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Social Security: Economists predict tepid economic growth, stock market returns for next 44 years
The Wall Street Journal polled 10 economists and found that most of them are less optimistic about the stock market and economy than President Bush. The thrust of the story is that if the public is bearish on stocks, personal savings accounts won’t be part of any SS reforms. What the article doesn’t say is that between 1959 and 2004, equities returned an average of 12.5%. If similar returns were achieved over the next 44 years, they would make personal savings accounts a very good deal. Nobody can forecast more than six months ahead, much less 44 years. Here are the impact graphs:
The Wall Street Journal polled 10 economists and found that most of them are less optimistic about the stock market and economy than President Bush. The thrust of the story is that if the public is bearish on stocks, personal savings accounts won’t be part of any SS reforms. What the article doesn’t say is that between 1959 and 2004, equities returned an average of 12.5%. If similar returns were achieved over the next 44 years, they would make personal savings accounts a very good deal. Nobody can forecast more than six months ahead, much less 44 years. Here are the impact graphs:
Social Security officials’ forecasts for the long-term returns on stocks and bonds make a desirable outcome look highly likely. The program’s actuaries predict that over the period of a typical American’s career, or 44 years, stocks would return an average of 6.5%, corporate bonds 3.5% and government bonds 3%, all in “real” terms—that is, after inflation.
Under the actuaries’ assumptions, the required portfolio for the personal accounts—60% stocks, 24% corporate bonds and 16% government bonds—would produce a net real return of 4.93%, after a 0.30% management fee. For a 21-year-old entering the work force in 2011, with an average lifetime wage of $57,548 a year, the extra 1.93% return would add up to $133,447 by age 65, according to a model built by Jason Furman, a New York University economist.
Problem is, the forecasts raise some serious doubts—to say nothing of conflicts. For example, there is that assumption of a 6.5% annual return on stocks. By contrast, the actuaries’ prediction that the Social Security system will become unable to pay full benefits in 2042 assumes that the economy will grow at a rate of 1.9% a year between now and then—a tepid pace that would be unlikely to produce stock-market returns of nearly 6.5%. Many economists are critical of the idea that stock returns can be so high relative to gross domestic product growth. “That stretches the imagination,” says David Rosenberg, chief U.S. economist at Merrill Lynch & Co. in New York.
The long-term return on stocks comes from two main sources: growth in corporate earnings and payouts to shareholders, which include dividends and share buybacks. Earnings tend to grow in line with the economy, which means that 1.9% GDP growth typically would produce 1.9% earnings growth. Add to that dividends, which in recent years have averaged about 1.7% of a stock’s price, and buybacks, which have averaged about 1%, and the total real return for stocks comes to about 4.6%. Most economists who predict higher stock returns assume higher GDP growth as well.
Administration officials, and economists who support the official forecasts, offer various explanations for the leap to 6.5%. The first is history: From 1802 through 2004, the real return on stocks has averaged 6.8%.
Beyond that, says Jeremy Siegel, a professor at the University of Pennsylvania’s Wharton School, two factors can drive future returns. First, companies might experience faster earnings growth because they choose to invest in their businesses instead of paying dividends—an idea supported by the fact that stocks’ current dividend yield of 1.7% is low compared with an average of 5% from 1871 to 1980. Second, U.S. companies can benefit from higher GDP growth in the developing countries where they operate. Together, these factors will help real stock returns reach 6%, says Mr. Siegel, who has written a book on the subject called “Stocks for the Long Run.”
Nobody in their right mind would allocate assets the way the SS actuaries have. Smart investors would put all of their money into stocks and none into bonds. If you’re going to take the risks of being in the market, go all the way, invest in stocks and stay away from bonds, which are poor investments anyway you cut it.