Explain how long-run stock market gains relate to the economy's sustainable rate of growth
The idea
An equity market's value can be written as GDP × (earnings ÷ GDP) × (price ÷ earnings), so market appreciation equals GDP growth plus growth in the profit share plus growth in the P/E. Neither ratio can rise without limit, because profits cannot exceed GDP and multiples cannot expand forever, so over long horizons equity appreciation converges to nominal potential GDP growth, real growth plus inflation. Over a finite period, expected changes in margins or multiples are added as compound annual rates. The trap is extrapolating a period when margins or multiples expanded; those gains are temporary and subtract from returns if they reverse. Compare real returns with real, not nominal, growth.
In the app: 2 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
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