Stock Market Fantasies

Historically, the stock market has performed well. In his celebrated 2002 book Stocks for the Long Run , Jeremy Siegel shows that the American stock market returned 6.9% per year in real terms between 1802 and 2001. Though the return varied by decade, even turning negative in some decades, overall it performed fairly consistently. This 6.9% annual average return has since been referred to as “Siegel’s constant,” as if Siegel had discovered a new law of nature.

The idea that stocks will perform well in the future has many promoters today, especially among those trying to sell investments in stocks. In the United States, President George W. Bush’s Commission to Strengthen Social Security cited Siegel for its claim that the government should encourage people to invest in stocks. Bush has been traveling the country promoting a plan to introduce personal retirement accounts invested in stocks and bonds. The plan assumes a 6.5% real return for stocks – only slightly below Siegel’s constant –in future decades.

But most people don’t believe that the stock market will perform so well in the future. Siegel himself recently projected only a 6% average real return for US stocks over the next four decades. Others have lower expectations.

I have been conducting surveys of US investors under the auspices of the Yale School of Management, asking what percentage change they expect for the Dow Jones Industrial Average. The expected one-year increase in the Dow in 2005 averages 4.8% for institutional investors and 4.3% for individual investors.