are absolutely one of the best ways to create wealth and beat inflation,” he said.
Subrahmanyam also sounded a note of caution, saying that nobody can predict how the stock market will perform over the next couple of years.
“It’s very tempting to go from the notion that stock markets generally keep going up, to the notion that over the next couple of years, if I invest in the stock market, surely my wealth will grow. That’s false,” he said.