This article is from James Hamilton's blog, Econbrowser
Why were the aughts so nasty for stocks? The U.S. ended the decade more or less where it began in terms of total employment.
Source: FRED.
The owners of capital fared no better, with the nominal S&P500 stock price index down 20% for the decade. The dividends stockholders collected made up for some of that, but inflation took away even more.
Data source: Robert Shiller. Blue line: Nominal value of S&P500 stock index, January 1980 to December 2009. Red line: value as of January 2000.
One of the reasons stocks did so badly was that real earnings ended the decade 80% lower than they began. Even when you smooth out cyclical variations by taking a decade-long average as in the dashed blue line below, the downturn in earnings at the end of the decade is still pretty significant.
Data source: Robert Shiller. Green line: Real value (in 2009 dollars) of earnings on the S&P500, January 1980 to December 2009. Dashed blue line: arithmetic average of green line for the preceding 10 years.
But a bigger reason why stocks did so badly was the changed valuation of those earnings. Yale Professor Robert Shiller likes to summarize this by using decade-long averages of real earnings to calculate a price-earnings ratio. In January 2000, this cyclically adjusted P/E ratio was profoundly out of line with the average values we'd seen over the previous century. If you trust the tendency of this series to revert to its long-run average, it means that whenever the blue line is above the red, you should expect stock prices to grow at a slower rate than earnings. If you bought when the blue was as far above the red as it was in January 2000, then I hope there was something else you found to enjoy about the naughty aughts.
Cyclically adjusted P/E over the last century.
Data source: Robert Shiller. Blue line: Ratio of real value (in 2009 dollars) of S&P composite index to the arithmetic average value of real earnings over the previous decade, January 1880 to December 2009. Red line: historical average (16.34).
That doesn't mean you should…
